Tag: Federal Reserve’s 100th anniversary

JAMES GRANT & RICHARD SYLLA: THE GREAT FED DEBATE! – Transcript 12/20/2013 #1026

January 27, 2014

CONSUELO MACK: This week on WealthTrack as the Federal Reserve celebrates its 100th birthday, is it a cause for rejoicing or despair? Two financial historians, NYU’s Richard Sylla and Grant’s Interest Rate Observer’s James Grant debate the case for lighting candles or snuffing them out- next on Consuelo Mack WealthTrack.

Hello and welcome to this special edition of WealthTrack, I’m Consuelo Mack. What is the proper role of a central bank? Can any institution prevent or control the booms or busts that dynamic market-based economies produce? Can they control interest rates and inflation, or insure robust employment? Should they try to?

Those are questions being raised anew as the Federal Reserve officially marks its one hundredth anniversary. On December 23rd, 1913, President Woodrow Wilson signed the Federal Reserve Act into law. As the current Federal Reserve describes it: “the Federal Reserve Act stood as a classic example of compromise- a decentralized central bank that balanced the competing interests of private banks and populist sentiment.” That rivalry and tension between private financial interests and populist sentiment is alive and well today and has been with us since earliest days of the republic.

Prior to 1913, populist forces killed two attempts to establish a permanent central bank. The nation’s business was financed by state banks, but it was also disrupted by a series of financial crisis and bank runs. Financier and banker JP Morgan had to come to the rescue twice- first in the banking panic and depression of 1893 and again in the banking crisis of 1907.

Calls for reform of the banking system became widespread. It took years of debate before the Federal Reserve Act of 1913 was signed by President Wilson, creating a decentralized system of 12 reserve banks with branches around the country and independent decision-making powers.

It wasn’t until the 1920s that the buying and selling of Treasury securities was coordinated as a monetary tool to influence the availability of credit.  Even so, the new Federal Reserve system didn’t seem to have much effect on the market crash of 1929 or the Great Depression that followed. Thousands of banks and businesses failed and one in four Americans was out of work.

In response, President Franklin Delano Roosevelt’s New Deal brought big changes to the financial system and the Federal Reserve. One of the biggest, the Glass-Steagall Act of 1933 separated commercial banking and investment banking and gave the Fed authority to supervise multi-bank holding companies.

The Banking Act of 1935 changed the Fed’s structure by establishing the Federal Open Market Committee as a separate legal entity and removing the Treasury Secretary and the Comptroller of the Currency from the Fed’s governing board. But it wasn’t until the 1951 Treasury-Fed Accord that the Fed gained the independence to pursue monetary policy on its own.

Meanwhile the Fed’s duties continued to expand. The 1977 Community Reinvestment Act required the Fed to ensure banks lent to low and moderate-income individuals. And the Federal Reserve Act of 1977 codified the Fed’s dual mandate of stable prices and maximum employment.

The Fed has been widely blamed for the double-digit inflation of the 1970s. But starting in 1979, the new Fed Chairman, Paul Volcker, took on the role of the nation’s number one inflation fighter, hiking interest rates to restrict credit and cut off inflation. His painful, recession-inducing strategy succeeded in killing inflation. His successor, Alan Greenspan, continued to use monetary policy to “serve as a source of liquidity to support the economic and financial system” from the market crash of 1987, the bursting of the tech bubble and the terrorist attacks of 9/11.

But it wasn’t 9/11 that revolutionized the Fed’s role. It was the subprime mortgage bubble, which morphed into a global financial crisis in 2008. Under Fed Chairman Ben Bernanke, the Fed invoked emergency authority to launch a series of new programs and assistance packages to rescue global financial markets and economies. The Fed also slashed short term interest rates to record lows in 2008 and have kept them there ever since. Nearly four trillion dollars of stimulus later, the Fed continues its activist role. In the words of Ben Bernanke, the Fed has “come full circle back to the original goal of preventing financial panics.”

Should that be the Fed’s goal and can it really succeed in doing it? Joining us are two WealthTrack favorites, each a respected financial historian and author.

James Grant is the Editor of Grant’s Interest Rate Observer, a twice monthly, self-described “independent, value-oriented and contrary minded journal of the financial markets” that is considered to be a must read by many institutional investors. He is a vocal critic of current Fed policy.

