All speculations of months were over with the 50 basis point cut in Federal benchmark interest rate. Now is the time for analysis of the decision, and expectedly opinions differ when it comes to grading the prudence of this decision.


Those who called the decision right (and part of it is true) and bold argued the reducing inflation numbers with various other indicators of price stability as latest as available and job losses figure of last available month. The shift now has to be from inflation targeting to economic growth and job creation/retention. And there is merit in that argument.


Defenders of the decision also highlight that no differentiation can be made between ‘good money’ and ‘bad money’. Good money is what’s used in creating productive assets; bad money is what’s used in speculations, hedge funds and in financial instruments that eventually create risky instruments, and asset bubbles. Human productivity sans capital productivity does not make any sense to me. Because focusing only on human productivity makes sense only when we associate that with zero cost of capital, on a sustainable basis, available to any without any collateral. I believe no where Central Bankers would lend the people, who need the capital the most, capital at Central Bank rates because this group can’t provide the collateral. So capital can be effectively leveraged by those, who only have prior access to some amount of capital, to create higher productivity-led growths, during expansionary monetary policies. But few interlinked factors work against that:


  1. As everyone effectively is in pursuit of ‘quick money’ with quarterly focus linked with take-home bonus and stock prices; innovations suffer.
  2. The global uncertainty also makes it hard to know what innovation would work and what won’t. Uncertainty has been on the rise constantly; and playing safe makes better sense than risking money in pursuit of productive growths when all may be lost. Macroeconomic forecasting has been more and more difficult acknowledging the fragile nature of globalization and global imbalances.
  3. Under this environment, it’s financial markets only that can absorb trillions of dollars in its system, or generate same money globally from nowhere due to exuberance. However there is no denying that in the short term, one may make book losses on prudent financial investments; in the long run the chances are bleak. So good financial investments (and without leveraged positions) are bound to yield:
    1. Either lot of money in the short run
    2. Descent return in the long run though initial hiccups may be there
    3. Arbitraging financial instruments eventually can give a return that’s unlikely to be met with average return from innovations or productive growth.
  4. Providing collateral is easiest for financial firms – therefore they qualify and garner easy money.


The point is, playing with money itself as a business input and business output have become so lucrative that more and more money chases this route than money chasing innovations, productive growths. And thereby have made it risky as well with many players playing the same ‘me too’ models with more and more aggression.


So real innovation, real productivity growth has taken 2nd position to financial innovation and more and more aggressive stance from financial players. Sub-prime issue is effectively an output of that aggression as more and more people in the business of money chases the market with known set of products.


The bottom line is, capitalism in its evolution has led to an economy to a point that awards ‘bad business’ more than ‘good business’. So even if Fed. creates more money with loose policies acknowledging the fact that ‘good business’ needs money to improve ‘real economy’, a major part of that actually lands up with ‘bad business’.


This has been happening since long; and many therefore claim that without a shock therapy, this will continue faster in an exponential rate.


There’s not been a rescue package to the auto-industry when they have been bleeding for long in the US. Because as per some measure; auto-industry, in-spite of their importance to the real economy, is not part of the markets that Fed listens to. The drawback I believe is too much focus and too much attention has been given to the financial markets ignoring the real markets and its sub-categories.


An increasing stock index is not the measure of healthy ‘real’ economy, rather a ‘healthy’ real economy would eventually have a healthy financial market. Focusing too much on financial markets and on its daily gyrations and fancies and delivering what they want is equivalent to putting the proverbial cart before the horse. The horse pulls the cart, not the other way round. One may argue that quarterly economic growth rates measure the health of the horse; but there are doubts on its measurement, effectiveness and also on correctness of the value. Other than the horse which is pulling the cart now, one has to look at the health of the other horses that would pull the cart in future to ensure ‘real’ economy remains healthy.


And to do that, we need a stable monetary policy. Movements of interest rates like a pendulum again helps one in the ‘bad’ financial markets economy (quick get in and quick get out) than the ones who would love to concentrate on productivity led real-economy. One needs time to raise a horse to bring it to productive stage, and cost of capital to do so remains unclear with high volatility for real economy players.


These defenders of Fed. decision have ignored this point that making money available to all irrespective of how it’s to be used without correcting the imbalances of return won’t solve the problem, rather it would magnify it. Many also argued, with logic, that the fire department can’t stop extinguishing fire at a home caused by a smoker due to callousness. The smoker is the poor mortgage taker at most here, not the fund houses; and Fed. decision does not extinguish the fire much for the loan-taker; it rather does for the loan giver.


The opponents of Fed. decision have (more correctly?) called the decision an act of socialism for the Wall Street. Honestly, my definition for socialism and capitalism is increasingly getting marred as in socialism, government bails out state-owned business/enterprises. So the money, used rightly or wrongly, eventually is used for common ownership. In capitalism, actions like the Fed. or Northern Rock bail out in the UK shows that common money is used to bail out selective people in distress, without benefiting all equally.  It also shows the fallacies of capitalism.


Finally, I believe that Bernanke felt creating a flood would solve a drinking water problem that’s critical only for sections of the credit market when it comes to end consumer. But like most waters from all rivers finally meet on the sea, one never knows when one trades these complex credit derivatives; which credit market is facing a shortage of liquidity. Bernanke must have tore part of his available scarce hairs solving this problem with an academic mindset, and found no clue.


Therefore he preferred what the US usually does in war front – cluster bomb all with credit. One never is sure where the terrorist may be hiding, and collateral damages are well-accepted now as long as it’s not US lives lost in collateral damages. Bernanke rather moved one step forward. He felt the flooding the markets would solve the drinking water scarcity that some regions are facing badly. And the flood was felt all over the world with stock surging by average 3% globally, if not more. No doubt that the collateral damages would again be borne more by the emerging markets. What he missed in the 1st place is abundant water has first of all led to the drinking water scarcity in pockets of economy as drinking water (good money) got contaminated with flood water (easy credit money for financial markets). One may even say people have been drinking too much, and that’s not sustainable again! And flooding the market again may therefore not be the sustainable solution to this problem of drinking water scarcity in pockets.


True, many treat snake-bites with venoms of snakes itself. The world however is not sure how well this treatment would work for the economy. What goes in favor of Bernanke is the fact that money, no doubt, is morally more poisonous for whole society than any snake bite. He probably wants to do what Lenin suggested: ‘to destroy capitalism, you effectively have to debauch the currency.’


The Concise Encyclopedia of Economics gave following:


‘Can capitalism survive? No. I do not think it can.” Thus opens Schumpeter’s prologue to a section of his 1942 book, Capitalism, Socialism and Democracy. One might think, on the basis of the quote, that Schumpeter was a Marxist. But the analysis that led Schumpeter to his conclusion differed totally from Karl Marx’s. Marx believed that capitalism would be destroyed by its enemies (the proletariat), whom capitalism had purportedly exploited. Marx relished the prospect. Schumpeter believed that capitalism would be destroyed by its successes. Capitalism would spawn, he believed, a large intellectual class that made its living by attacking the very bourgeois system of private property and freedom so necessary for the intellectual class’s existence. And unlike Marx, Schumpeter did not relish the destruction of capitalism. He wrote: “If a doctor predicts that his patient will die presently, this does not mean that he desires it.”‘

Is his views of 1942 is becoming relevant with too much success of capitalism (inequality with abject poverty) in 2007…I am not sure.



Ranjit Goswami is a research scholar with the Indian Institute of Technology (IIT), Kharagpur, India; and is the author of the book “Wondering Man, Money & Go(l)d”. 

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