Milton Friedman co-worker Anna Schwartz on the present financial problems

Yet isn't Bernanke a disciple of Friedman and Schwartz? He publicly refers to them as mentors, and, thanks to their scientific breakthrough, he has famously declared that "the Great Depression will not happen again." Bernanke is right about the past, Schwartz says, "but he is fighting the wrong war today; the present crisis has nothing to do with a lack of liquidity." President Obama's stimulus is similarly irrelevant, she believes, since the crisis also has nothing to do with a lack of demand or investment. The credit crunch, which is the recession's actual cause, comes only from a lack of trust, argues Schwartz. Lenders aren't lending because they don't know who is solvent, and they can't know who is solvent because portfolios remain full of mortgage-backed securities and other toxic assets.

To rekindle the credit market, the banks must get rid of those toxic assets. That's why Schwartz supported, in principle, the Bush administration's first proposal for responding to the crisis--to buy bad assets from banks--though not, she emphasizes, while pricing those assets so generously as to prop up failed institutions. The administration abandoned its plan when it appeared too complicated to price the assets. Bernanke and then-Treasury secretary Henry Paulson subsequently shifted to recapitalizing the banks directly. "Doing so is shifting from trying to save the banking system to trying to save bankers, which is not the same thing," Schwartz says. "Ultimately, though, firms that made wrong decisions should fail. The market works better when wrong decisions are punished and good decisions make you rich." She's more sympathetic to Treasury secretary Timothy Geithner's plan, unveiled in March, to give private investors money to help them buy the toxic assets, but wonders if the Obama administration will continue to support the plan if the assets' prices turn out to be so low, once investors start bidding for them, that they threaten the banks.

What about "systemic risk"--much heard about these days to justify the government's massive intervention in the economy in recent months? Schwartz considers this an excuse for bankers to save their skins after making so many bad decisions. "The worst thing for a government to do, though, is to act without principles, to make ad hoc decisions, to do something one day and another thing tomorrow," she says. The market will respond positively only after the government begins to follow a steady, predictable course. To prove her point, Schwartz points out that nothing the government has done to date has really thawed credit.

Schwartz indicts Bernanke for fighting the wrong war. Could one turn the same accusation against her? Should we worry about inflation when some believe deflation to be the real enemy? "The risk of deflation is very much exaggerated," she answers. Inflation seems to her "unavoidable": the Federal Reserve is creating money with little restraint, while Treasury expenditures remain far in excess of revenue. The inflation spigot is thus wide open. To beat the coming inflation, a "new Paul Volcker will be needed at the head of the Federal Reserve."

Who listens to her these days? "I'm not a media person," she tells me. She rarely grants interviews, which distract her from her current research: a survey of government intervention in setting foreign exchange rates between 1962 and 1985. Never before have these data been combined to show what works and what doesn't. In her nineties, she remains a trendsetter.


Posted by John Ray. For a daily critique of Leftist activities, see DISSECTING LEFTISM. For a daily survey of Australian politics, see AUSTRALIAN POLITICS Also, don't forget your daily roundup of pro-environment but anti-Greenie news and commentary at GREENIE WATCH . Email me (John Ray) here

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