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David Stockman on Why the Federal Reserve is Running Out of Monetary Oxygen

What passes for central banking today is really a perverse form of Wall Street-pleasing monetary manipulation. It employs the vocabulary of central banking, but in practice it fundamentally undermines main street prosperity, even as it showers the 1% (the top wealthiest people) with unspeakable financial windfalls.

Stated differently, virtually everything the Fed does for the alleged benefit of the American economy is both unnecessary and a ruse. The Fed has actually become a captive of the Wall Street traders, gamblers and high rollers, and functions mainly at their behest.

The proof of this proposition starts with the startling historical fact that the post-war US economy did just fine without any interest rate targeting, heavy-duty bond-buying or general macroeconomic management help from the Fed at all. For all practical purposes today’s omnipresent Fed domination of the financial and economic system was non-existent at that point in time.

We are referring to the full decade between Q4 1951 and Q3 1962 when the balance sheet of the Fed remained flat as a board at just $51 billion (black line). Yet the US economy did not gasp for lack of monetary oxygen. GDP grew from $356 billion to $609 billion or by 71% (purple line) during the period. That’s nominal growth of 5.1% per annum, and the majority of it represented real output gains, not inflation.

Change in Federal Reserve Balance Sheet Versus GDP, Q4 1951 to Q3 1962.

As it happened, this halcyon span encompassed the immediate period after the so-called Treasury-Fed Accord of March 1951, which finally ended the WWII expedient that had pegged Treasury bills at 0.375% and the long-bond at 2.5o% in order to finance the massive flow of war debt.

The effect of the WWII pegs, of course, was that the Fed had been obliged to absorb any and all US Treasury supply that did not clear the market at the target yields. Not surprisingly, the Fed’s 1937 balance sheet of $12 billion had risen by 4.3X to $51 billion by the time of the Accord, thereby reflecting what amounted to the original version of backdoor monetization of the public debt, which was justified at the time by the exigencies of war.

By contrast, in the post-peg period shown below interest rates were allowed by a newly liberated Fed to find their own market clearing levels. So there was no continuous guessing game on Wall Street about where the next monthly Fed meeting would peg short-term interest rates. Back then, it was understood that the forces of supply and demand down in the bond pits of Wall Street were fully capable of discovering the right interest rates, given the financial and economic facts then extant.

The combination of high growth, robust investment, strong wages and smartly rising real family income, on the one hand, and rock-bottom inflation on the other, surely constitutes the gold standard of performance for a modern capitalist economy.

And yet, and yet. It was all accomplished under a regime of persistent “light touch” central banking that assumed free market capitalism would find its own way to optimum economic growth, employment, housing, investment and main street prosperity. No monetary Sherpa at the Eccles Building was necessary.

Even more crucially, no money printing was necessary, either. The sterling economic results depicted below happened during a 11-year period when the Fed did not purchase one net dime of U.S. Treasury debt!

Read the full article here: Internationalman