Cover Story

The house that Ben built

"The house that Ben built" Continued...

Issue: "Moneymaker," March 23, 2013

Robert L. Pollock, writing in The Wall Street Journal, places blame both for the slow recovery and the massive growth in U.S. debt in the past four years directly at Bernanke’s feet. He said that “to the extent that the United States finds itself in a precarious financial situation, Bernanke shares much of the blame. Simply put, there is no way Washington could have run the deficits it has in recent years without the active assistance of a near-zero interest rate policy.”

Conservatives deride the practice as “printing money,” saying the inevitable consequence is inflation, possibly hyperinflation. Japan resorted to quantitative easing in the early 2000s to prevent deflation in that country. Economists say it worked at preventing deflation, but it doomed the Japanese economy to more than a decade of stagnation. 

That Bernanke would follow this path is no great surprise. In 2002, when Bush appointed him to the Fed, the U.S. economy struggled under the twin blows of the technology bust of 2000 and the aftermath of 9/11, in 2001. Inflation, which had been falling since 1990, was near zero—below zero according to some models. Deflation seemed a real possibility. In 2002 Bernanke gave a speech to the National Economists Club in Washington that laid out what has come to be called the Bernanke Doctrine: “Sustained deflation can be highly destructive to a modern economy and should be strongly resisted.” 

Bernanke continued on the Fed until 2005, when he resigned to serve a short stint as chairman of Bush’s Council of Economic Advisers. It was a post many thought was an audition for the Fed chairmanship. Conservatives took comfort in Bernanke’s open appreciation of Milton Friedman, the 20th century’s leading conservative economist. Friedman advocated free markets, minimal government intervention, and “monetarism,” the small, steady, incremental expansion of the money supply. Friedman stood against the dominant Keynesian orthodoxy, which advocated a much larger role for the government.

But a growing number of conservative economists say Bernanke has left Friedman behind, and it was his 2002 Bernanke Doctrine speech that should have been the first clue. 

“He is not a monetarist,” said Jeff Herbener, a professor of economics at Grove City College. “His views have become decidedly more Keynesian, and his policies are counter-productive.”

Herbener believes that Bernanke has not only failed to help the country’s economic situation, he has made it worse by keeping interest rates low and increasing the money supply dramatically—not incrementally, as Friedman advocated—in order to buy assets. Artificially low rates reduce the incentive of young families to save and squeeze the interest income of retirees. They also create an incentive to borrow more than is prudent. That ease of borrowing is the main reason the housing market overheated in 2008.

Not only does Bernanke’s strategy of increasing money supply—“printing money”—increase the likelihood of inflation, it has also dramatically increased the amount of monetary assets under government control. “The state is an inefficient allocator of resources,” Herbener said. “The best economic policies reduce the amount of resources in the command of the state.”  

Bernanke’s current quantitative easing plans will add $1 trillion per year to the amount of assets under government control, bringing the total to $5 trillion by the end of 2014. 

In early 2008, the government had only about $1 trillion in assets on its balance sheet. By buying up assets and bailing out the companies who own non-performing assets, the Fed has disrupted the economy’s natural cleansing process, Herbener said. “Market economies are excellent at displacing bad entrepreneurs with good entrepreneurs. The good assets of bad entrepreneurs get reallocated by natural market mechanisms to good entrepreneurs,” he said. “One of the reasons the recession was as long as it was and the recovery has been so slow is that the government has interrupted that process.” Bailouts and buy-backs allow good assets to remain in the hands of bad entrepreneurs. The result is that these assets fail to reach their full productive potential.

But what about the argument that the situation was so dire in 2008 that without an immediate and massive government intervention, the economy would have fallen into not just the Great Recession but a second Great Depression? Herbener doesn’t buy it. “Just screaming ‘fire’ and running for the exits is not an argument. The burden of proof is on those who make those claims,” he said. “And so far they have failed to make the case.” 

Herbener says Bernanke and the Fed should have let the global markets, not the U.S. government, provide liquidity and solve the crisis. The U.S. government is big, but Herbener says “the world markets are huge by comparison. It is simply implausible that the world markets would not have done a better job of responding to the financial crisis, of providing liquidity and re-allocating assets, than the U.S. government did.” 

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