Richard Sylla is the Henry Kaufman Professor of the History of Financial Institutions and Markets and Professor of Economics, Entrepreneurship, and Innovation at the New York University Stern School of Business.

I began the interview by asking them to go back to basics: what is the role of a central bank?

JAMES GRANT: Well, one might start with the role that was assigned in legislation 100 years ago. It was to lend against sound collateral. It was to create a market in commercial paper, meaning business loans. It was to furnish so-called elastic currency and it has to be a lender of last resort, and that was it. Oh, yes. They added “and for other purposes” and we have all too many of the other purposes, but my suggestion is the Fed think more about the roles for which it was created rather than the ones it has arrogated to itself.


DICK SYLLA: Since the 1970s, the Federal Reserve has had the obligation to stabilize the price level. That was there for a long time, but an added obligation was to generate high levels of employment, and so this is called the dual mandate. The Fed had a dual mandate. We talked for the last 30 years about the dual mandate of the Fed. The Dodd-Frank Act of 2010, I think, added another item. The Fed is not only supposed to stabilize the price level and give us the maximum amount of employment, but it’s also to foster financial stability. So the Fed now has those three things to do.

CONSUELO MACK: So my question, though, is what do you think the role should be?  We know there’s this long litany of ever-expansive roles that it has, so…

JAMES GRANT: Well, Dick has just told us what it can’t do.

CONSUELO MACK: …would you say that was one of the original goals?

DICK SYLLA: Yeah, I think traditionally a central bank was responsible for stable prices, and that happens to be what they might be pretty good at. Most economists, I’m one, think that the Federal Reserve actually has the power, the tools to stabilize the price level. There’s a lot of evidence in favor of that. It’s much less certain that they can do much to change the unemployment rate, reduce the unemployment rate.

JAMES GRANT: See, the Fed has got into its head that it can improve the future before it comes to pass. The Fed has morphed from central banking into kind of a seat of the pants central planning. It has these models don’t you know, very, very complex, a lot of differential equations. They don’t work, but they do give the Fed the seeming intellectual authority to do so many things that common sense would tell you that simply the Fed cannot do.

For example, the Fed now is in the business of manipulating the structure of interest rates. It is in the business of suppressing some interest rates, and new thing, it is in the business of talking up the stock market. In other words, Dick mentioned stabilizing prices. The Fed is manipulating prices, especially on Wall Street. It’s a very new thing.

CONSUELO MACK: Has it been an effective price stabilizer? And stabilizing prices I’m assuming means that they don’t go up or down too much.

DICK SYLLA: I would say in the long run the Fed has not really been all that effective, because the 20th century was a three percent inflation century. You know, there was some low inflation, some very high inflation, but you can compare it with the previous period of the 19th century when prices in 1914 were not very different from what they were in 1815 according to pricing. So the 19th century was a zero inflation century without the Federal Reserve. When the Fed came in, we had basically a three percent inflation trend ever since then, but I don’t think we can entirely blame that on the Fed. There was something called World War I. There was something called World War II, and…

CONSUELO MACK: The Korean War, The Great Society Program.

DICK SYLLA: Yeah, and if you look back at those periods, it turns out the Federal Reserve was sort of conscripted to be part of the government’s financing machine, and the Secretary of the Treasury told the Fed what to do. In World War I, it was to lend a lot of money to banks so they could buy first liberty bonds and then victory bonds.  In World War II, the Secretary of the Treasury commanded the Fed to keep the interest rates no higher than two and a half percent on long-term bonds and three eighths of one percent on a Treasury bill, and so the Fed was told what to do.  We did not have an independent central bank. So I’m saying there’s…

CONSUELO MACK: Until 1951. Right.

DICK SYLLA: 1951. Then the Fed was freed from the control of the Treasury but, of course, the worst inflation we had was from 1965 or ’66 through 1981, which ended up with double-digit inflation in ’79 to ’81, and the Fed had a lot to do with that inflation. It was using the wrong models. Jim talked about the Fed uses the wrong models. I think they were definitely using the wrong models in the 1970s. Then Paul Volcker came in. He knew what to do, and he’s become sort of an American hero since that time, and 30 years after he whipped inflation, now he has his Volcker Rule passed.

