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Politics and the Federal Reserve   November 15th, 2010
Republicans are late to the game, but at least they're IN the game now       

 
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Republican lawmakers are attacking the Federal Reserve's decision to print $600 billion (QE2) to finance government spending. Good! The Federal Reserve has been "political" at least since it started enabling the reckless spending of liberal Democrats and a political response is entirely appropriate.

The Federal Reserve's latest attempt to boost the U.S. economy is coming under fire from Republican economists and politicians, threatening to yank the central bank deeper into partisan politics.

A group of prominent Republican-leaning economists, coordinating with Republican lawmakers and political strategists, is launching a campaign this week calling on Fed Chairman Ben Bernanke to drop his plan to buy $600 billion in additional U.S. Treasury bonds.


The Federal Reserve is autonomous, in theory, to keep it from being subject to political pressure. The thought behind this autonomy is that, left to their own devices, politicians will not have the political will to engage in sound spending--so giving them the power to control the printing press would be extremely dangerous and risk currency debasement.

The reality, though, is that the Federal Reserve has been a willing accomplice of the Obama Administration. The Obama Administration wants to spend more money than the world will loan us, so the Federal Reserve is printing money to make up the difference.

Obama's spending plans and increasing federal debt would be dead in the water if the Federal Reserve had not capitulated to Obama last year. So obvious was the Fed's capitulation and submission to political pressure last year that the Federal Reserve felt the need to reaffirm its independence with a public statement.

Had the Federal Reserve refused to print money last year, Obama would not have been able to do nearly as much deficit spending. The lack of printed money would have meant there would have been less demand for government bonds, bond prices would have gone down, and interest rates would have gone up commensurate with the amount of borrowing. The higher interest rates and weaker demand for government bonds would have constrained the spending of the federal government far beyond the $300 billion that the Federal Reserve provided.

Now, with QE2, the $600 billion that is being printed (plus the $300 billion in reinvested returns) is providing the vast majority of financing for this year's federal deficit. Were it not for the Federal Reserve, the federal government would have to immediately reduce spending quite substantially--most likely by more than a trillion dollars. A back of the envelope calculation suggests that would amount to 25% spending cuts.

This would certainly be painful medicine. But we're not going to be able to fix our national debt without some pain. We're going to have withdrawal symptoms just like a drug user that's getting his life in order. But the first step (beyond admitting you have a problem) is to stop paying visits to the drug dealer that is selling you the drugs. In the case of the United States, the drug dealer is the Federal Reserve.

QE1 was bad. QE2 is worse, because it is convincing the world we're not serious about maintaining the value of our dollar nor serious about addressing our deficit, and it's creating the distinct impression that our economy is circling the drain. Not only that, QE2 is going to lead to an eventual QE3 which will most likely be the final nail in the coffin of the dollar. And one of our most valuable national assets--and one of our key advantages over other countries--is our dollar, and its status as the primary global reserve currency.

Obama's reckless deficit spending is not worth gambling the future of the dollar.

So I'm very happy to see prominent Republicans--such as Rep. Paul Ryan and Sarah Palin--publicly calling the Federal Reserve on this bad policy. Great work!

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