Fighting this Depression with the Last Depression's Tactics is a Recipe for Disaster
In Chairman Bernanake's doctoral thesis, he "focused on the role of monetary policy in affecting economic activity, and on the historical analysis of the causes of the Great Depression."
His thesis and resulting understanding of the negative impact that uncertainty has on business cycles should provide insight on the actions needed by government to resolve our current economic difficulties. In short, Dr. Bernanake understood that "[i]t is shown that increased uncertainty provides an incentive to defer such investments in order to wait for new information" (page 2 of the dissertation). In the same paper, he wrote, "Uncertainty is seen to retard investment independently of considerations of risk or expected return. Introduction of uncertainty can be associated with slack investment, resolution of uncertainty with an investment boom."
The causes and nature of the first Depression have been studied extensively. It has become increasingly obvious that there were a series of events that collided to bring forth the "Great Depression." Be it fragmented fiscal policy, bank failures, collapsing prices on farm goods, the events of the economic malaise caused by the Versailles Treaty in Germany, the collapse of foreign trade, or the stock market collapse of 1929, it would be difficult to deduce that one single event caused the "Great Depression."
In real terms, deflation had set in, and the "perfect economic storm" came into being. Once the ravages of deflation become clear, the fears of inflation dissipated.
During my tours while serving as a colonel in the U.S. Marine Corps Reserve (ret.), I had the opportunity to spend much time in Eastern Europe in the mid-1990s. I saw firsthand the negative effects of deflation in Romania, Bulgaria, Slovenia, and parts of Bosnia. With deflationary fears, citizens will stop spending, waiting for even lower prices for what they want to buy. And once the deflationary spiral begins, it is extraordinarily difficult to stop.
Just as World War I was called the "Great War" prior to World War II, the "Great Depression" will soon be called the First World Depression if government does not act immediately to minimize uncertainty and stop the spiral.
Chairman Bernanke understands the role of uncertainty on investment, but I allege that that same uncertainty influences consumer spending as well. Consumers and businesses have been dealing with this recession since 2008. Government has yet to deal with their fiscal irresponsibility. Just as GM was not too big to fail, neither is the federal government.
What is absolutely essential today is that Congress and the president solve the problem -- the problem of uncertainty. It's the uncertainty, stupid!
The Federal Reserve can change all of that, and very quickly.
The Federal Reserve is enabling this administration to be fiscally irresponsible with its unrealistically low interest rates. Be it Quantitative Easing 1, Quantitative Easing 2, or Operation Twist and its successor, the implications of a loose monetary policy enables our federal government not to solve the problem.
President Obama, when he took office, should have made dealing with the economy his number-one priority. Instead, he chose to make health care reform his number-one priority because he had complete control of the House and Senate -- a perfect storm.
Meanwhile, the Federal Reserve is merely providing fuel to the fire with cheap money and thereby enabling this administration to delay tackling the tough problems that must be faced.
Whenever long-term interest rates are below 2%, one must be concerned about why a rational person would tie up money for 10 years at rates below the rate of inflation. This economic abnormality may be an indicator that the economy is unsure of whether anything has value. Not spending now is a potential indicator of deflation to come. In a deflationary environment, an investor "makes money" by not spending.
The uncertainty exists in our economy in many forms. Be it the 200+ regulations that have not yet been enacted in the Affordable Care Act or the 200 or so regulations not yet enacted from the Dodd-Frank Bill, the reality is that our citizens and our businesses have no idea what their government is going to do next. We call that uncertainty in my world!
The longer the Federal Reserve continues to allow this government to spend irresponsibly, the longer this recession will continue, until it becomes The World Depression II. There was nothing great about the Great Depression, nor will there be anything great about the second depression.
Should the Federal Reserve choose to act in its independent role, it can force government at the executive and legislative levels to make tough decisions by allowing interest rates to properly reflect the risk of the investment. When uncertainty is removed due to prudent fiscal actions by government, economic growth and economic boom will follow.
The sad reality, however, is that our citizens understand that a government cannot deficit spend-forever, interest rates this low are not rational, and there is no such thing as a free lunch.
It's the uncertainty, stupid! As long as the Federal Reserve enables this administration to be fiscally irresponsible, the Second World Depression is inevitable.
Should the Federal Reserve not exercise its leadership responsibility, the last vestige of hope will be when Congress faces raising the debt ceiling, but by then it may be too late.
The time to act is now. The Federal Reserve must remove all uncertainty by showing our citizens and the world that we are serious about instilling fiscally responsible behavior. The Federal Reserve must stop this loose monetary policy philosophy.
It's the uncertainty, stupid! Solve the problem!
Col. Frank Ryan, CPA, USMCR (Ret.) served in Iraq and briefly in Afghanistan. He specializes in corporate restructuring and lectures on ethics for the state CPA societies. He has served on numerous boards of publicly traded and non-profit organizations. He can be reached at FRYAN1951@aol.com and Twitter @fryan1951.