CONSUELO MACK: So Jim, would you give the Fed the role of stabilizing prices?  Is that a fair role to give?

JAMES GRANT: No, no. Prices ought to be determined, it seems to me, through what they call future price discovery; that is to say, the unplanned and unmanipulated dynamics of free people making choices in the marketplace. You know, the time of terrific technological progress one would expect the general price level to kind of dwindle, because every day lower and lower prices is how Wal-Mart’s made a pretty good business about that. Prices dwindled a percent or so a year, one and a half percent or so a year in the last quarter of the 19th century. People kind of liked that. They regarded it as a sign not of deflation but of progress.

Now we have a Fed that wants us to know that prices must not go down. Well, in order to assure the prices don’t go down, the Fed creates lots and lots of credit that creates lots and lots of distortions, some of which end up from time to time in crises. This price stability is a very glib thing to say. It sounds very, very… it sounds commonsensical off of the tongue but it is, in fact, not so.

CONSUELO MACK: So I guess the issue is, can any institution really in an economy such as ours and in a world that we live in which is so dynamic, really be chartered…?

JAMES GRANT: Well, no.  If it could, the Soviet Union would still be in business. The idea of the humble but wonderful institution of the price mechanism, the price system, is it is what makes free economies work. It’s how work is measured and how goods are allocated. It’s a pretty cool system, and the Fed without an explanation really why is interposing itself between that system and us.

CONSUELO MACK: If you talk to most people on Wall Street and in the country, they feel that without the Fed, we would have had financial Armageddon. So Dick, I mean, does the Fed have a role in what Bernanke is saying, is to prevent financial panics?

DICK SYLLA: Well, Jim mentioned that one of the obligations of the Fed traditionally… and this is not just the Fed but central banking history going back to an Englishman named Bagehot, I would even say back to Alexander Hamilton… the central bank should come to the aid of the market in a crisis. Crisis is typically when almost nobody wants to lend to anyone else, so a central bank, when nobody wants to lend to anyone else, the central bank is supposed to keep lending on good collateral at a high rate of interest. You know, recently the Fed lent on dodgy collateral at a low rate of interest, so that’s a corollary I guess to the old rule.

JAMES GRANT: Also to solvent institutions.

DICK SYLLA: To solvent institutions, right.

JAMES GRANT: Violated their own…

DICK SYLLA: …but if you bring in collateral, whether you’re solvent or not, at least the Fed … if the collateral is good, then you can make the loan. So I think the Fed, you know, I think we do need it. Most people say we need a central bank to act as a lender of last resort. That’s the term, end of crisis.

CONSUELO MACK: So would you give the central bank that, Jim, that we do need a central bank that is the lender of last resort?

JAMES GRANT: We don’t need one. We can have one that will do less harm if it sticks to that kind of business, but the trouble is the Fed- this is a trend that’s been in operation over the decades- the Fed has presided over the decay of finance, and it has presided over the degradation of the dollar. By decay of…

CONSUELO MACK: And how so?

JAMES GRANT: By decay of finance, I mean by the integrity of private financial institutions. An example, before 1935, say, the stockholders of a bank were responsible for the solvency of that institution. If the capital was impaired, if the bank went broke, the courts came after the stockholders for a capital call to restore the bank to working order. Now we have, of course, the FDIC. We have the socialization of credit. We have the sidewalk superintending of almost every detail of our financial lives, but notice that in 2008 almost every major financial institution, certainly in the city of New York, was functionally insolvent. Now, how did that happen?

I submit to you that finance and central banking are different than almost any other set of phenomena in modern life. Most things we see progress. We see cars work better. We don’t shave with a cutthroat razor anymore. We don’t use sextants at sea. Progress. Right? In banking, what we see is the cyclical insolvency, virtual or actual, of things like Citicorp. Right? We see retrogression in finance rather than progress, and I say that the retrogression can be laid at the feet of the Fed and of the regime behind it.

CONSUELO MACK: But how so? I mean, why is the Fed to blame basically for the problems that the banking industry had?

JAMES GRANT: Well, the Fed is the creation of a system of paper money and of socialized and subsidized credit. Now, Dick mentioned that the Fed was dragooned into financing the First and Second World War. Nobody ever quits from the Fed in protest or the outrage of being seconded or being dragooned by the government. Right? They just go along with it. Let the record show that Dick is laughing sympathetically at this.

