Today's WSJ Op-ed on the Fed
Jude Wanniski
May 8, 2001


Todd G. Buchholz of Victoria Capital LLC, writing on the editorial page of today's WSJ "The Fed Won't Allow a Deja-Vu Recession" manages to get almost everything wrong, and let the Greenspan Fed off the hook for the current dysfunctions in the economy. This op-ed represents a continuing campaign at the WSJ to dismiss our longstanding warnings of deflation. Here are a few points we took issue with in the piece.

1. Bucholz states that Federal Reserve Chairman Alan Greenspan won't make the same mistake he made in 1989-90 -- hiking rates too high and then waiting too long to cut them "even as Treasury Secretary Nicholas Brady pounded on the desk demanding an increase in the money supply" -- which produced the Bush recession. First, the 1991 recession resulted from the Bush tax hike and the disturbances in the energy market following the Gulf War. At the time, the Greenspan Fed was trying to mop up the excess liquidity that resulted from the ill-conceived Bush deficit reduction tax hike package. The fact that then Treasury Nicholas Brady was "pounding the table for easier money" when inflation expectations were on the rise only inserted additional risk into the credit markets which added a "Brady premium" to bond yields and forced Greenspan to stay tighter longer. Bucholz mentions none of this, but it was an important factor which made the recession -- and Greenspan's job -- more difficult than would have been the case had Brady kept his mouth shut.

2. Bucholz belittles those who think lower Fed rates will be impotent and brushes aside mounting layoffs, rising unemployment and deteriorating manufacturing on the notion that "the consumer is still shopping" and the consumer "will save us from a plunge into a recession." Bucholz fails to take into account that investment and production lead consumption, which spells worse times ahead for consumers since business fixed investment and capital spending have taken it on the chin. He then states that a big bounce back in the auto industry and good data from the housing sector will add markedly to GDP. This flatly contradicts yesterday's report from UBS Paine Webber that showed its "meter reading" on sales volume relative to incentives offered by the auto industry to push cars has worsened again, the inference being "that business performance in the auto industry has worsened again... Conditions look grim, with assemblers vulnerable to a profit squeeze. A turnaround is not expected in light of our outlook that calls for falling sales volume throughout this year and into next."

3. We are then asked to believe that double digit growth in the Ms is evidence that the Fed is not "strangling the economy." As we pointed out last Friday, the pickup in the Ms has nothing to do with "easy" money since market based indicators of liquidity demand continue to show that the supply of money is outpacing the demand for it -- deflation. Bucholz doesn't concern himself with spot commodity prices and currency exchange rates that point to insufficient liquidity, only the Ms which support his point that Fed policy is accommodative. The velocity of "money" always rises in an inflation and falls in a deflation, remaining constant only when the money is fixed to gold. Money is "easy" only when there is more of it than financial intermediaries desire.

4. The sub-head of the Buchholz op-ed is: "Fed-mockers shout that lower interest rates aren't powerful enough to pull the country out of recession. But then they said rising rates wouldn't cause a slowdown either." This is a straw man. Rate hikes do slow the economy, especially when you see the yield curve inverting, which shows they are Fed errors. Rate cuts then help the economy, as the yield curve comes out of inversion as it now has. We believe they do little or nothing to resolve the deflation, though, which is primarily a problem of debtor/creditor relationships that are resolved by declines in nominal prices and wages, at least on average.