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Steve Forbes explains how the Fed is hurting the economy

26605966702_8ff6d85eda_qBy Steve Forbes


THE RECURRING FOCUS on whether the Federal Reserve will raise interest rates raises a question no one thinks to ask: Should the Fed–or any other central bank, for that matter–be in the business of manipulating interest rates in the first place?

The answer is no.

History shows that since Roman times–and even before–price controls don’t work. They deform markets, doing far more harm than good. President Richard Nixon imposed them in the early 1970s, and the result was disastrous, especially in the energy field. When Ronald Reagan, soon after taking office, removed oil-and-gas caps, the price of oil plummeted and the gas lines disappeared. Time and time again we’ve seen the baleful impact that rent controls have on the creation of new, affordable housing.

Setting interest rates is no different. They are the price that lenders pay borrowers for money. The question is, how much damage will the central bank’s machinations wreak on the economy?

That question has become especially acute since the economic crisis of 2008-09, when the Fed went from suppressing short-term rates to suppressing long-term rates as well. The Bank of Japan (BOJ) has been playing this game since the 1990s. Today the BOJ and the European Central Bank (ECB) have gone to negative interest rates on bonds. The impact of all this has been horrible. The manipulation of interest rates, combined with the excessive regulation of banks, has caused bank lending to small and new businesses to wither. Startups, essential to job creation and innovation, are a fraction of what they should be. Working capital to finance inventories has become less available and, contrary to the Fed’s motives, more expensive. Ditto the money for expansions. Remember, bonds are instruments for large, established businesses, not for the everyday enterprises and startups that are crucial to a well-functioning and expanding economy.

Whether it fully appreciates it or not, the Federal Reserve has gone into the business of credit allocation. Uncle Sam and large corporations find credit all too easy and cheap to obtain, while the rest of the economy suffers. Apple AAPL +0.70% has cash and financial instruments totaling more than $230 billion, yet it has been issuing tens of billions of dollars in bonds to engage in financial engineering, namely buying its own stock and raising its dividend. Earlier this year Exxon Mobil sold $12 billion in bonds for buybacks, and other companies have done the same for the purpose of purchasing their own equity. And why not, when money is at virtually giveaway prices?

Noted economist David Malpass, a fierce and longtime critic of what the Fed and other central banks have been doing, has pointed out that the proportion of bonds to the U.S. economy’s total credit has surged from 39% a decade ago to 53% today. Manifestly, this isn’t healthy, as the global economic situation testifies. The reliance on central banks to gin up growth has allowed governments to avoid making badly needed structural changes, such as cutting tax rates, reducing bloated public sectors, liberalizing antigrowth labor laws and easing suffocating regulations.

Economists will cry that interest rates are different, that manipulating the price of lending money is essential to guiding the economy. Nonsense. Since when has such central planning ever worked? Economies aren’t like an automobile whose speed can be regulated by an accelerator. By such logic the Fed should have the power to decree price reductions for everything: Cut all prices by 50%, and watch the economy boom as people are thereby stimulated to buy more stuff!

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