Sumner and His Market Monetarists Compared to Mish, Libertarians and Keynesians

 This article was first published by me on Talkmarkets: 

Scott Sumner and his market monetarist buddies have made a name for themselves. All the way back to articles on Business Insider, mostly written by Joe Weisenthal, they have maintained that the Fed was too tight in late 2007, leading to the Great Recession. They say that the cause of the Great Recession was tight money, including Interest On Reserves, IOR paid to keep banks from lending.

Now, please note, they do not deny a housing recession. But they say what happened was much deeper than that. The argument is compelling. They are opposed by Keynesians, Mish Shedlock, and Mises (Austrian economists). Please bear with me as I attempt to sort this out for you.

This accusation of tightening on the part of the Fed has become a hot economic topic because of  Ted Cruz's comments about the Fed showing a disposition to tighten prior to the deep crash in 2008. Mises would not accept this and says that blowing the bubble in the first place was the real evil of the Fed.

That has some truth to it as well, because many, including myself, believe that the Fed did misprice risk of the faulty MBSs in order to allow them to be used as collateral in the money markets. They broke one money market and were exposed after that. Confidence in the markets was damaged by the bubble and crash of MBSs.

But Mises and the Austrians say that easy money was the fault, while the monetarists say tight money after the crash began was at fault. Sumner and his friends have an agenda to print more money, but some of what they say makes perfect sense. Benjamin Cole and all the market monetarists want money printing and Ben freely admits it. I am no fan of Ted Cruz, but could he be latching on to some valid arguments? (Austrians), and their buddies like Peter Schiff, want money tightening in place of printing.
What I think is that the Fed tightens when it should loosen and loosens when it should tighten. What works one time does not necessarily work another time. But that is a layman's opinion. I just think there is not enough flexibility in the system to do what needs to be done,when it needs to be done.

Now, I believe that Keynesians like Roger Farmer and non Keynesian Mish would say the tightening by the Fed was a result of the credit crisis, and that the credit crisis, not tight money, was the cause of massive layoffs. That isn't so far different than the Austrians.

There are compelling arguments on all sides. For example, the Keynesians would say that massive unemployment cannot be solved by monetarism. Roger Farmer calls for fiscal solutions. But Sumner would say, print money and unemployment will decline.

But the monetarists call for unlimited growth and think a bunch of easy money loans are just fine and won't cause a Great Depression if the Fed is there to keep NGDP on track. More on that later. But, they aren't good for the people who take out the loans and I oppose predatory loans. But are they good for the economy that is heading for deflation, negative interest rates, economic despair, and a cashless society? That is a tough question. 

I have written against the cashless society and demand deflation. Those aren't any good, but we could be headed to those results if we don't loosen up lending for productive gains. Giving a small stipend to each citizen may be the only real answer, but could big finance blow a worse bubble with all that money?

And what collateral would the Fed take in in order to print all that money? Would they be owning malls and power plants? Questions abound. And I think we have a bigger shortage of bonds than we do of money. 

You could say that there is truth to Sumner's position on the crash of the economy, as well. I observed and reported that watching LIBOR explode and doing nothing was clearly a tightening.  That happened in mid to late 2007. Add to this inaction, the implementation of IOR, and you can see it clearly was a tightening for a whole year. It was a result of the Fed's fear to act, but could it have been the cause of a deeper recession?

It is time that the Fed members be held responsible for their actions. After all, it does seem that paying interest on reserves in October, 2008, really hurt the economy. Maybe it saved the banks, and that is an argument to consider. But, saving the banks should be secondary to saving the economy.

I remember the late Bill Seidman going on CNBC every day saying that you just needed to put the banks into something like the Resolution Trust Corporation that he applied to the Savings and Loan crisis banks. Could Seidman have saved the economy and wound down the banks at the same time? He seemed to think it could be done, even with the mountain of derivatives that existed.

But the Fed exists to save the big banks no matter what happens to the economy. They proved it beyond a reasonable doubt.

This is my take, if you are going to try the Sumner experiment and print away, you have to do two things. You have to tie fixed income to whatever inflation results. Sumner doesn't believe in targeting inflation, but rather targeting Nominal Gross Domestic Product or NGDP. But that could result in inflation so you have to protect fixed income.

And you have to repeal recourse lending. You must allow non recourse loans only if you try Sumner's way. That way, if the house crashes, and you mail in the keys, you won't be liable for any other charges. And that could include HELOC  liability, which made even a non recourse loan into a recourse loan.
If society is not willing to do those things, then Scott should never have the opportunity to apply his experiment to the world economy.  Putting citizens through what they went through in the last Great Recession is simply unacceptable.

I know in my bones that Fed tightening contributed to the Great Recession, but I don't know if I could stomach the solutions of the market monetarists. And who could trust the Fed to have their backs?
I partly believe the market monetarists when they say raising interest rates is not tightening. Seems like the banks make more money on loans that have a higher interest rate, plus house prices are cheaper so it helps the consumer. But when the Fed raises the IOR along with raising interest rates, it could be another tightening.

Yes, big business and big banks benefited from low interest rates, and bought up many assets while improving balance sheets. But this has not helped the economy, because small business creates most of the jobs. The Fed has simply been a zero interest rate failure. It was OK for awhile, but failure is the massive amount of people not looking for work. Do not think that is success when big business has billions of dollars on their balance sheets.

I don't think a low interest rate regime of years was called for by Keynes himself. However, Keynes has said that people will borrow less if interest rates rise. While that seems logical and applies to big business, what really happens is that as interest rates rise, prices for things come down, and more importantly, banks are more willing to lend. At rock bottom interest rates, banks are afraid to lend. 

The market monetarists are onto something here. But as we can see, the macro battles wage on. For example, while there is a shortage of bonds, there certainly is enough money at the top. There is not enough money at the bottom.

The answers on how to solve the dilemma require honest people putting a damper on greed long enough to establish a greater good. Certainly, we have been disappointed by the Austrian economists' invisible hand of self interest, since all we got from that was bank deregulation and massive housing speculation and closed access cities with all the high paying jobs.

Market monetarists and the Austrians agree that bank deregulation was no big deal. They are wrong about that, in my opinion, because speculation drove up the price of houses in certain markets, causing the crash in house prices. When they all say that the house bubble would have been a run of the mill recession but for Fed tightening, things get murky. Certainly, the Fed did nothing while LIBOR exploded. And they did nothing for the year after that.

But the Austrians and market monetarists must realize that the Fed cares about the banks and not about the society, if it has to choose. And it did have to choose, or at least thought it had to in the Great Recession.

So, as long as the Fed has interests opposite the Austrians and market monetarists, deregulating the banks only plays into the hands of the Fed, and does not give the Austrians and market monetarists what they want, lending into society, private stimulation of the real economy. Both camps simply trust banks too much.

The market monetarist supply side increases of production morph into supply side increases in unproductive lending for speculation, the way the system is devised now.

Yet the Keynesians have been wrong too, trying to stimulate a banking system that would rather speculate and take IOR than take an active role in helping society. Keynes' ideas worked in the Great Depression because there were rules in place to stop speculation. Perhaps that should be the first rule applied before any economic theory is applied going forward.

After all, people hoard if they don't trust that the financial system is fair.


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