Why the Fed Should Boost Interest Rates

If the Fed wants to boost economic activity, it should think about raising the federal funds target rate. Why? Wouldn't that restrict lending? Paradoxically, it would likely increase lending.

This would force banks to engage in more lending in order to make a profit. Currently, banks can make money doing virtually nothing, as they borrow money from the Fed at zero percent interest and use that money to buy government bonds yielding 2-3%. This blog makes the same point. If banks can make a profit without risk -- because government bonds carry no risk -- then why lend at risk? But if the Fed raises its rates, then this margin will shrink and banks will be forced to engage in riskier activity, such as lending to business and consumers. Perhaps then, as the big banks move away from risk aversion, interbank rates would drop, facilitating borrowing across the board.

The argument is that raising rates will plunge the economy into a depression. With bonds trading at yields of less than 2%, bond markets, it is said, are signalling that inflation is dead. But is this not to reverse the actual situation? Are bonds not trading at this low a level because the baseline rate is zero? Raise the rate, and these short-term rates will also rise. This will simply have the effect of flattening the yield curve -- 30-year rates remain stubbornly above 3 1/2%. As long as the yield curve does not invert, is there a problem with that?

St. Louis Fed chairman Thomas Hoenig has been arguing for some time that the federal funds rate needs to be moved out of the zero percent range. His argument makes sense. The Fed can do more to boost economic activity than lower rates.

What is Common Law?

Common Law is a term I use as an umbrella concept, shorthand for a comprehensive world-view of limited sovereignty, restricted government, private law (property and contract), the self-reliant citizen, the market order not only of goods and services but of credit and debt and goodwill, of coordination of equals rather than command by superiors of inferiors. Another term for this is the rule of law. But because that latter term is fuzzy and not often filled in with concrete content, I resort to common law, which is the better term for that reality anyway.

But the term common law does generate some confusion. Usually when one hears it, one thinks of the historically determined Anglo-Saxon and cognate legal systems, with all of their peculiarities and practices, which only the practicing lawyer has occasion to master.

Indeed, this is a valid viewpoint. For one salient characteristic of true common law is that it develops practically through the process of adjudication, in the courtroom, through the dialectic of adversarial thesis and antithesis. Here, of course, lawyers rule the roost. But that does not mean that common law is not also something more than mere practitioners' fodder.

Hence, it cannot be that the practicing lawyer "owns" this system, and views any incursion by "laymen" to be illegitimate. But alas it is more often so than not. Yes, the guild mentality reigns here as everywhere else, despite the fact that in a democracy, the law ought to be a domain open to the citizen, accessible to his inquiry, amenable to his uses. Ah, for a return to the days of a truly liberal conception of citizenship, where the professional saw his task as aiding the gentleman citizen rather than lording it over the unclean and untutored! But that is a subject for another day.

We need the historically grown positive law, even for legal and political philosopy, even for economics, because without it we are all at sea. Which means that the practitioners of that law cannot withhold it as their own private domain. The law is of and for us all. And, to properly understand common law, one must understand the philosophy behind the very notion of a common law.

Very simply, common law is law which applies across the board in a given jurisdiction, applies to all equally. It is the uniform law of a sovereign polity. And, beyond this, it is the general equity behind all positive law. So it is both basic principles, and practical application thereof in a universal way. Opposed to this regime is the regime of privilege, where the rulers exercise their wills to impose commands or orders or distributions, rather than allowing matters to be arranged by free and equal individuals in the give-and-take of bargaining owners. The regime of privilege ruled the roost in pre-modern Europe, and has since taken up its positions in modern government, with its war against the rule of law in favor of favoritism, privilege, and interest-group-based politics.

To combat privilege we need to recover the concept of the common law. I hope to set up a web site soon dedicated specifically to exploring the common law paradigm. This will integrate the various books I've written, and will write, on the subject, as well as other work in the fields of law, politics, and economics, so as to see them in the light of this same paradigm.

Stay tuned.

The New Normal

Rush Limbaugh discussed the concept of the "New Normal" on his radio show yesterday. He was pretty much on target: the "New Normal" is considered by many to be some inevitability, for which the Obama government is not responsible. I discuss the concept at length in my upcoming book Common-Law Investing. What I try to make clear is that the "New Normal" is not anything inevitable but simply the result of overspending government, entitlement-mentality citizenry, and the dysfunctional dependency fostered between these two. And I make clear that there is an alternative, in terms of investment, to this "New Normal," and that is emerging-markets countries where this kind of dysfunctional politics has been abandoned in favor of market discipline. The "New Normal" is not inevitable but it certainly is a good possibility given the state of mind of First World citizenries these days. That's bad news, but the good news is that emerging markets offer an alternative to those who do not buy into it.

New Book: Common Law & Natural Rights

I haven't been posting much lately, and there's a reason. I've been busy writing a new book. And it's ready for the reading public. The title is Common Law & Natural Rights: The Question of Conservative Foundations, and it is an examination of natural rights as the foundation for conservatism, as opposed to the common law. It is the contention of the book that natural rights has served neither conservatism nor contemporary polities well. The reliance on natural rights and its daughter, the separation of powers, has led to overweening government, based on absolute democracy. The common law as a self-contained, independent bulwark of liberty is proposed as the alternative. For more information, follow this link.

