Blame Hubert Humphrey for the Fed’s Bad Policy

Demand for full employment leads the central bank to inflate bubbles.

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in million is able to diagnose.”

John Maynard Keynes (1920)

Thirty-one years after his death, Hubert Humphrey‘s legacy is alive, but perhaps not so well.

While the Federal Reserve is under well-deserved criticism for its attempts at bailing out Wall Street, its defenders worry aloud over compromising the independence of the central bank.

Yet the Fed was politicized long ago by the Full Employment and Balanced Growth Act of 1978, later known by its eponymous title, Humphrey-Hawkins.

At its inception in 1913, the Federal Reserve had no planned role in supervising the economy.

Though a series of economic swings undoubtedly put pressure on monetary authorities, Humphrey-Hawkins codified two contradictory goals for the central bank.

Ostensibly, the legislation embraced sound money through stable prices, but it also required the Fed to promote “maximum employment … and moderate long-term interest rates.”

Monetary policy cannot do both. The stagflation of the Carter years should have proven that once and for all.

And even though Humphrey-Hawkins has technically expired, its legacy lives on by subjecting Fed officials to congressional inquiries over what they’re doing about unemployment and recession.

The result has been a clear bias toward artificially low interest rates and easy money manifest in a dollar worth less than half of its 1970s counterpart.

It’s gotten so bad that Wall Street now transparently counts on the Bernanke “put” — a reference to the Fed chairman’s desire to bail out a sagging economy.

Indeed, since 2008, the Fed has purchased (read: loaned) almost $2 trillion worth of mortgage-backed securities and Treasury IOUs in a desperate attempt to inflate our way out of a financial crisis.

The latest $600 billion round of “quantitative easing” (called QE2) is aimed at lowering long-term rates, though they are now going in the opposite direction.

Politicians love central bank interventions precisely because economic adjustments to excess speculation — also known as recessions — are bad for their careers.

Instead of allowing the market to clear and malinvestment to be worked off, Washington resorts to a sneaky way to get workers to lower wage demands and get businesses to accept less income: It turns on the printing presses.

Financing bailouts or unemployment insurance by monetizing the debt amounts to little more than economic subterfuge.

Those who get the newly created money first do all right, but by the time the rest of America sees it, prices and interest rates are already on the rise. This cruelest tax of all is evident in rising gas and grocery bills, not to mention skyrocketing prices for precious metals.

The intelligentsia say this doesn’t matter and insist on regaling us with stories about subdued levels of “core” inflation — as though food and energy prices don’t count.

But it’s hard not to see rising commodity prices as anything but a harbinger of things to come. In fact, asset bubbles in tech stocks, housing and the bond markets have followed predictable Austrian cycles of boom and bust.

Of course, had the government not misdirected investment into housing with its own fiscal and monetary policies, the downturn would have been quite manageable.

Corrections, far from market failure, are its salvation. As it is, policymakers are merely attempting to reinflate the bubble by doubling down on the very policies of spending and debt that got us here in the first place.

Suffice it say, you can’t tax or spend your way out of a recession — nor can you print your way out, either.

It is long past time to do away with Humphrey-Hawkins dual mandate and limit the Federal Reserve to its fundamental role of stable prices.

Rep. Mike Pence of Indiana has already introduced legislation to that effect, and it might just be a good starting point for the new Republican House.

Published in the Star Tribune, January 8, 2011