DRI-131 for week of 8-16-15: Hillary on CEO Short-Termism: Three Views

An Access Advertising EconBrief:

Is the Purpose of Government to Eliminate All Sources of Discontent?

If we took every action taken by government at face value, we would be forced to conclude that its central purpose is to eliminate all sources of discontent. And that is exactly the goal set for it by a long-forgotten Labor Party parliamentarian in early 20th-century Great Britain. Is that really what motivates politicians and bureaucrats? Should it be?

Actions taken by state-government regulators in New York raise these questions. Earlier this month, state Attorney General Eric Schneiderman announced that retailer Abercrombie and Fitch was the most prominent of 13 companies to end a work practice known as “on-call scheduling.” The Attorney General (hereinafter, AG) cited pressure by his office as the motivating force behind the change. The practice requires workers to be “on-call” for work in the sense that they must be prepared to show up or stay home on very short notice of as little as one hour. As noted in The Wall Street Journal (“Abercrombie Agrees to End On-Call Scheduling,” 8/7/2015, by Lauren Weber), “workers whose shifts are canceled don’t receive pay, even if they had blocked out that time and made child-care  or other arrangements.”

Abercrombie’s general counsel, Robert Bostrom, described the company’s capitulation by stating that workers will henceforth receive their schedules one week in advance and can choose to receive word about additional shifts that become available on short notice. The new policy, intended to “create as stable and predictable a work environment as possible” for Abercrombie’s employees, will become effective in September in New York and eventually be phased in nationwide.

Why did the Attorney General of New York state choose to intervene in the work-scheduling policies of a baker’s dozen retailers? “Unpredictable work schedules take a toll on all employees, especially those in low wage sectors,” commented Schneiderman, adding that other companies should follow Abercrombie’s “important step.” In April, the AG had claimed that Abercrombie’s policy “potentially” broke a New York law. That law states that staffers who report for scheduled work must receive at least four hours’ pay at minimum wage even if sent home. (Several other states have similar laws.) As the Journal points out, the law was passed before the advent of text messaging and e-mail made it easy to reach most people on short notice. Despite its change of policy, Abercrombie admitted no violation of law.

To an economist, the regulatory action taken by the New York Attorney General’s office and the explanations accompanying it seem utterly inexplicable – unless we are willing to believe that the inherent purpose of government is to eliminate all sources of human discontent.

Why Oppose – That Is, Regulate – On-Call Scheduling?

AG Schneiderman has chosen to regulate on-call scheduling by issuing an unfavorable opinion of this particular work practice, then pressuring firms behind the scenes to drop it. The question is: Why?

According to the Journal, “a number of current and former Abercrombie store associates nationwide left complaints about the scheduling policy on the employer-review site “Glassdoor….” (Parenthetically, we should note that the ghastly use of “a number of” could denote anything from one to infinity and is the kind of elementary error that freshman journalism students are taught to avoid.) Let us stipulate that some workers find the practice of on-call scheduling objectionable. So what? Is the purpose of government to act as a sort of all-purpose complaint department? Or is there something unique, perhaps, about the situation of retail employees – or human labor in general – that requires complaints to be addressed by government rather than directed to management?

As a matter of fact, why don’t workers who find the practice of on-call scheduling objectionable adopt the great American solution open to all workers in a free society; namely, quit and find a different job with working conditions more to their liking?

The Great Fried-Chicken Dilemma

To clarify this problem, consider a much easier problem posed in a much more familiar context.

Consider the problem of consumers confronted with a product they don’t like. Suppose a diner visits a fried chicken restaurant and finds the main course unpalatable. Should the diner complain to management? Well, many restaurants encourage this; it may or may not produce a refund for the diner. Conceivably, it might even result in alteration of the restaurant’s recipe or staff. But chances are that the diner will simply shrug and go somewhere else. After all, there are untold numbers of competing fried-chicken restaurants.

