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Federal Reserve Should Do Less, Not More: Morici

Monday, 4 Feb 2013 | 11:48 AM ET
Hisham Ibrahim | Photodisc | Getty Images

It's time for the Federal Reserve to do less to prop up the recovery and jobs creation.

The economy suffers from too little demand—simply, the huge trade deficit with China and on oil sends too many consumer dollars abroad that don't return to buy U.S. exports, goods and services.

(Read More: Buy Banks, Despite Fed's 'Crippling' Low Rates: Bove)

During the Bush years, Americans artificially boosted demand by spending more than they earned, borrowing recklessly against their homes, on credit cards and for college educations that proved poor investments. Ultimately, failing loans sank financial markets.

Meanwhile, other problems festered—health care costs and university tuition rocketed, longer life expectancies undermined Social Security, and states borrowed too much.

When the President campaigned in 2008, he promised to get tough with China on trade and produce more oil. He has done little about the former, and in the wake of the Deepwater Horizon disaster, he punished an entire industry for British Petroleum's sins by curbing drilling offshore and in Alaska.

He dramatically increased federal spending on entitlements, made student loans even more accessible, and eschewed the recommendations of the Simpson-Bowles Commission to raise the retirement age.

With federal deficits exceeding $1 trillion for five years, Mr. Obama faces the same skeptical bond rating agencies that downgraded European government debt.

The Congress shares blame—unwilling to address honestly trade, energy, health care, and education.

The Federal Reserve became an enabler of Presidential and Congressional inaction by keeping interest rates artificially low for five years, and now by printing money to buy U.S. bonds and mortgage backed securities at a $1 trillion annual pace.

Record low interest rates are propping up weak consumer demand but sowing the seeds of another financial crisis.

(Read More: No Risk of Higher Interest Rates This Year: Pro)

Easy money is again pushing to unsustainable levels prices for real estate in prime urban areas and boom towns, agricultural land and the bonds of weaker corporations. And cheap borrowing rates help banks push student debt over $1 trillion, even though one in six loans is in default, and permit California, Illinois and other states to avoid reforming pension systems and issue debt they never will repay.

Inevitably, all that money will push up inflation, and then the Fed will be compelled to stop buying bonds and let interest rates rise to levels the federal and state governments can't bear easily.

(Read More: Fed to Trigger 'Collateral Financial Damage': Lavorgnia)

The federal and state governments will be forced into draconian spending cuts in the manner of an Italy or Spain, corporations and state governments will default on many of their lower grade securities, and higher mortgage rates will drive down real estate and agricultural land values, creating a new round of mortgage defaults. Former students overburdened with debt won't be able to manage daily living expenses, and simply will default.

Financial markets will collapse, again!

This calamity will be worse than the last, because much of the middle class's residual wealth—retirement and savings accounts and other assets—will be dissipated and federal spending will be contracting not expanding.

By late spring, the Congress and President will likely raise taxes or cut spending without addressing the fundamental structural problems bedeviling the economy.

That could easily instigate another recession, and the Fed will be pressured to enable more Congressional procrastination on structural issues, and President Obama will set his sights on replacing Ben Bernanke with an even more compliant Fed Chairman.

It might be better to take a second recession now than face the kind of calamity in real estate and financial markets that is brewing, and for the Fed to resist calls to do more.

That would require a lot of courage from Ben Bernanke. If he doesn't try to avert another immediate recession the President and Congress seem bent on instigating, he will be vilified.

Yet, sooner rather than later, Mr. Bernanke must speak truth to facts, or leave his successor an even bigger pending crisis than he managed.

(Read More: Global Economy Living Off Fed's Gravy Train)

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and a widely published columnist. You can follow him on Twitter @PMorici1

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