CONSUELO MACK: So is the Fed responsible do you think, as Jim says it is, for the degradation of our currency, for the problems that we have with the mismanagement of the financial institutions and basically for the financial crisis? Was it a contributing factor to this global financial crisis that we’ve just experienced?

DICK SYLLA: Well, I think it was a contributing factor. I wouldn’t be quite so…

CONSUELO MACK: And how did it contribute, Dick? What’s your take on the problems that the Fed has created?

DICK SYLLA: Look over the economic financial history of the last 10 to 15 years. You know, we had a late 1990s dot-com bubble which sort of burst in 2000, and by 2001 the U.S. economy emerged into a recession. The Federal Reserve then pushed interest rates to very low levels and held them there for a couple of years, and that’s when the housing bubble began.

CONSUELO MACK: Right, and this was under Alan Greenspan.

DICK SYLLA: It was under Alan Greenspan, but Ben Bernanke was on the Federal Reserve Board then, and so we got this housing bubble going, and I think the problem isn’t the Fed’s monetary policy so much as its regulatory policy. I mean, it was not… the Fed is one of our regulators. Maybe one of our problems is we have too many regulators. We have the Commodity Futures Trading Commission, the FDIC …

JAMES GRANT: Six of them.

DICK SYLLA: … the Comptroller of the Currency, the Federal Reserve, and they sometimes…

CONSUELO MACK: And they’re all doing different things and ..


JAMES GRANT: Or worse, the same thing.

DICK SYLLA: Or maybe somebody thinks, well, you know, this other person will regulate. This other agency will regulate, so I don’t have to, but in the end maybe none of them regulate as much as they should.

JAMES GRANT: But the city of London flourished for decades and decades without a bank failure and without a regulator. I mean, you can walk into Goldman Sachs and look around, and you’re never sure if the person you’re looking at, except by, I don’t know, maybe the color of his socks or something, is a federal employee or one of the paid help. These regulators swarm over these institutions, and still there’s “too big to fail” anxieties.  These anxieties are well founded. These institutions are leveraged, and they operate under the supposition that the government will be there in time of stress. So the apparently innocuous and indeed necessary idea of lender of last resort I say has become distorted such that the government is now guaranteeing underwriting risk that individuals ought to be bearing for themselves.

CONSUELO MACK: So another interesting development is that when the Fed in the Community Reinvestment Act, for instance, was given the job of making sure that banks lent more to low-income individuals and low-income communities, I mean, again it just seems that… but this is Congress, Dick. Right? The Fed’s roles are ever expanding. It’s given more and more oversight to do more and more, I mean, political things, in fact.

DICK SYLLA: Yes, well, we have to remember that the Federal Reserve is a creature of Congress. Congress created the Federal Reserve. Congress oversees the Federal Reserve. Congress asked the Federal Reserve to do all these things such as the Community Reinvestment Act. You know, you go out and make sure that banks lend to people who aren’t such good risks.

JAMES GRANT: You know, Consuelo, what…

CONSUELO MACK: So it’s not the Fed’s fault, Jim. It’s Congress’ fault. Right?

JAMES GRANT: Congress ought to pay more attention to its, as Dick said, creature. We have not really talked about the nature of the dollar of which the Fed is a steward. The dollar from Alexander Hamilton’s time until about Richard Nixon’s time was to find as a weight of something, that something being gold …


JAMES GRANT: … mostly something silver, sometimes both. Since 1971, the dollar has been kind of faith-based. It has been a piece of paper. It’s been a concept to a degree, and now increasingly it is pixels, computer pixels. The Fed materializes these on computer screens, but in the absence of a definition of the dollar, the Fed can create as many of these things as it deems expedient, and its definition of expediency comes from its mathematical models which I attempted to lampoon into, smirk at earlier in the session.

CONSUELO MACK: But can you lay the blame for going off the gold standard at the Fed’s feet?

JAMES GRANT: No, no. The Fed was the agent of this, but still, we can still hate it for other reasons, Consuelo.

CONSUELO MACK: So if you had your druthers, Jim Grant, and you were in charge of Congress…

JAMES GRANT: Now we’re talking.

CONSUELO MACK: Yeah, so now we’re talking. So what would you do with the Fed?

