Fed Critics Run Risk Their Attacks Will Backfire

Bigamy, grave robbing and passing false checks are pretty much the only crimes that Ben Bernanke and the Federal Reserve have not been accused of in the past few weeks.

United States Federal Reserve
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United States Federal Reserve

Since the US central bank launched its $600 billion round of asset purchases at the start of November, its critics have not hesitated to accuse it of recklessness, incompetence and conspiracy to devalue the dollar, often in vitriolic terms.

Wolfgang Schäuble, the German finance minister, called the Fed “clueless” and accused it of steering “the dollar exchange rate artificially lower”. Republicans in Congress decried a Fed policy that, through some voodoo, they think will not only fail to stimulate the economy but will also create inflation.

Last week’s Fed “data dump” – revealing details of 21,000 transactions with banks during the financial crisis from 2007-2009 – has prompted accusations that the Fed bailed out foreigners or lent against dodgy collateral.

There are legitimate criticisms of the Fed, but many of these attacks could be turned back on the attackers.

Start with the dollar. All else being equal, some fall in the exchange rate is the inevitable consequence of the easing of monetary policy, always and everywhere.

Yet since the start of November the euro has depreciated by about 5 percent against the dollar, prompted in large part by Germany’s insistence on talking about future mechanisms to restructure eurozone sovereign debt in the middle of a eurozone sovereign debt crisis.

Then there is the political criticism that the Fed’s asset purchases will lead to runaway inflation. Central bank purchases of government bonds can do this – but only in cases when politicians run a persistent fiscal deficit and then force the central bank to finance it.

“The Federal Reserve hasn’t gotten the message. Printing money is no substitute for sound fiscal policy,” said Mike Pence, a leading Republican in the House of Representatives, last month.

Quite right, the Fed might say, now how about that sound fiscal policy? Even as members of Congress attack the Fed, they are moving towards an extension of Bush-era tax cuts on all income levels that will add about $3.7 trillion to the deficit if continued over the next 10 years.

The official deficit commission run by Erskine Bowles and Alan Simpson came up with a plan that, like it or not, would deal with the deficit. It did not win sufficient bipartisan support. Congress is adding more than its share to long-term inflation risks in the US.

Finally, consider the fallout from the Fed’s data release last week. “After years of stonewalling by the Fed, the American people are finally learning the incredible and jaw-dropping details of the Fed’s multi-trillion-dollar bail-out of Wall Street and corporate America,” said Bernie Sanders, an independent senator from Vermont.

Two of the biggest criticisms are that the Fed lent against the questionable collateral of low-rated debt and that much of its help went to foreign banks. There is no doubt that the Fed took risks.

If Congress had not come through with the $700 billion troubled asset relief program then the results for the central bank would have been unpleasant.

But the point of the Fed’s lending was to provide liquidity to markets that had frozen up. It could not have done this if it had only been willing to lend against Treasury bonds, which were almost the only asset that remained liquid throughout the crisis without Fed help.

Heavy use of Fed facilities by foreign banks reflects the global role of the dollar and the intense demand for US currency during the crisis. Denying liquidity to overseas central banks and to the New York branches of foreign banks would have been a quick way to end that global role. It might also have forced foreigners to default on their obligations to American banks.

At least the Fed’s rescue worked: it was paid back in full, with interest, on all its emergency loans and prevented a devastating financial collapse. Would that Ireland– where bank losses have overwhelmed the government’s finances – could say the same.