Growth At All Cost – A Faustian Bargain

Here is an introduction to my coming report on a Federal Reserve Bank’s overreaching.
I wrote it last summer, but it seems even more relevant today.

Wednesday June 16, 2010.

America is unique.

It is the only country in the world that goes full speed in one direction, turns on a dime and then goes unapologetically in the exact opposite direction with the exact same conviction.

I learned this decades ago from Roland Leuschel, the flamboyant global strategist at BBL.

This amused the German-born Roland.

Although he also understood that this was often America’s strength.

The upside of this flexibility is that we, in America, do not get stuck in a rut for very long.

If something does not work, we change it.

Unfortunately, sometimes we also change things that work perfectly well.

But change we do.

When I came to this country, the government was not the solution.

We made fun of the French nationalizations.

Yet, today we renamed it too-big-to fail and implement it at a rate that would make Mitterand envious.

Even one of the most laissez-faire administrations, when confronted with the possibility of a recession, did not hesitate much to bail out banks, AIG and the major car companies.

A recession had to be avoided.

At all cost.

This, at least, has been a constant in recent US policies.

And it has pushed us into a Faustian Bargain:

Our soul for a few more quarters of growth.

To avoid the dreaded recession, we gave up free markets, fiscal restraint and monetary discipline.

One can argue about the many motivations for this abjuration.

Fear of a nineteenthirties-style depression, the ultra short political cycles, the low tolerance for pain among the baby boomers all played a role.

But most of all, the main culprit is the Fed’s dual manadate of low unemployment and low inflation.

This is like having our cake and eating it.

Unfortunately “to promote effectively the goals of maximum employment” as well as “stable prices and moderate long-term interest rates” can at times be contradictory.

How can one continuously promote growth AND keep inflation under control?

Greenspan, to his credit, did just that.

But his actions also sowed the seeds of asset and credit bubbles of unimaginable proportion.

The Fed’s response?

Well, Ben Bernanke decided to double down.

As we are now entering the second phase (dixit Soros) of the crisis, the Federal Reserve system will come under severe pressure.

Giving the best and the brightest unelected Maestros too much unchecked power was a mistake in the first place.

Asking them to perform uninterupted miracles was pushing it.

Inevitably the cruxification has to come.

I actually believe it is on its way.

We have entered the post-Fed era.

By that I mean the era when the Fed was the solution to everything and its octogenarian chairman a rockstar.

The end result is anybody’s guess, but already Ron Paul is no longer ridiculed.

I doubt we will go back to Jacksonian policies of no public debt and the abolition of the central bank.

A return to gold standard does not seem in the cards either.

Rather, a scaled-down Federal Reserve Bank could be the answer.

One with only one mandate: keep inflation under control.

This may sound too German for anybody’s comfort.

But we can adopt what is working overseas without turning into a social-democracy.

The latter is very unlikely, anyway.

Germans, unlike Americans so far, are attached to their welfare system.

They have been ever since Bismarck introduced it in the 19th century and never wavevered.

Germans do not waver.

Even the conservative Chancelor Helmut Kohl was unmoved by Reaganomics.

He was also irritated by Bill Clinton’s lectures on the need for more labor flexibility at a G7 in Denver.

The toughest reforms came after him, implemented by the socialist Gerhard Schroders.

That’s because the Germans like their entitlements so much they make sure not to kill the goose that lays the golden eggs.

Then they distribute the egggs.

Call it Realsocialism.

There is no need to emulate them on everything.

But maybe we can learn from the ECB!

The Federal Reserve was, after all, the child of the 1907 run on the banks.

Its main raison d’etre at the time was to prevent such an event.

But, somehow, its mission has evolved into the guarantor of economic expansion.

This is unfortunately not possible.

Neither is it desirable.

Recessions, preferably short ones, play a role in capitalism.

Avoiding creative destruction is what socialism was made for, not the Fed.

Fighting these cycles is often a way of prolonging them.

Ask the Japanese.

At the end of the day, our reaction to the latest asset bubble burst is not very different from what the Japanese did two lost decades ago.

The only real difference is that we went all the way.

Shock and awe.

We threw all our chips on the table.

If it works, we’ll look brilliant.

If it does not work, our children will not be happy.

Sadly, we did not use the last crisis properly.

Instead of rethinking our economy thouroughly, we again kicked the can down the road.

The tyranny of short-termism is still with us.

It has not left our industry either.

Performance is still dominated by the surprise factor, not companies’ long term performance.

A 1998 McKinsey study is still valid today.

That study showed that share prices largely reflect differences between a company’s actual performance and the market’s expectations about it.

Not the company’s performance in itself.

While waiting for the necessary crisis, defensive stocks and gold stocks look good to me.

Shorting high beta stocks too.

After that we will go full speed in the right direction again.

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