JAMES GRANT: Well, I would recall the founding legislation. I would go back to that.  I’d read the founding legislation and let us reinvent this institution.

CONSUELO MACK: You mean the 1913 Federal Reserve Act? You wouldn’t go back to Alexander Hamilton and…

JAMES GRANT: I would at least go back to the founding legislation and ask whether we have made progress over these past 100 years. Now, every institution must adapt. Right? The United States Navy has missiles that John Paul Jones did not anticipate. The difference with money is that it is not physics. Right? Money is about human behavior, and we have let the would-be physicists, namely these mathematical economists, into running this institution behind their formula, behind their models, and Congress has let this happen. Congress ought to take this institution by the scruff of its neck and ask it, “What for Pete’s sake are you doing?” You materialize $2 trillion in the past like six or eight weeks. Are we sure that’s what we ought to be doing? You’re doing $85 billion a month, and the financial markets shudder at the prospect of them doing $84.5 billion a month. Is this the right way forward? At least let us ask some common sense questions.

CONSUELO MACK: Dick, what would you do if you were in charge of Congress?

JAMES GRANT: I’m in charge of Congress.

CONSUELO MACK: I just reappointed.

DICK SYLLA: I know that if Ron Paul had become President, Jim Grant was going to be his candidate to be head of the Federal Reserve.

CONSUELO MACK: So I understand, unbeknownst to Jim, he found that out later that he was going to be the Fed Chairman under Ron Paul.

JAMES GRANT: Well, it apparently didn’t happen.

CONSUELO MACK: No, I guess it didn’t.

DICK SYLLA: I think the Fed, you know, it defines price stability as the consumer price index basically.

CONSUELO MACK: Which gets changed all the time.

DICK SYLLA: It gets changes all the time, and there hasn’t been a whole lot of inflation in the consumer price index in recent years. The Fed, by what it’s trying to do, it could say that it did a very good job, but Jim mentioned there are some other prices in the economy, like Wall Street’s prices, like the stock market and interest rates. The Fed seems to have, I think almost deliberately trying to push the stock market up. I mean, I’ve watched this stuff for 40, 50 years now, and this is the first time in my memory when it seemed to be official U.S. government policy that the stock market goes up, and the Fed likes this because it thinks that when the stock market goes up, people who own stocks feel richer. They’ll go out and spend more money, and the unemployment rate will come down.

JAMES GRANT: The portfolio of balance channel, I think, Dick, is the phrase you’re looking for.

DICK SYLLA: That’s right.

CONSUELO MACK: Well, so a former Fed official said that he calls quantitative easing the biggest backdoor bailout of Wall Street of all time. Would you agree with that?

DICK SYLLA: Well, there’s some truth in it, because whenever last…

CONSUELO MACK: You don’t agree.

JAMES GRANT: It’s front door.

CONSUELO MACK: We’re going to have to leave it there, but thank you so much and, if I had the power, I would appoint both of you, a committee to be in charge of Congress to redefine and perhaps recharter the Fed but, Dick Sylla, it’s so great to have you here from NYU Stern School of Business and Jim Grant from Grant’s Interest Rate Observer. Thanks so much for joining us.

JAMES GRANT: Thank you, Consuelo.


CONSUELO MACK: At the close of every WealthTrack, we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: Whether you agree with them or not, pay attention to what the Federal Reserve is saying.

Ever since 1978, when the Humphrey-Hawkins Act required the Chairman of the Fed to testify in front of Congress twice a year about its objectives and plans for monetary policy, the Fed has become increasingly more forthcoming. The Bernanke Fed has made a point of being more transparent as has Fed Chair nominee Janet Yellen. The Fed is arguably the world’s most powerful financial institution. It influences the economy and it moves markets. Understanding their thinking has never been easier. Just go to their website, federalreserve.gov and click on News & Events for their latest meeting minutes and commentary.

I hope you can join us next week. We will sit down for a rare interview with Great Investor Brian Rogers, long time portfolio manager of the T. Rowe Price Equity Income Fund, a consistent Morningstar favorite. In the meantime, to see more WealthTrack interviews and previous programs, just go to our website, wealthtrack.com. And for those of you on Facebook and Twitter, we look forward to connecting with you. In the meantime, have a Merry Christmas and make the week ahead a joyous, profitable and productive one.


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