Should we demand that the Federal Trade Commission monitor consumer websites for customer complaints and “crack down” on restaurants that sell “inferior” fried chicken? No, there are huge flaws with this approach to the problem of maintaining restaurant quality. One drawback is that consumer tastes in fried chicken differ; one man’s inferior chicken is another man’s delight. Requiring government to enforce a quality standard in fried chicken will inevitably result in the production of “government quality” fried chicken; that is, one kind of fried chicken that diners of all tastes will have to eat or else. In this case, “or else” means they will have to prepare their own fried chicken. Since they previously had that alternative but rejected it in favor of dining out, this clearly makes them worse off than they would be if they could find a fried chicken to their taste. Of course, we could pretend to solve this problem by having government set up a different quality standard for each different flavor of fried chicken – one for extra crispy, one for spicy, and so on. But this would only create a host of new problems. And it assumes that government is just as responsive to consumer desires as producers are in free markets, whereas our experience tells us that government is quite insensitive to the desires of constituents and tends to impose a “one-size-fits-all” standard on the public whenever it can.

Another obvious drawback is the vast number of fried-chicken restaurants and diners, which would force government to employ huge numbers of people and spend ungodly amounts of time checking out complaints. (Lack of resources also argues against having government set up multiple quality standards for fried chicken, since it would hardly have sufficient time and manpower to enforce one standard, let alone multiple ones.)

Still another drawback would be the inducement sellers would have to file complaints against their competitors. Not only would this tie up government resources in investigating bogus complaints, it would also imperil the workings of competitive markets. If sellers could use government as a tool in falsely branding their competitors’ products as inferior, this would vitiate the very purpose that regulation is intended to serve.

Just think about all the problems we don’t have because we don’t force government to regulate fried-chicken quality in free markets. We don’t have to worry about how many different flavors of fried chicken to allow – are regular, extra-crispy, spicy, and Cajun-style enough, too many or insufficient to satisfy us? Should the number vary in different cities? Counties? States? Regions? Should it change over time, and if so how often? We don’t worry about any of these things. In fact, we take the answers to these questions completely for granted without ever realizing that they might be a problem in the first place. The market takes care of the answers without any of us ever giving the matter a moment’s thought.

Upon consideration, we realize that the mere fact that somebody doesn’t like fried chicken at a restaurant doesn’t necessarily mean that a market failure calling for government regulation has occurred. It might simply mean that the consumer has tasted fried chicken prepared in one of the various ways that don’t suit him; he needs to visit a restaurant better suited to his tastes. Of course, this could be styled a failure of information, but it is certainly not clear that government regulation could have prevented it or could solve it for other consumers. Markets, not governments, are collators and transmitters of information.

If we tried hard enough, we might envision a role for government in such a situation. Maybe the consumer didn’t like the chicken because it was tainted by salmonella. But we have government regulation of health standards in restaurants and preparation standards in chicken plants – and salmonella cases still happen. In reality, markets solve the problem of food poisoning in restaurants by turning restaurants that serve tainted food into commercial pariahs – a disincentive that exceeds any penalty government offers.

The Great Fried-Chicken Dilemma offers vast insight into the problems of labor markets in general and the regulation of on-call scheduling in particular.

The Potential Efficiency Benefits of On-Call Scheduling

Neither Wall Street Journal article nor Attorney General Schneiderman – nor, for that matter, Abercrombie itself – said anything to suggest that the practice of on-call scheduling might actually be beneficial for retail sellers, for consumers and for workers themselves. That omission is startling. There was a reason why Abercrombie and 12 other retail businesses employed this business practice.

Every consumer has patronized a retail seller and knows that these businesses are sometimes bustling with business and sometimes nearly empty. At some point, every consumer has experienced the frustration of seeking a sales clerk in vain. Businesses strive to keep exactly the right number of staff on the floor – not too many, not too few. Depending on the particular good(s) sold, human labor may be the most expensive cost incurred by the business, so it behooves managers to manipulate their “inventory” of sales staff to best advantage.

Just as businesses want to manage their inventory of sales staff optimally, so they also want to keep just the right amount inventory of goods on their shelves. For centuries, this was one of the biggest headaches facing the average business. Economists even identified the phenomenon called an “inventory recession,” caused by too many businesses simultaneously overestimating the need for future inventories and producing far more goods than were needed – only to find shelves and warehouses full to overflowing when consumer demand did not keep pace with expectations. Recent technological innovations in transportation, logistics and computers have allowed business to employ an inventory scheduling practice called “just in time” inventory management. This allowed businesses to postpone restocking until the last minute, letting them gauge demand much more accurately and avoiding the necessity for accurate long-distance forecasting of inventory needs.

