In less than three months recently (from August 30 to November 19), the Federal Reserve System increased bank reserves in U.S. banks to more than $650 billion from under $50 billion. To remark that this was both a large and an unprecedented action would be an understatement. Since banks are permitted to lend a multiple of such reserves, it is possible that some day the U.S. money supply will begin to skyrocket amidst a new lending boom. Mr. Bernanke may now longingly dream of that day when he can become the stern central banker who must "take away the punch bowl" while at the same time receiving accolades for having "saved the economy." Between now and then, however, American businesses must overcome the mountain of fear that they have come to know during this past year. Unless their fear is overcome, banks won't lend, and worthy business borrowers won't seek loans. Money supply growth will be stunted, at best, and GDP will continue to languish or fall as it faces the headwind of a drop in the velocity of spending.
What are businesses afraid of? Perhaps they suspect that asset values may continue to drop a lot more or for a longer time than experts predict. This scenario implies a difficult period of indeterminate length for businesses -- i.e., employers -- and for stock and credit markets. The medicine for this? -- to make sure nothing prolongs the agony, that is, to let the free market work.
But a look at certain facts implies there is more to fear than just adapting to lower asset values.
Fact # 1: The Federal government and the Federal Reserve appear determined to use all their power to prevent the downward adjustment of asset values, that is, to prevent price changes that must take place prior to recovery. For example, to the extent they are successful in propping up or, God forbid, reestablishing status quo ante housing prices, real estate markets could be frozen indefinitely. Many buyers, certainly, might avoid the housing market for this reason and any other market they saw as artificially propped up by government. A new round in the effort to prop up the real estate market began Tuesday with the Fed's promise to "provide support." Fact # 2: The "rescue" program of the Bush (and, prospectively, the Obama) administrations consists in an expansion of the public sector at the expense of the private sector. Allegedly, some of this program (the "bailouts") is to be temporary and will be reversed when recovery comes. Yet, even temporary public sector expansion suppresses the forces for recovery-including both the confidence of the un-bailed-out businesses and their financial means of survival.
Fact # 3: The Federal government and the Federal Reserve have not admitted their roles in producing the economic crisis, much less the implications of such an admission. The theory of Congress and the bureaucracy, it appears, is that "the free market" was to blame for the crisis and that the existing vast reach of business regulation must therefore be increased. This will not encourage recovery. It merely frightens businesses and investors-again, read employers if you are concerned with the unemployment rate. Then there is the Federal government's impressive avoidance of admitting blame for having encouraged the sub-prime mortgage fiasco and the real estate boom in general. But the most amazing evasion of responsibility, surely, is that of the Federal Reserve System, whose provision of the necessary and sufficient conditions for the asset bubble will be studied for decades. The academic debate may eventually be: Was it Fed policy of the last few years only which caused it, or the many decades of easy money that never once allowed the money and credit system to regain a sound footing?
The Fed's attempt to reinflate the economy may "succeed," i.e., it may overwhelm fear with a new round of delusion by providing us with a fresh array of high asset valuations. If it does, we can then wonder about the next frightening downward adjustment. Or perhaps we are now beginning a prolonged economic depression, like the last one impervious to "pragmatic" governmental "stimulus"-macabre government-orchestrated parodies of free market activity. Either way, American business may be forgiven for thinking the inmates are still fully in charge of the asylum. This could be the real fear.
Mikiel de Bary is a freelance observer of macroeconomics in contemporary society.
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