That’s the theme of Dan Henniger’s piece today in the WSJ. Angela Merkel, you’ll recall, has been loudly criticizing the Fed for ‘quantitative easing’ of the money supply as well as for wading into the political arena in its quest to buy up Treasuries, Agencies and really smelly corporate bonds. Merkel is advocating a ‘hard money’ position quite at variance with most politicians who like easy money, deficit spending and inflationary policies.
Remember that the Fed was created to be (1) non-political and (2) control monetary policy. This latter bit means simply that the Fed is charged with regulating the money supply to provide adequate liquidity while controlling inflation. It shouldn’t be wading into purely fiscal policy – that is, how much money should the government borrow and spend – which is the province of politics.
But when the Fed grotesquely inflates the money supply and begins buying up treasury debt, then it’s wandering far afield. More to the point, Fed policy is supposed to create stability and confidence – not scare the crap out of people. And that’s precisely what the Fed is doing when it purchases the Federal debt.
As Henniger points out, Merkel may be channeling postwar German politicians whose hard money policies – a reaction to Wiemar – propelled Germany into prosperity in the 1950s and 1960s. But she sees what all of us see:
[T]the world is wondering when the Fed will start to remove the flood of money it has injected into the economy during the crisis. Mr. Bernanke says not to worry, as his mentor Alan Greenspan also did yesterday. But this is cold comfort given their earlier track record. The Fed’s habit is to look at backward indicators, such as the cost-of-living index and the jobless rate, rather than at currency and commodity prices that can warn of asset bubbles and inflation ahead. This is precisely the mistake both men made in 2003, as the recently released Fed transcripts from that year illustrate. The warning that Mrs. Merkel — and China and the financial markets — is sounding is whether the Fed will have the political courage to start removing that liquidity even if the unemployment rate is high, and before it creates another mess.
Bear in mind that when the Fed becomes political, it usually takes a political fight to draw back. The last time the Fed purchased US debt was World War II and the immediate postwar years. Drawing back from politics has always been difficult, as Truman appointee William McChesney Martin, Jr. found after his 1951 Senate confirmation. Truman expected Martin to be his creature and the Fed to continue the inflationary policies of prior years. Martin didn’t oblige and pursued tighter money through four administrations. Somehow, I don’t think we’ll see Bernanke channeling the great Martin anytime soon.
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