Politics: Friendly note from George Shultz and friends: Things are much worse than you think

Published by: Dan Calabrese on Monday September 17th, 2012

Dan Calabrese

By DAN CALABRESE - Let's put it this way: We're screwed.

It's nothing you didn't know, or at least I'm sure you knew a lot of it, but see it laid out this comprehensively is almost too much to bear when you gulp and understand: This is our reality.

It's really something, though, when you understand how the Fed is circumventing what should be a free-flowing, decentralized financial system:

The Fed has effectively replaced the entire interbank money market and large segments of other markets with itself. It determines the interest rate by declaring what it will pay on reserve balances at the Fed without regard for the supply and demand of money. By replacing large decentralized markets with centralized control by a few government officials, the Fed is distorting incentives and interfering with price discovery with unintended economic consequences.

Did you know that the Federal Reserve is now giving money to banks, effectively circumventing the appropriations process? To pay for quantitative easing—the purchase of government debt, mortgage-backed securities, etc.—the Fed credits banks with electronic deposits that are reserve balances at the Federal Reserve. These reserve balances have exploded to $1.5 trillion from $8 billion in September 2008.

The Fed now pays 0.25% interest on reserves it holds. So the Fed is paying the banks almost $4 billion a year. If interest rates rise to 2%, and the Federal Reserve raises the rate it pays on reserves correspondingly, the payment rises to $30 billion a year. Would Congress appropriate that kind of money to give—not lend—to banks?

The Fed's policy of keeping interest rates so low for so long means that the real rate (after accounting for inflation) is negative, thereby cutting significantly the real income of those who have saved for retirement over their lifetime.

Clearly, the machinations required to paper over a deficit this large involve more than just cranking up the printing presses. The Fed is manipulating interest rates, manipulating the capitalization of banks, and in many ways usurping the appropriations role that constitutionally is supposed to belong solely to the Congress.

Not that any result would justify this, but just for fun, let's ask: What kind of result are they getting?

Come to think of it, this exercise is not much fun at all, is it? This is the real magnitude of the mess we're in. The good news, as the writers explain at the end, is that it's still possible to fix the problem:

The fixes are blindingly obvious. Economic theory, empirical studies and historical experience teach that the solutions are the lowest possible tax rates on the broadest base, sufficient to fund the necessary functions of government on balance over the business cycle; sound monetary policy; trade liberalization; spending control and entitlement reform; and regulatory, litigation and education reform.

So the voters just need to elect people who will do that stuff. Sounds easy enough. You on that, voters?