If we view a retail business’s roster of employees as its staffing “inventory,” it is clear that on-call scheduling is a kind of “just-in-time” program for staffing. It allows retail managers to postpone determination of their final staffing schedule until the point when they can gauge the demand for retail staffing much more accurately. This allows them to avoid paying superfluous clerks when the store is virtually empty while having extra clerks on hand when demand is unexpectedly strong. It is crystal clear that on-call scheduling is potentially very beneficial for a retail business.

Moreover, it should be equally clear that on-call scheduling benefits consumers, too. This is a case where the interests of consumers and those of the business are directly aligned. Consumers want to have extra clerks on hand at busy times but don’t benefit much, if at all, from the presence of superfluous clerks in slack times. In the long run, competition between retail businesses will insure that the benefits of lower costs are passed along to consumers in the form of lower prices, so the efficiency gains from on-call scheduling really go to consumers, even though we associate the concept of business efficiency with productive advantage and gains to business owners.

What obviously failed to occur to AG Schneiderman, the Wall Street Journal and (from outward appearances) even Abercrombie and its spokesman is that on-call scheduling is also a potential source of benefits to retail employees. Just as consumers in our fried-chicken example derive benefits from product differentiation, so also may workers derive benefits from different terms of employment and work environments. Retail sales work is generally viewed as a form of low-skilled labor. Economists treat low-skilled labor as homogeneous; that is, as indistinguishable. But on-call scheduling allows workers the chance either to accept employment or, alternatively, earn a higher wage by competing on the basis of willingness to work – or forego work – on short notice. Since the decision to work for a particular employer is voluntary, nobody is forced to take this offer – just as no consumer is forced to eat fried chicken they don’t like. There are countless retail sellers, so workers who don’t relish the practice of on-call scheduling can work for a business that doesn’t follow the practice – just as consumers who don’t like one variety of fried chicken can patronize one of the many other competing brands extant.

So Why Regulate On-Call Scheduling?

On-call scheduling offers potential benefits to retail businesses, consumers and even to retail workers – just as different types of products offer potential benefits to consumers. Nobody is forced to endure on-call scheduling if they don’t like it, since the large number of retail businesses competing for workers gives workers a wide choice of employment – just as consumers have wide choices of different products and aren’t forced to put up with a particular brand. If it would be incredibly wasteful and a huge mistake to regulate brand variety and quality of consumer goods – and it would – wouldn’t it be just as big a mistake to regulate the practice of on-call scheduling for analogous reasons?

The answer is yes. There is no earthly reason for government at any level – municipal, state or federal – to regulate the practice of on-call scheduling. Only bad can come of it. The implication of AG Schneiderman’s actions is that government has a duty to prevent human beings within its jurisdiction from experiencing even momentary discontent. The AG must consider workers to be either too stupid to act in their own interest or too helpless to do so even if they had the wit to perceive it. Left unspecified, however, is how or where the AG acquired the superior wisdom and knowledge to substitute his judgment for those of the workers whose interests he claims to represent.

Free Markets vs. Regulation

We have shown that various ways of producing goods and services (such as utilizing on-call scheduling to staff retailing establishments) and various types of goods (such as different varieties and flavors of fried chicken) offer potential benefits to consumers. How is that potential actuated; that is, how do we cross the bridge from “potential” to “actual?”

Apparently, there are two ways. We can give the processes and products a trial in the free market and see how they work, keeping the ones that succeed and discarding the ones that fail. The failures will lose money for sellers because consumers will reject them, either because they do not like them or because they are too expensive. That makes it easy for producers to discard them. Alternatively, regulators can accept or reject them on an a priori basis. In order for this method to succeed, regulators must know as much about technology and costs as the producers of the affected goods and services do. Regulators also must know as much about consumers’ tastes and preferences as the consumers themselves do – as well as knowing what is “good” for consumers to consume in a physiological and moral sense. In other words, regulators must be well-nigh omniscient. (Where input markets are directly affected, as in this case, we can treat workers as the “consumers” of the relevant process.)

