The approximate hour Janet Yellen spent wandering in circles and spewing double talk during her presser yesterday was time well spent. When the painful ordeal of her semi-coherent babbling was finally over, she had essentially proved that the Fed is attempting an impossible task.
And better still, that the FOMC should be abolished.
The alternative is real simple. It’s called price discovery on the free market; it’s the essence of capitalism.
After all, the hot shot traders who operate in the canyons of Wall Street could readily balance the market for overnight funds. They would do so by varying the discount rate.
That is, they would push the rate upwards when funds were short, thereby calling-in liquidity from other markets and discouraging demand, especially from carry trade speculators. By contrast, when surplus funds got piled too high, they would push the discount rate downward, thereby discouraging supply and inciting demand.
Under such a free market regime, the discount rate might well be highly mobile, moving from 1% to 10% and back to 1%, for example, as markets cleared in response to changing short-term balances. So what?
Likewise, the world is full of long-term savers like pension funds, insurance companies, bond funds and direct household investors on the supply side, and a long parade of sovereign, corporate and household borrowers on the demand side.
Through an endless process of auction, arbitrage and allocation, the yield curve would find its proper shape and levels. And like in the case of a free market in money, the yield curve of the debt market would undulate, twist, turn and otherwise morph in response to changing factors with respect to supply of savings and demands for debt.
It goes without saying that under such a regime, savers would be rewarded with high rates when demands for business investment, household borrowings and government debt issuance were large. At the same time, financial punters, business speculators, household high-livers and deficit-spending politicians alike would find their enthusiasm severely dented by high and rising yields when the supply of savings was short.
What would be the harm, it must be asked, in letting economic agents in their tens of millions bid for savings in order to find the right price of debt capital at any given time as opposed to concentrating the task on 12 people who, as Janet Yellen admitted yesterday, can’t possibly figure it out, anyway?
There are three reasons given as to why capitalism’s monumental and crucial tasks of setting the price of money and debt cannot be trusted to the free market. But all of them are wrong; all of them are a variation of the giant Keynesian error that capitalism self-destructively tends toward entropy absent the ministrations of the state, and especially its central banking branch.
The three cardinal errors of which we speak are the claim that 1) debt is the keystone to prosperity, 2) the business cycle is inherently unstable and bleeds the economy of growth and wealth and 3) active central bank intervention is needed to stop bank runs and financial crises from spiraling into catastrophe.