Economist Allan Meltzer: Bernanke Is Dead Wrong

It looks like an open rebellion at the Fed...

Allan Melzer is an economist who wrote the definitive history of the Federal Reserve. He was interviewed in the BBC World Service radio program Business Daily (first 9 minutes) and spoke about the Fed policies and internal strife regarding those policies. In his own words, he is still very well connected to people inside the Fed.

Melzer claims that the current rescue measures of the Fed will have unintended consequences, and the U.S. is heading for another financial disaster. To avoid it, he says the government should implement the policies of cutting the budget deficit, and slowing the future money growth so that we have a fighting chance.

As to the Chinese continuing to fund the U.S. deficit, he replies it is basically a wishful thinking. The U.S. government projects $1 trillion to 1.5 trillion a year deficit, which would suck up most or all the savings in the world. Is it sensible for the world to fund the consumption in the United States, is it the sensible policy for the U.S.? he asks.

But the bulk of his interview focuses on the Federal Reserve. He is emphatically critical of the Fed chairman Ben Bernanke as highly political (i.e. doing the bidding of the administration), contrary to his public remarks of the Fed "independence". Melzer says his connections, including the governors at the Federal Reserve tell him that they disagree with Bernanke and are encouraging Meltzer to "keep talking".

The Federal Reserve's balance sheet is full of the administration's fiscal policies - buying up agency bonds/MBS to prop up the housing market, direct loans to financial institutions to prop them up, special investment vehicles to manage the assets of the failed investment bank (Bear Stearns) and failed insurance company (AIG) that have been decreasing in value. These have nothing to do with the monetary policy, which is one of the two mandates of the Fed.

Is the Fed interfering in places where it shouldn't be?

Absolutely, he answers, and he is not alone in thinking that way.

Meltzer even says the Fed policies jeopardize the democracy. "Democracy works best when you have the legislature involved in resolving the crisis, not by taking a quasi-independent agency and giving them the power."

He says he hates to see the country go where it's going: high unemployment, inflation, dollar's fall, hurting the rest of the world; Americans will have high unemployment, stagnant or lower wages, and inflation that will decrease their bank accounts.

His final message: Economy IS recovering, but the recovery will be short-lived unless we do something. Now is the time to slowly restore the stability (i.e. getting out of fiscal policies). We shouldn't wait until the next crisis hit, and we have to act in a draconian fashion. Do it now, slowly, deliberately, firmly.

His choice of venue (BBC) is interesting to me. His comments are not for the domestic (U.S.) consumption but an appeal to the international community, i.e. Europeans and Chinese who are increasingly uneasy about wanton spending by the U.S. government and the Fed's monetization. Meltzer seems to be trying to win them over by presenting the opposings view to Bernanke's within the U.S. central bank, promising restraint.

You can listen to the entire interview here.

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