Put in this way, the choice is as clear as two-way glass. Free markets work vastly better and are less expensive than regulation. Given this, why do governments leap to regulate at every opportunity?

Why Governments Almost Always Choose Regulation

The New York State Attorney General chose to regulate on-call scheduling for a reason. Based on our analysis, we might suppose him to be perverse – deliberately choosing a result that makes everybody worse off than before. But that is not so. Economics tells us that somebody has to be better off, and the first place to look for the beneficiary or beneficiaries would be the AG himself and his sponsors and constituents.

The AG is a bureaucrat, a denizen of state government. He benefits when his domain grows larger and his power over it increases. When the number of firms he regulates increases, the AG’s power increases and his budget increases or, more properly, his basis for demanding a budget and staffing increase strengthens. When the AG’s office regulates the processes employed by retail firms, preventing them from using innovative means to compete with other firms, state government is cartelizing what would otherwise be a competitive market. The result of this will be less output and higher prices in the retail-sales sector. This creates a constituency of business owners and managers who are beholden to the AG and state-government politicians. (In the broad sense, this is what happened for over four decades when the old Civil Aeronautics Board cartelized interstate airline travel in the United States between the 1930s and 1978.)

Notice that the list of beneficiaries from regulation of on-call scheduling is small compared to the roster of potential beneficiaries from unregulated on-call scheduling. Regulation benefits government bureaucrats, workers and politicians directed involved with the affected industry, along with business owners who gain from market cartelization. It harms everybody else, most notably the consumers of the good involved and (in this case) almost certainly the workers affected as well. The gains of business owners are probably temporary, but the gains accruing to government will last as long as government regulation continues.

The best way to visualize the actions of government vis a vis markets is by thinking of government as entrepreneurship in reverse. Politicians and bureaucrats are always alert for opportunities to expand their domain. But whereas the invisible hand of competition and voluntary exchange insures that free-market entrepreneurship creates broad, mutual benefits, the coercive, visible hand of government subtracts net value from almost all of its interchanges with markets.

Is the Purpose of Government to Eliminate All Sources of Discontent?

Now we understand the heretofore inexplicable contention that the purpose of government is to eliminate all sources of discontent. How could anybody be so naïve as to think that government has the ability to remedy all unhappiness? Doesn’t the speaker realize that his statement is a recipe for fiscal insolvency? Writing a blank check to government is a fruitless quest for a non-existent nirvana.

Alas, the author of those words didn’t particularly care whether government actually succeeded in eliminating any discontent or not. He was not striving for universal bliss. Rather he sought an unlimited warrant for government intrusion in order to benefit his own special interest. The more power government has, the larger it grows. The larger it grows, the more its servants prosper. And the more the servants of government prosper, the more the rest of us suffer.


DRI-180 for week of 2-15-15: The Midnight Ride of the Interest-Rate Alarmists

An Access Advertising EconBrief:

The Midnight Ride of the Interest-Rate Alarmists

In every Middlesex village and farm – and these days, the word “Middlesex” carries a decided double meaning – the alarm is being sounded. Interest rates will rise. The only question is when.

For six years, the question has been “if,” not “when.” At first, interest rates were held down by “stimulus” – the combination of fiscal and monetary policy embodied in the multi-billion (or trillion, depending on how one counts) dollar program enacted in the early days of the Obama administration in 2009. Then, when the “zero lower bound” beckoned, the QE series of quantitative expansions in monetary “stimulus” helped enforce a continuing ZIRP (Zero Interest Rate Policy).

Now, we have reached a point at which some middle-school youths have no memory of what a real interest rate looked or felt like. And quite a few adults in financial and policymaking circles have no desire to relive their old memories, either. They have mounted up, a la Paul Revere, to cry “The rate hike is coming! The rate hike is coming!”

In a recent Wall Street Journal op-ed (“Why the Alarms About a Slight Rate Hike?” WSJ, 02/18/2015), author Omid Malekan quotes several of these alarmists. “Charles Evans, president of the Chicago Fed and a voting member of the board that determines rate policy, said last month that raising rates too soon would be a ‘catastrophe.’ Former CEO of General Electric Jack Welch, during a Feb. 4 interview on CNBC, called a possible spring rate hike ‘ludicrous.’ Billionaire investor Warren Buffett told Fox Business Network on the same day that he didn’t think a rate increase this year would be ‘feasible.'”

