Reverse The Fed’s Monetary Practices

Original Article at Forbes.com.

 

As a believer in the free enterprise system, I believe the best thing the federal government can do to spark our economic recovery is to create a favorable climate for small-business owners to expand and create jobs. Such a climate must include a lower tax burden, reasonable regulations, less public borrowing, open markets and a sound currency. For the past year and a half, the Obama administration has followed the opposite policies–going on a tax, spend and borrow binge of historic proportions–and the results, including the loss of three million private sector jobs, have been tragic.

But while the failure of President Obama's fiscal policies are evident and well-known, less attention has been paid to the failure of the Federal Reserve's monetary policies–specifically, its easy money program that enables the administration's spend-and-borrow addiction. I believe reversing the Fed's policy is essential to getting our economy back on track.

Since 2008 the Fed has kept short-term interest rates at nearly 0% and bought about $1.4 trillion in mortgage-linked securities and debts. The main reason for these policies is to stimulate borrowing in the private sector, including–whenever necessary–shifting the cost of toxic assets from Wall Street to the taxpayer. This hasn't worked, however. In the second quarter of 2010, for instance, bank lending dropped by $96 billion, even while bank profits surged by $22 billion. This seems counterintuitive, but there's a strange logic to it: With the private sector engulfed in so much uncertainty because of the government's spending, borrowing, and bailouts, banks are reducing credit to businesses, while increasing their purchase of government debt. The banks take in low-cost funds from the Fed and then lend it back to the government at a higher rate. This produces a small profit that–when done on a large enough scale–can become quite lucrative, indeed.

Because of this distortion, the Fed's low interest rates make it harder–not easier–for the private sector to get credit. Meanwhile, savers and investors–ordinary citizens who are building their nest egg for retirement–are getting little return on their money. Banks are paying 0.97% interest to their depositors–the lowest level since at least 1984, when the FDIC started keeping records. The question is, why is the Fed taking this path which seems so destructive?

This is where things get interesting. As I mentioned earlier, the Fed's low-interest rate policy does have a clear benefactor: the federal government. In the past two years, Washington D.C.'s appetite for borrowing has grown enormously. Since President Obama took office in January 2009, he has borrowed $2.6 trillion and he expects the government to borrow another $10 trillion over the next ten years. Keeping the costs of that borrowing down isn't just a luxury; it's a necessity. That's where the Fed comes in. By keeping interest rates low, it encourages banks to lend to the government, even at the expense of the private sector.

After all–from the bank's perspective–Treasuries are "safe" while the private sector–overburdened with higher taxes starting Jan. 1, new health care mandates, and the potential costs of cap and trade is "risky." A flood of money is pouring into Washington. But how much longer can that continue?

Think about it: In the immediate aftermath of the 2001 recession, the Fed kept interest rates extremely low for several years to "prime the pump" of the U.S. economy. But what some call "pump priming" others call "easy money." And a lot of that "easy money" was dumped into housing which was considered "safe" (after all, housing prices "always" go up). When the housing bubble burst in 2007, it had devastating effects–effects we're still grappling with today. Today, Treasuries are considered "safe" even while others worry about a "Treasury Bubble." As we saw this year in Greece and the European Union, the idea that government debt is "safe" is illusory, and the shift from euphoria to fear–as people grow concerned about the government's ability to pay back their debts–can happen in the blink of an eye. Knowing that, the Fed's policy to make it easier for Washington to borrow money–$5 billion per day, over $1 trillion per year–seems dangerous, at best; reckless, at worst.

To grow our economy, we need a fiscal and monetary policy that encourages saving and investment; not spending and borrowing. The Fed can do its part by bringing interest rates closer to their historical average and stopping its plan–approved on Aug. 10–to purchase long-term Treasury securities. Congress and the White House can do its part by implementing a series of tax reforms to encourage savings and investment. For starters, we should extend the tax cuts of 2001 and 2003 which are set to expire in about 100 days. Then we should undertake more comprehensive reforms. I've signed onto legislation introduced by Rep. Jim Jordan, R-Ohio, and Rep. Jason Chaffetz, R-Utah, The Economic Freedom Act, which would cut the Payroll Tax in half, eliminate the Capital Gains Tax, reduce the Corporate Tax Rate to 12.5%, provide immediate business expensing, and give the death penalty to the death tax. When taken together, these policies will create a favorable climate for businesses to grow, innovate, and create jobs.

No country in history became rich by overspending and borrowing; the key to growth has always been savings and investment. Let's renew our commitment–painfully absent over the past two years–to encourage the most fundamental American virtues–savings and investment–and discourage the vices that have mired us in stagnation: overspending and debt. We can do better, we must do better, and we need to do it now.

Rep. Cathy McMorris Rodgers is vice chair of the House Republican Conference and represents Washington State's Fifth Congressional District.

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