“It’s now official. The proposed legislation to reform America’s financial service supervision includes granting the Secretary of the Treasury a veto over Section 13(3) emergency action by the Federal Reserve Board of Governors. If this becomes law, it will be a sad day for the independence of America’s central bank.
The Secretary of the Treasury, a very senior cabinet position, is appointed by the President and meets with the President in the Oval Office weekly. The governors of the Federal Reserve Board are also appointed by the President. Both cabinet officers and Federal Reserve governors are confirmed by the US Senate. There are supposed to be seven governors; politics has purposefully limited this to five throughout the three-year financial crisis period.
The Federal Reserve governors are supposed to serve staggered 14-year terms with all seven seats filled. Instead, we have been governed by the present five member politically configured board.
The original seven governor construction was designed to insulate them from political pressure for very good reasons. Decades of monetary history throughout the world have disclosed what happens when political influence on a central bank intensifies. The Weimar Republic and Zimbabwe are evidence of the worst inflationary effects of politics. The Great Depression in the US and the nearly two decade deflationary recession in Japan demonstrate that monetary policy is not only inflation-prone. When central banks are under political influence you can get fire or you can get ice.
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History shows that, over time, politics tends to favor easier monetary policy and lower interest rates than would otherwise be required. Thus inflation-prone tendencies are more likely to be the outcome of political intervention in monetary affairs of the US.
In the US we are experimenting with a massive issuance of federal debt. We now measure that additional debt in the trillions each and every year. And we are now trying to intensify and formalize the political intervention into the governing body responsible for the value of the US dollar. At the same time, this legislative initiative concentrates unprecedented power in the executive branch and in the hands of the Secretary of the Treasury.
If this becomes law, will global financial markets reprice the US currency to reflect this new asymmetrical policy threat? Will this risk premium result in higher interest rates, where deregulated markets can set them? Will there be a currency crisis? Will politics that create class warfare with “too big to fail” also, by implication, create an under class of “too small to survive?” “
David Kotok, “Fed Independence: R.I.P.?”, Cumberland Advisors Market Commentary (23 October 2009).
http://www.cumber.com/commentary.aspx?file=102909b.asp
David Kotok is Chairman and Chief Investment Officer of Cumberland Advisors, a money management firm headquartered in New Jersey.
The Federal Reserve System is the organization charged with the responsibility to set U.S. monetary policy. This is a task of great importance for the economy and the prosperity of the country. Given its critical important, it is also one of the few functions of government (another being the judiciary) where an effort has been made to isolate it from the vagaries of popular opinion and political control. This is the reason Fed Governors have such long tenure and their deliberations are withheld from immediate release.
The decisions of the Fed have tremendous immediate and long-term consequences for the economy. The Federal Open Market Committee of the Fed has been given the arbitrary power to determine the monetary stock of the country and short-term interest rates, which have great influence over long-term rates. It does this by buying and selling Treasury securities, which puts cash into the economy when it purchases securities or removes cash from the economy when it sells securities. Buying securities and putting cash into the economy lowers interest rates by increasing the price of the securities, and hence lowering their yield. Interest rates can be raised in a reverse operation, when securities are sold and their price falls, hence raising their yield. Long-term rates tend to follow the course of short-term rates. Taken together, lowering and raising the constellation of interest rates has an enormous effect on the prospects for economic activity, employment and inflation.
Pumping too much money into the economy spurs domestic economic activity and inflation. Not enough money depresses commerce and employment and tends to bring down inflationary pressures.
In the case of the United States, the actions of the FOMC spill over into the international economy and literally affect the external balance and money supplies of all countries, in some countries more than the actions of their own central banks. The value of the dollar on foreign exchange markets and hence the economic fate of all industries, both here and abroad, are greatly affected by Fed decisions.
The ability of central banks to affect the state of the economy is a great political temptation. For this reason, an effort is made in almost all countries to keep central banks politically independent. Nowhere is the central bank truly independent and in too many countries its independence is totally compromised. But it is equally true to say that the more the central bank is subject to political control the greater are the problems of the economy, both in terms of inflation and financial crises and in terms of deflation and recession. Moreover, keeping monetary policy decisions independent of political interference is consistent with the principle of separation of powers, and any loss of independence by the Fed should be seen as portending political as well as economic problems.
The U.S. has been slowly marching down the road to greater involvement by the political authorities in the setting of monetary policy. Last year at the urging of the Treasury the Fed relied on its rarely used legal authority to lend to “any individual, partnership or corporation” in “unusual and exigent circumstance” to prop up financial institutions. It has refused to provide details about many of the actions it has taken, including the financial institutions it has helped and the amount of help provided. This is not good.
It would appear that the U.S. is now going to go further and explicitly inject politics into the broad setting of U.S. monetary policy. Let me suggest that this is dangerous and a development to be watched closely in the months and years ahead.
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