Malekan’s view of these modern-day midnight riders is droll. “Catastrophe. Ludicrous. Not feasible. Really?” For the previous five decades, Malekan notes, the benchmark overnight Fed funds rate averaged 5.7%, ranging from a high of 19% in the early 1980s down to 1% in the early 2000s. But for most of the five-decade reference period – including the Vietnam War, most of the Cold War, the stagflation of the 1960s and 70s and two serious recessions in the 70s and 80s – that 5.7% figure wasn’t far off the mark. But “since December 2008 the fed-funds rate has been kept close to zero.”

And what would the Fed’s proposed interest-rate hike, anathematized as unthinkable by its critics, do? It “would take the fed-funds rate from near zero to about 0.25%, and no that isn’t a misplaced decimal point. We aren’t talking about 2.5%, which would still be less than half the 1954-2007 average. We are talking about 0.25%, which would mean the Fed’s monetary policy would be rolled back from full pedal-to-the-metal to a fraction above pedal-to-the-metal. On a historical chart of the fed-funds rate, the proposed hike would barely be visible to the naked eye. Does that sound like inviting catastrophe?”

The fact that Malekan can mine humor from ZIRP and QE is testimony to the human capacity for finding fun in the darkest of circumstances. After all, one of the most popular motion-picture comedies of all time poked fun at nuclear war and ended with the destruction of the planet. A rise of one-quarter basis point in interest is hardly that apocalyptic, so a little black humor isn’t out of place. But the underlying issues make this no laughing matter.

Hamlet or Waiting for Godot?

For free-market economists, the last six years have been a living nightmare. Like many nightmares, this one has been murky and hard to follow. It has many features of Shakespearian tragedy. The Fed often seems to be playing the role of Hamlet, as when it cannot make up its mind whether or when to raise interest rates. At other times, economic policy takes on the surrealism of a Samuel Johnson play. The QE sequence and the long wait for the return of normality to monetary policy casts the Open Market Committee as the characters from Waiting For Godot – waiting for someone or something they aren’t sure they know or want.

One of the alarmists cited above is actually an Open Market Committee member and Fed policymaker. This just adds to the atmosphere of surrealism surrounding economic policy. But it jibes with the ambivalent reactions that the Fed itself has displayed to its own rate-hike proposal.

The exasperation of Fed watchers is captured in another Wall Street Journal op-ed (“A Muddle of Mixed Messages From the Fed,” WSJ, 02/19/2015) by two members of the Shadow Open Market Committee, Charles W. Calomiris and Peter Ireland. The SOMC is a group of economic and finance professors whose avocation is criticizing the Fed’s monetary-policy actions.

These two men begin by noting that the conventional index of market expectations is the futures market. Interest-rate futures indicate that markets do not believe the Fed will follow through on its stated intention to raise interest rates discretely over the next two years, beginning in mid-2015. Instead, markets expect rates to rise more slowly beginning later this year. Why does this divergence exist? Because the Fed has been giving mixed signals; Fed leaders say one thing (“rates will rise beginning in June”) but hint otherwise (by implying in various forums that both labor markets in particular and the overall economy in general are still shaky). Market participants believe the hints that Janet Yellen and other Fed officials are dropping, not the official policy statements issuing from the agency.

The Fed is legendary for using language reminiscent of the Delphic Oracle as a means of preserving its policy flexibility. While this is politically and bureaucratically useful to the agency, it is economically harmful. If market participants plan for one type of monetary policy and interest-rate environment but later experience a different one, their plans will be adversely affected. The very essence and purpose of interest rates is to coordinate the plans of savers and investors over time, so this confusion cannot be a good thing.

Without saying it in so many words, the two authors also accuse the Fed of reverting to old-line Keynesian habits. This wouldn’t be surprising in view of Chairwoman Janet Yellen’s left-wing Keynesian ideological slant. The hoary Phillips Curve tradeoff between inflation and unemployment has apparently been resuscitated with the Fed’s pathological fear of deflation, insistence on a 2% annual rate of inflation as a positive goal and Ahab-like pursuit of the ever-receding goal of “full employment.” Calomiris and Ireland insist that falling oil prices are not something to be feared and cannot – in and of themselves – cause a deflationary Depression. Only a sudden and severe decline in the money supply can do that. In effect, they are invoking the spirit of Milton Friedman’s famous dictum, “Inflation is always and everywhere a monetary phenomenon” – only in reverse gear.