Regarding the Stahl book on constitutional law, it is nearly finished. I hope to have it ready for publication within a month or two. Stay tuned.

Responses to the Geithner Plan...

are lukewarm at best. Today's Wall Street Journal op-ed ("The Geithner Asset Play") raises the appropriate objections. The goal of the plan, which is to rid banks' balance sheets of unmarketable assets, really is something that has to be done if credit relations are to be restored. But it seems that Geithner wishes to accomplish this, once again, on the backs of the taxpayer. Why not try something such as was suggested by Larry Kudlow (see my blog here), whereby mark-to-market accounting rules are eased -- something which will cost the taxpayer nothing. John Berlau notes that Geithner's plan mentions nothing about mark-to-market.

Furthermore, Paul Krugman's running commentary on the plan ("The Conscience of a Liberal") is well worth perusing, even if sprinkled -- liberally -- with really funky liberalism.

What the Fed is Up To

The recently announced Fed action has been characterized as a massive exercise in printing money, in "pumping liquidity". But such characterizations, once again, are misleading.

Take a Wall Street Journal article from March 19th, 2009, by John Hilsenrath. In "Fed in Bond-Buying Binge to Spur Growth" he wrote,

The Fed had already cut its benchmark interest-rate target to near zero. Unable to go lower, the central bank now is essentially printing money to raise the supply of credit and thus push down the longer-term rates paid by families and companies on mortgages and other key loans. The impact was immediately felt.

First, has the Fed been "printing money"? Let's look at a few graphs, downloaded from the Fed web site, to determine if that's the case.

First, the trend line of the amount of assets on the Fed's balance sheet:










This means that the Fed has done a lot of buying since mid-2008. How has it paid for this? By printing money? Let's look at the trend line of liabilities over the same period:




Here you can see that the amount of currency in circulating (money printed) is roughly stable, while the amount of deposits at depositary institutions has ballooned. The Fed, thus, bought up all those assets by crediting the accounts of depositary institutions (mainly banks).

What does this do? It enables these depositary institutions to lend. How much they are able to lend is a function of how much they have on account at the Fed. Those Fed deposits, plus their own cash on hand (vault cash), constitute what is known as the money base. The money base was fairly stable through mid-2008, and then went through the roof, from $800-plus billion to over $1.5 trillion in March 2009 (see the table here).

So the money base, and thus the amount available to lend (which, with our fractional reserve banking system, is a multiple of the money base), has nearly doubled.

But the money supply, actual money put into the economy, has not. Here are the figures for the broadest money supply counter (monetary aggregate), M2. In March 2007, M2 stood at $7.111 trillion. In February 2009, it came to $8.275 trillion, an increase of about 16%. Nearly all of that increase has occurred recently: the year-on-year gain (February 2008-February 2009) was 9.8%, the six-month gain was 15.3%, and the three-month gain was 15.2%. Still, the gain is not nearly what one would expect given a near-doubling of the money base.

The conclusion: the Fed hasn't been printing money, it has been expanding the money base and thus the amount banks can lend. But even in that case, the banks can't lend what people won't borrow. Given the none-too-precipitous increase in the money supply, it doesn't appear that borrowing has increased much even given the enormous increase in potential for lending (look here for confirmation).

It would seem to me that the Fed's purpose in buying up the more unorthodox assets, which underlies the big increase in assets on its balance sheet, is 1) to stabilize the mortgage market by buying up mortgage-backed assets from Fannie Mae et al., 2) to bring down long-term interest rates by buying up long-term Treasury bills.

Bringing down long-term rates is a new way for the Fed to operate. It apparently is working, or at least has a chance of working. By bringing down long-term rates the Fed hopes to spur investment (see Hilsenrath's article from March 20th, 2009, "Excess Capacity Keeps Heat on Fed").

The danger is, of course, that by engaging in all this spending it has provided way too much lending potential to banks which could lead to inflation. Hilsenrath's "Excess Capacity" article shows just how much the Fed is expanding the money base by doing this. But on the other hand, it can head off the danger of rampant inflation by raising interest rates, as well as by selling off those self-same assets.

So this is an area which bears watching but is not yet cause for alarm. The Obama government's fiscal policy (not to mention war on capitalism) is where one really needs to watch out.

And We Have a Winner

The solution to the toxic asset problem, and the credit crisis, may well be the one propounded by Holman W. Jenkins in his Wall Street Journal column of March 18 2009: "Needed: A Bailout That Doesn't Look Like One." The root of the crisis is bad assets (securitized subprime loans) on banks' balance sheets. Mr. Holman's column discusses how these assets can be most easily taken care of. It looks so easy that a child could do it. But there's the rub. It's too easy. After all, it would constitute the waste of the opportunity this "crisis" affords to Cloverfield government.

(Update March 20th: Larry Kudlow offers an alternative approach to solving the crisis. He may be right that no further action is required than the switch to cash-flow accounting from mark-to-market accounting, together with the normalized yield curve on short- and long-term loans. Who's to say? Not me.)