Top Central Bankers Gather in Jackson Hole, Wyo.: Why This Is Bad News

Steve ForbesForbes Staff

FIFTY YEARS AGO novelist Katherine Porter wrote the bestselling Ship of Fools. That would be an apt description of the annual gathering of central bankers from around the world, now underway in Jackson Hole, Wyo.—one of the most beautiful places on Earth—instead of on an ocean-going vessel.

These money pooh-bahs are an unhappy lot: Economies just about everywhere are performing in a sub-par fashion. China’s bank-lending plummeted in July, a sign things are cooling off as the mini government stimulus program winds down. Japan is in recession. Germany is stalling, and Italy and much of Europe are contracting or about to do so. The U.S. is doing better but is still moving at a fraction of its potential pace; incomes for most people remain stagnant, this in the sixth year of an alleged recovery.

What to do? “Central bankers [are in] an awkward position,” reports the Wall Street Journal. “Many worry the low interest rates they’re employing to encourage borrowing and spur growth could spark a new financial bubble. In places such as London and Vancouver, real-estate prices have soared, and Fed[eral Reserve] officials are uncomfortably watching a boom in U.S. leveraged-loan issuance and junk bonds.”

The sad, unsettling fact is that central bankers are a major part of the problem rather than the solution. These supposed exemplars of the best and the brightest know less about monetary policy than their forebears did more than a century ago.

The blunt truth is that an active monetary policy has never, ever led to sound, sustainable growth. Without exception it has always done more harm than good, the only variable being the degree of damage rendered. When a central bank does something right, it is to undo previous errors. A classic example was in the early 1980s, when Federal Reserve Chairman Paul Volcker broke the back of the terrible inflation that had beset the nation since the late 1960s, an affliction caused by the Fed’s previous ultra-loose monetary policies.

It’s truly amazing that economists and policymakers remain obliviously impervious to the mountains of evidence proving that you cannot constructively guide an economy by manipulating interest rates and bank reserves. They are also blind to the fact that their activities were the principal cause of the financial crisis of 2008–09 and remain an immense barrier to achieving healthy prosperity.

Here are some of the key areas in which these central bankers are clueless.

• The role of money. Classical economists, who dominated economic thinking from the time of Adam Smith in the 18th century to the rise of John Maynard Keynes in the 1930s, recognized that the production of goods and services were the “real” economy and that money was the “symbol” of the economy. Keynes defiantly reversed that order: Money controls economic activity; the supply of money and the cost of borrowing it—interest rates—determine the level of economic growth. Entrepreneurs, business owners, executives and investors are mere cogs, responding to the dictates of monetary and fiscal policies.

This is like saying that the production of coat checks determines the number of coats and jackets that will be checked at restaurants. Worse, the arbitrary activities of central bankers distort and damage the marketplace.

Look at the 1970s, when the Federal Reserve repeatedly weakened the dollar to stimulate the economy. Oil prices soared from $3 a barrel to almost $40. The price of farmland zoomed, as did those of agricultural commodities, such as corn, wheat, soybeans and sugar. When money has a stable value—as it does under a gold standard—prices convey critical information about supply and demand. Unstable money is like a virus in a computer, and information conveyed by prices is corrupted. The rapid rise in oil prices during the 1970s seemed to mean that oil was in high demand, that, indeed, we were running out of the stuff. After the terrible inflation was brought to an end in the early 1980s, the price of petroleum crashed to a low of $10 before stabilizing in the $20-to-$25 range. We saw a similar process with other commodities.

In the early part of the last decade housing experienced a false boom that ended in a spectacular crash. The price of oil is still in the stratosphere, as is the price of farmland.

• What money is. Money reflects marketplace activity. It’s a claim on products and services produced by people. It facilitates transactions, billions of them every day. Without these transactions we couldn’t achieve a higher standard of living.

Money isn’t wealth. It measures wealth the way a ruler measures length, a clock measures time and a scale measures weight.

Because money is a claim on products and services, counterfeiting it is rightly considered theft. Yet when the Federal Reserve, the European Central Bank or any other similar institution attempts to conjure money out of thin air, the act is called “stimulus” or “quantitative easing.”

• Commerce does not cause inflation or deflation. Bad central banking does. Inflation is caused when a central bank undermines the value of its currency by creating too much of it; deflation, when a central bank creates an artificial shortage of its money, as Japan has periodically done over the past 20 years.

Nonetheless, the worthies now cavorting in Jackson Hole, particularly Janet Yellen, still prattle on about how inflation is necessary to get their economies moving again. During her Senate confirmation hearing late last year to succeed Ben Bernanke as Fed head, Yellen openly proclaimed her belief that 2% inflation is just what the doctor ordered for our ailing economy. No senator asked her to explain just how raising the cost of living for a typical American family by $1,000 a year is supposed to create prosperity.

Inflation actually retards long-term growth. Had the U.S. maintained its average historic growth rate that it experienced for 180 years under the gold standard (it went off gold in 1971), the American economy today would be 50% larger, i.e., more than $8 trillion bigger.

That’s a staggering, sobering statistic.

• Manipulating interest rates is like controlling prices—it doesn’t work. Interest rates are the price we pay to borrow money. Suppressing them, as the Fed and other similar institutions are doing, has damaged credit markets. In the U.S. it has reduced the availability of credit to new and small businesses, just as rent controls reduce the availability of affordable housing. Markets should set prices for products and services, including loans.

• Central banks have only two legitimate tasks: preserving stable values for their money and dealing quickly, decisively with financial panics. A gold standard keeps currency values stable better than any other system—and certainly better than the arbitrary whims of today’s central bankers.

As for panics like those of 1907 and 2008, the Bank of England in 1866 showed how they should be dealt with: A central bank should, until the crisis abates, be ready to lend temporarily and without limit at an above-market interest rate to a sound financial institution putting up good collateral.

• Monetary policy can’t cure an economy’s structural flaws. Excessive taxation, which is the reality of all too many countries today, will hinder commerce no matter how much money a central bank prints. Ditto suffocating regulations and labor laws.

Alas, these realities about money and monetary policy won’t make a dent on those currently gathered in Jackson Hole. But the winds of change are beginning to blow. One example: Paul Volcker, who led the Fed from 1979–87, recently declared that what is happening now is unacceptable, that we must consider doing things differently.

One good way to get the great debate rolling would be for Congress to pass a bill proposed by Representative Kevin Brady (R–Tex.). It calls for a commission to examine thoroughly and dispassionately the whole area of monetary policy and to make recommendations of where we should go from here.

(See Steve Forbes’ new book, Money: How the Destruction of the Dollar Threatens the Global Economy—And What We Can Do About It.)