Former Federal Reserve Chairman William McChesney Martin joked that it was his job to “take away the punch bowl just as the party gets going.” But Alan Greenspan never did, choosing instead to spike it every time the party slowed down. The results were more than a little unfortunate.
Now, faced with years of economic stagnation, most economists conclude interest rates will stay low indefinitely. The Fed is doing little to disabuse them, though an opinion article from Fed Governor Kevin Warsh in today’s Wall Street Journal tries to warn us not to get complacent.
Warsh says, a bit technically: “‘Whatever it takes’… cannot be an asymmetric mantra, trotted out only during times of deep economic and financial distress, and discarded when the cycle turns.” In other words, if the Fed only intervenes during downturns, it risks its credibility as protector of the dollar.
But talk is cheap. Not since Paul Volcker raised rates significantly in the early 1980s has the Fed done anything substantial to fight the forces of irrational exuberance. The Fed won’t reestablish its bona fides until it puts the economy through pain.
With a “recovery” under way, the printing press running on high to support the housing market and $850 billion of excess reserves just waiting to spark inflation, the Fed’s credibility is, well, strained to say the least.
So Warsh goes a bit further: “Policy likely will need to begin normalization before it is obvious that is necessary, possibly with greater force than is customary …”
Dollar bears like me like the sound of “greater force than is customary,” but we don’t believe the Fed would actually use it.
Why should we? Earlier this week, the central bank put out another wishy-washy policy statement that says it will hold interest rates low “for an extended period,” while gradually weaning the economy from the support of the printing press.
That will only encourage investors to take on risks that will tie the Fed’s hands later on.
To avoid a return to that status quo, we need more than tough talk. We need a fire drill — a quick, small rate increase that no one is expecting.
Always telegraphing your moves months in advance is what breeds complacency. Investors make stupid mistakes and the Fed is left to pick up the pieces, putting the dollar at risk.
So, Kevin, if you’re worried about investor complacency, give us a rate increase when we least expect it. Perhaps next week?