The Fed’s problem is that Keynesians like Yellen were trained to believe that the interest-rate hike they are now advertising will torpedo an economic expansion – and the existence of a current expansion is the ostensible justification for the interest-rate hike in the first place. As the two authors point out, “even with a hike beginning in midyear, interest rates would remain very low and still well below the inflation rate, implying a negative real interest rate. Prior rate hikes in similar circumstances in 1994 and 2004 did not throw the economy into recession.

Calomiris and Ireland also resurrect another Friedmanism – his famous reference to the “long and variable lags” with which changes in the monetary policy affect the economy. Since 2011, the broad measure of the money supply, M2, has increased at an annual rate of over 6%. The two men see the excess reserves of banks gradually being absorbed into the economy after long sitting idle on deposit at the Fed. This will eventually – sooner rather than later – ratchet the annual rate of inflation toward and above the Fed’s target rate of 2% and completely offset the downward price momentum created by the decline in oil prices. Why, they complain, doesn’t the Fed own up to this?

Thus, the Fed’s case in favor of its announced policy is vastly stronger than the Fed pretends. The Fed is acting as though it doesn’t believe in its own policy.

The Crowning Irony

As if all this weren’t enough to leave any sensible observer groggy, we are forced to acknowledge that the Fed’s critics – fans of interest-rate hikes who are itching to “get back to a normal monetary policy” – suffer from their own blind spot.

Ironically, Calomiris, Ireland and Malekan are so dumbfounded by the Fed’s progressive march away from monetary reality that they haven’t noticed how far into the swamp that march has taken us. Having marched in, we can’t just turn around and march back out again and expect that the exit will be as smooth as the entry.

Calomiris and Ireland cite the interest-rate hikes of 1994 and 2004 as precedent for the one upcoming in June. But the previous increases did not take place in an economy staggering under the public and private debt load we carry today. Malekan cites the quarter-basis-point increase derisively; who’s afraid of a big, bad quarter point, anyhow, he laughs? Hell, we used to live with real interest rates of 5.4% in the old days. So we did, but then the federal-government debt wasn’t $14 trillion, either. We weren’t forced to finance federal-government debt with short-term debt instruments to hold down the rate. If we had to pay even halfway realistic interest rates on our current debt, the federal-government budget would be eaten alive. Suddenly, the U.S. would become Europe – no, it would become Greece, facing a full-blown fiscal crisis that would instantly become a political crisis.

Oh. Well, then – maybe it’s right to be so cautious, after all. Come to think of it, maybe we shouldn’t increase rates at all. Maybe we’re just stuck. You know, life really isn’t so bad. After all, unemployment has declined to the neighborhood of 5%. The economy is growing – slowly, but it’s growing. Let’s just stay where we are, then. Why is the Fed even talking about increasing rates?

From Op-ed Page to Front Page

Let’s jump from the op-ed page of the Wall Street Journal to the front page. The headline for 02/19/2015 reads: “Borrowers Flock to Subprime Loans.” Uh-oh; déjà vu all over again. “Loans to consumers with low credit scores have reached the highest level since the start of the financial crisis, driven by a boom in car lending and a new crop of companies extending credit. Almost four of every 10 loans to autos, credit cards and personal borrowing in the U.S. went to subprime customers in the first 11 months of 2014,” based on data supplied by Equifax.

In other words, the ultra-low interest rates stage-managed by the Fed have paved the way for a new financial crisis. The lead-in to the article didn’t even mention student loans, probably because the category of “subprime” is not meaningful for that type of loan. The auto-loan, credit-card and personal-finance industries are different from real estate. Banks no longer face the same risk exposures as they did in the early years of this millennium. Various elements of this impending crisis differ from the mortgage-finance-dominated crisis that preceded it. To be sure, history does not repeat itself – but it does rhyme, in the words of one sage observer.

