No Extra Credit

What if the Obama jobs plan, the coming deliberations of the supercommittee, the debate over taxing millionaires — what if none of it is likely to make a whit of positive difference for the economy? What if the only thing that matters is something Congress and the president rarely mention, and can do nothing about?

I’ve come to believe this is the case. What is killing the economy is lack of credit. In the aftermath of an asset bubble, invariably the result of too-loose credit, banks don’t just tighten their standards; they practically shut down.

This was true during the Great Depression, and it’s been true during the Great Recession. And until normal credit standards return, economic growth will continue to be stunted. “Overreaction to the credit bubble is now the knee on the throat of the economy,” says my friend Lou Barnes, a mortgage banker at Premier Mortgage Group in Colorado.

Not long ago, Lou sent me a powerful new piece of evidence, a presentation put together by Paul Kasriel, chief economist for Northern Trust. Titled “If Some Dare Call It Treason, Was Milton Friedman a Traitor?” (the title will become clear shortly), it has the force of revelation.

The first part of the paper is spent “dispelling the nonsense” (Kasriel’s words) that factors besides credit are the root of the problem. He persuasively mocks the idea that “uncertainty” is holding back companies from borrowing. (“Uncertainty,” Kasriel told me, “is the last refuge of economists who can’t explain what is going on.”) Ditto for onerous taxes, record budget deficits and lack of demand.

He then documents “a post-WW II record” credit contraction, before moving on to a surprising solution: more quantitative easing from the Federal Reserve, which is essentially the buying of bonds from investors by the Fed, using money it prints, as Kasriel freely admits, “out of thin air.”

That this solution is controversial is not lost on Kasriel; his title is an obvious play on Rick Perry’s comment that continued quantitative easing by the Fed chairman, Ben Bernanke, would amount to borderline treason. But that’s where his reference to Friedman comes in. Kasriel is absolutely convinced that if the great conservative economist were alive today, he would be leading the charge for quantitative easing. It’s all we’ve got left.

In the 1930s, the Fed’s tight money policy compounded the lack of credit and sent the country into the Depression. Decades later, Milton Friedman was the economist who most persuasively proved that point. Bernanke, a student of the Depression, took that lesson to heart; his willingness to flood the system with liquidity during the financial crisis prevented a repeat.

It is also what led Bernanke to try the first two rounds of quantitative easing. “Banking under normal circumstances is a transmission mechanism from the Fed to the economy,” Kasriel told me. “That transmission mechanism is broken.” Quantitative easing is not nearly as efficient at expanding credit as having the banks involved, but it does work. During the decade of stagnation in Japan, Kasriel points out, Friedman urged its central bank to expand the money supply and buy bonds — exactly what Bernanke has been doing.

The main argument against the printing of money is that it raises the odds of inflation; even the esteemed Paul Volcker is worried about it, as he wrote in Monday’s Times. But Kasriel is convinced that the bigger fear right now is deflation, and that the expansion of credit by the Fed should be seen in combination with the contraction by the banks. In that larger context, the Fed’s move no longer looks inflationary. It looks instead like the only means we’ve got right now to create badly needed credit.

There is much resistance to another round of quantitative easing, not just from G.O.P. presidential hopefuls, but from many in the political establishment. Yet it’s worth noting that the reason Volcker is esteemed today is because, 30 years ago, as Fed chairman, he stuck by a monetary policy — a severe tightening, in his case — that he believed in despite fierce denunciations. His willingness to chart an unpopular course led directly to the economic revival of the 1980s.

Today, Ben Bernanke is every bit as vilified as Volcker was back then. Yet the Fed remains politically independent, and like Volcker, he has the right to chart the course he believes best, without political interference. The course he has charted is quantitative easing. Kasriel is utterly convincing that this is the right course. Bernanke should make the Fed’s independence matter.

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