One day your friend comes up to you. He is in a parlous state. He has lost all his money on failed investments. He owes so much money that some of his belongings have been repossessed already.
You shake your head at his story but you can't help but feel as though your friend is entirely to blame for his situation. You knew the warning signs were there and you're miffed at the fact that the ten thousand dollars he owes you may never come back.
You also know what he should do. He should cut his spending and live more frugally. He should divert most if not all of his remaining income into paying off his debt. You know that this process will be hard for him, but before you can say anything he asks you: "So, are you going to lend me money to cover my costs? Come ON man!".
What would you do?
By the time you read this, Ben Bernanke may have publicly announced a cut in official interest rates. To me, this is the complete opposite of what should happen. If you haven't worked out my anecdote already, the spendthrift friend is the market, who is reeling from the Subprime meltdown. You, of course, represent the Federal Reserve bank.
I'm a great believer that economics is actually simpler than what most folks think. I believe that the anecdote I have shared is true both in its micro and macro form - the best way to make people treat their money properly is by treating it seriously. This is as true for the poverty-stricken underemployed worker in Michigan as it is for the Wall Street stockbrokers who command eight figure salaries.
To cut interest rates would, in this case, be the same as lending your spendthrift and near-bankrupt friend more money. The Subprime meltdown, which is likely to plunge America and much of the world into recession, is a result of market failure. Easy money and easy credit have distorted the market's ability to spend and invest wisely.
But the market is, of course, demanding that Bernanke cut rates. "Come ON man!" they are saying to him "we'll be ruined if you don't cough up!".
It seems to me that the market's argument is that the cause of the problem is its solution. If easy money and easy credit have caused the market to go haywire, then the solution is more easy money and more easy credit. To me, this makes as much sense as a heroin addict arguing that the best way for him to get off drugs is to have another hit of heroin.
But in the anecdote you have the chance to say to your friend "No! I am not going to help you in this. The best thing for you to do is stop spending like it is going out of style and to stop investing money in crazy things! You have to cut your spending and live frugally until you pay off your debts!".
If Bernanke and the Federal Reserve wish to act in the best interests of America and make the best decision then they will decide to, at the very least, keep rates where they are. This may not be popular, but it will be the right thing to do. The market needs to learn restraint and the best way to do it at the moment is through frugality and austerity.
Bernanke has two choices: He can be a Greenspan or he can be a Volcker. If he chooses to be another Alan Greenspan he will cut rates, bask in the glory of sharemarket highs and then, in his retirement, be reviled for being part of America's poverty. If he chooses to be a Paul Volcker he will, like Volcker did in 1980-81, refuse to blink as he acted for the good of America's economy. Volcker's actions were instrumental in bringing about a protracted recession, but were also responsible for bringing about sanity into the world economy for some years afterwards.
If Bernanke wants to be as courageous as Volcker then he will keep rates as they are or even raise them. By doing this he will, no doubt, help bring about a global downturn over the next 18 months... but at least he would have done the right thing and helped bring America's (and the world's) economy back into balance.
Bernanke gave a 50 basis point blink.
© 2007 Neil McKenzie Cameron, http://one-salient-oversight.blogspot.com/
FAQ about the author
This work is licensed under a
Creative Commons Attribution 3.0 License.