It has now penetrated even the thick skulls of Federal Reserve policymakers, though, that asset bubbles are not born spontaneously. They are generated by bad government policies, with interest-rate manipulation prominent among those. It cannot have escaped notice that fixed investment during the six years of ZIRP and QE has fallen to anemic levels. Apparently, it is not so much low interest rates that promote healthy levels of investment as real, genuine interest rates – that is, interest rates that actually reflect and coordinate the desires of savers and investors.

Savers are people who plan savings today and on an ongoing basis to provide for future consumption. Investors are people who plan investments today and on an ongoing basis to provide the future productive capacity that makes future consumption possible. Interest rates coordinate the activities of these two groups of market participants over differing future time periods. This serves to coordinate intertemporal production and consumption in a manner analogous to the way that the prices of goods and services coordinate production and consumption over short-term time periods. (In this connection, “short-term” refers to time periods too short for interest rates to play the major role.)

When the interest rates prevailing in the market are not real interest rates but the artificial interest rates controlled by a central authority, that means that rates are not performing their vital coordinative function. And that means that future investments fail because investors were responding to a false market signal, one that told them that savers wanted more future goods and services in the future than were actually wanted. Having been burned very badly by this process just a few years ago, investors evidently aren’t about to be suckered again. They’re sitting things out, waiting for markets to normalize so they can invest in a market environment that works instead of one that fails. (The exceptions are situations in which “the fix is in;” when investors can get subsidies from government or are sure they will be bailed out in case of failure.)

If this comes as a surprise, it shouldn’t. Over a 70-year period, the Soviet Union tried to live without functioning capital markets. Any mention of interest rates was verboten in Communist circles, but after a while the need for intertemporal coordination in production was so crying that Soviet planners had to invent the concept of an interest rate. But they couldn’t call their invention an interest rate without risking execution, so they called it an “efficiency index.” Alas, merely calling it that did not actually give it the coordinative properties possessed by genuine market interest rates and the Soviet economy collapsed under the weight of its failures in the late 1980s. Similarly, the Chinese Communist economy got nowhere until, in desperation, Deng Xiaoping liberated market forces sufficiently to allow flexible prices and interest rates to prevail in an independent, competitive sector of the Chinese economy. And it was this sector that thrived and promoted Chinese economic growth, while the official, government-controlled sector stagnated.

More and more, respected commentators and observers across the spectrum are speaking out about the untenable status quo into which the Fed has forced us. The speech usually takes the form of grumbling about the need for return to a “more normal” policy. Of course, the problem is that any sort of normal policy is now impossible given the box we are in, but the point is that recognition of the harm caused by ZIRP and QE is becoming general.

So the Fed can’t just sit tight either, much as it would like to. The pressure to change the status quo has built up and is growing by the day. If the Fed continues to stall, it will be obvious to all and sundry that its so-called political independence is a fiction and that its policy is aimed at saving the government’s skin by preserving deficit finance and stalling off fiscal reform.

Actually, the proper metaphor for our current dilemma is probably that of a man riding a tiger. Once the man is atop the tiger, he faces a pair of impossible, or at least wildly unattractive, options. If he gets off, the tiger will kill and eat him. But if he stays on, he will be scratched, clawed and whipsawed to death eventually. Really, the question he must be asking himself as he tries desperately to hang on is: How in the world did I ever get myself in this position?

That question is purely academic to the man on the tiger but vitally important to us as we contemplate the Fed’s dilemma. How in the world did the Fed every get itself in this no-win situation? What made it seem attractive for the Fed to follow a policy that now seems disastrous? Alternatively, what made it seem necessary?

The Keynesian Link With ZIRP: Keynes’ Embrace of Marx

Close students of John Maynard Keynes know that Keynesian economic theory was mostly the work of Keynes’ followers. Students like Nicholas Kaldor, Piero Sraffa, Joan Robinson, Richard Kahn and John Hicks made numerous contributions to the theory that eventually dominated macroeconomics textbooks for some four decades and still survives today in skeletal form.

Nobel laureate Paul Samuelson once observed that Keynes’ General Theory was a work of genius in spite of its poor organization, confusing theoretical structure and intermittent moments of inspiration. Even more pertinent to our present predicament is that the second half of The General Theory leaves economics behind and takes up the cause of social policy.

