The Federal Reserve Debt Engine

Federal Reserve Chairman Alan Greenspan testifies for both US House and Senate committees several times each year, and last week appeared before the Joint Economic committee on which I serve.  These appearances by Mr. Greenspan always cause quite a stir on Capitol Hill.  Often the stock markets react within hours of his pronouncements regarding the health of the economy and the future of interest rates.

Congress and the financial press treat Mr. Greenspan as an all-knowing sage, seeking his wisdom on political and even social issues that have nothing to do with monetary policy.  During last week’s hearing Mr. Greenspan was asked his opinion on topics such as Social Security, tax cuts, federal spending, corporate accounting rules, the congressional budget process, and even immigration.  It seems bizarre that a credulous Congress and public are willing to accept the judgment of on unelected, virtually unaccountable central banker while knowing little or nothing about the Federal Reserve itself.

Judging by Mr. Greenspan’s statements to a Senate committee in February, Fed economists are confusing debt with wealth.  Mr. Greenspan praises the “sustained expansion of the US economy,” but then goes on to highlight the real reason for the expansion: loose monetary policy and near-zero interest rates.  Since Fed bankers set interest rates artificially low, the cost of borrowing money is very cheap.  This leads to more and more consumer spending, which Mr. Greenspan touts as the driving force for economic growth. 

In fact, he expressly cites the benefits of increased household spending made possible by mortgage refinancing.  But new debt is not wealth, and it’s impossible to borrow one’s way into prosperity.  Mortgage debt increased 13% last year, while consumer credit debt also increased.  American households unquestionably have more debt and save less than ever before.  Yet we are expected to believe that more spending and more debt are the keys to economic prosperity.

During past recessions, many Americans shed debt either through bankruptcy or through austerity measures.  In other words, they either changed their spending and borrowing habits or went broke.  At some point their debts were in essence cleared from the books.  In the recent recession of 2000-2002, however, many cash-strapped households managed to stay ahead of creditors by borrowing even more money.  This is directly attributable to Fed easy-money policies, which greatly expanded the money supply and caused banks to lower creditworthiness standards.  As a result, many Americans are overextended rather than bankrupt.  Someday, however, they simply won’t be able to borrow another dime.  All the Fed has done is make the bubble bigger and postpone the day of reckoning.  This hardly makes for a strong economy, which must be based on savings and investment.

It’s not enough to question the wisdom of Mr. Greenspan.  Americans should question why we have a central bank at all, and whose interests it serves.  The laws of supply and demand work better than any central banker to determine both the correct supply of money in the economy and the interest rate at which capital is available- without the political favoritism and secrecy that characterize central banks. Americans should not tolerate the manipulation of our economy and the inflation of our currency by an unaccountable institution.