Keynes faulted capitalism for its preoccupation with what he called the “fetish of liquidity.” It was the capitalist’s insistence on liquidity that underlay the speculative demand for money, which created idle balances that thwarted the expenditure of money necessary to purchase the short-term full-employment level of output. The payment of interest similarly thwarted the level of investment requisite for long-term full-employment. Capitalism would have to be supplanted with a kind of quasi-socialism in order for the market order to be preserved.

The linchpin of this new, stable market order would be a government-directed investment policy specifically intent on driving the rate of interest to zero by injecting fiat money as necessary.Only then would long-term investment would be maximized because the marginal efficiency of investment would be zero. (Another way of characterizing this outcome would be to say that all possible benefit would be squeezed out of investment.) Reading this second section of the General Theory makes it clear that Keynes was the original impetus behind ZIRP.

Keynes’ antipathy towards capitalism and the charging of interest brought him into general sympathy with Marx. Although they reached their respective conclusions by different routes, they both fervently sought the negation of capital markets and the castration of capitalism. Keynes felt he was preserving the institution of private property while Marx sought to destroy it, but in practice Keynesianism and Marxism have had similar effects on free markets and private property.

Should we be surprised, then, that Keynesians in Japan and the U.S. unveiled ZIRP to the world? Certainly not. ZIRP was the deep-seated secret desire of their hearts, the long-denied, long-awaited desideratum for which the financial crisis finally provided the pretext.

Reconsidering the Financial Rescue

Malekan no doubt echoed the views of most when he blandly observed that “although at the time few could argue with the need for such extraordinary Fed action.” He then went on to insist that things were different now and ZIRP and QE had outlived their usefulness and were no longer needed. But our full analysis suggests something quite different. If the Fed’s actions got us into a box from which there is no escape, then the only answer to the dilemma we face today is: Don’t get ourselves into this situation in the first place.

That means that we shouldn’t have ratcheted up federal-government debt with the Obama stimulus – or, for that matter, the Bush stimulus that preceded it. That conclusion will not resonate with most observers, given the overwhelming consensus that we had to do something to prevent the recurrence of a 1930s-style Depression and that massive government stimulus was the only thing to do. But we certainly aren’t forced to take that consensus verdict at face value now, six years after the fact. Six years ago, we felt under time pressure to do something fast, before it was too late. Now we have the luxury of retrospective review.

Neither stimulus lifted the U.S. economy out of recession. The Obama stimulus had hardly been spent when the U.S. economy officially emerged from recession in June, 2009. The unemployment rate declined with painful slowness in the six years after the stimulus, notwithstanding that academic students of economics are taught that the only theoretical rationale for preferring stimulative policies is that they act faster than waiting for markets to eliminate unemployment on their own. There is compelling evidence that the decline in unemployment resulted mostly from long-term departures from the labor force and elimination of unemployment-benefit extensions rather than from job creation. Malekan remarks that “the fact that there is a debate about a quarter-point rate hike tells us that extraordinarily low interest rates have mostly failed to deliver a robust recovery. That people opposed to even the tiniest increase in rates are resorting to hyperbole tells us that they too know this.” And what did we get for what Malekan calls “modest benefits,” but what we can see are really almost no benefits but a flock of trouble? We are riding a tiger with no way out of the fix that confronts us.

Although the reflex action of critics and commentators was to blame the financial crisis and the Great Recession on the usual suspects – greedy capitalists, Wall Street and deregulation – the passage of time has produced numerous studies decisively refuting this emotive response. The roster of government failures at the local, state and federal level was so lengthy that no single study has comprehensively included them all. That lengthy list is the only bit of evidence implying that things could have been worse than they actually were. Everything else – a priori logic and the long history of recessions since the founding of the republic – leads us to think that if left alone to recover, the U.S. economy would be vastly better off now than it actually is.

James Grant has recently written at book length about the severe U.S. recession of 1920-1921, which lasted no more than eighteen months despite no countercyclical government action at all. This is a template for government (in-) action in the face of impending recession. We have tried every form of preventive, stimulative and recuperative remedy the mind of man can devise and they have all failed. Maybe, if we’re lucky, we will someday have the chance to try the free-market cure.