WORD ON THE STREET: Winston Churchill was in New York on Oct. 29, 1929, Black Thursday. Bernard Baruch took him to dinner that night with some 40 or so luminaries of finance – ‘friends and former millionaires,’ Baruch called them.
Churchill listened and, over the course of the evening and the next few days, took measure of the situation. He recorded his impression as follows: No one ‘could doubt that this financial disaster, huge as it is, cruel as it is to thousands, is only a passing episode in the march of a valiantâ�¦people whoâ�¦are showing all nations much that they should attempt and much that they should avoid.’ The historian Martin Gilbert later wrote that in the face of a fearful crisis, Churchill had seen the United States ‘at its most magnificent and its most tormented.’
Move the clock forward 82 years. We have no one on the world stage as eloquent as Churchill. But even the most prosaic observer might now be given to repeating the Last Lion's observation: The financial disaster of 2008 and 2009 was huge. It was cruel – not to thousands, but to millions of Americans who lost their jobs and saw their savings and standard of living decimated. And yet, painful as it was – and remains for so many – it is proving to be a passing episode in the onward march of a valiant people.
In coping with the crisis and its aftermath, we have seen America at its most magnificent and its most tormented. We have shown others much that they should attempt and much that they should avoid.
During the recent panic, the most important ingredient in the functioning of financial markets – trust in counterparties – imploded. The liquidity required to finance the business of America disappeared. Interbank lending evaporated. Risk premiums soared. The commercial paper market faltered. A hallmark money-market fund ‘broke the buck.’ Asset-backed-security lending stopped cold. The entire spectrum of financing for businesses collapsed; the gears of the American economy went into reverse.
Seemingly overnight, we were transformed from a grand vessel that had been sailing along on the tranquil sea of the Great Moderation into a battered wreck tossed about in a perfect storm threatening to dash us on the rocks of deflation, depression and ruin.
Eager to avoid the mistakes made by our predecessors during the 1930s, and led by an unassuming but determined chairman, the Federal Reserve created a panoply of programs to revive the key financial markets. In the face of widespread fear among businesses and the broader public, consternation among financial operators, and a great deal of breast beating by politicians threatening to compromise the independence that is so vital to operate a successful central bank, the Fed stepped into the breach.
It did so in keeping with the ultimate duty of any central bank as lender of last resort: Drawing on emergency powers previously given to us by the Congress, we addressed the exigent circumstances we faced by opening the floodgates to restore the credit markets and pull the economy back from the brink.
The long and short of it all was that the medicine applied by the Federal Reserve worked. Whereas, then there was no liquidity to finance our economy, now there is plenty: Money is cheap; banks and credit markets are flush; the stock market has soared. Financial wherewithal is widely available to businesses – public and private – that have the capacity to put the American people back to work.
To be sure, there are some, including me, who worry that the Fed ultimately may have taken out too much insurance against a double-dip recession and slippage into a deflationary spiral. There are some, including me, who argued against the last tranche of insurance we took out in committing to buy $600 billion in U.S. Treasuries between last November and the end of this coming June as we were simultaneously purchasing additional Treasuries to make up for the roll-off in our mortgage-backed securities portfolio.
There was a strong feeling among those of my policy persuasion that we had already sufficiently refilled the tanks holding the financial fuel businesses needed to drive their job-creating machines. They felt that by being too accommodative, we might run the risk of planting the seeds that could germinate into renewed volatility, speculation and inflation, or give comfort to a government that for far too many congressional cycles has fallen down on the job by spending, borrowing and committing to unfunded programs with reckless abandon.Â
But whether you feel that the Federal Reserve has gotten it just right or gone a bit beyond the call of duty, it is hard for anyone to argue that the Fed did not succeed in pulling the financial markets back from the brink and has successfully reliquefied the economy, restoring the flow of the vital lifeblood of commerce.
I happen to believe one of the best outcomes of the crisis is that the Fed demonstrated the importance of a central bank's keeping its word. We said we would close the numerous emergency programs we engineered once they had done their job. And we have thus far done so.
Imagine that: A government agency that (a) does what it says it will do; (b) actually closes down programs once they have served their purpose; and (c) not only does not lose taxpayer money in the process, but makes a profit for the Treasury from it.
The next chapter
I do not, however, feel that further monetary accommodation will speed the process. It might well retard job creation, should it give rise to inflationary expectations or, worse, imply that, having suffered the slings and arrows of popular and political contempt as we went about doing what we did to save the financial system, we have now been compromised and become a pliant accomplice to Congress' and the executive branch's fiscal misfeasance.
I am wary of those risks. Indeed, as a voting member of the Federal Open Market Committee this year, I have made clear within the meeting room and in public speeches that, barring some frightful development, I will vote against any program that might seek to extend or enlarge the substantial monetary accommodation we already have provided, just as I argued against the $600 billion extension the voters on the Committee approved last November.
And I remain doubtful enough as to its efficacy that if at any time between now and June, it should prove demonstrably counterproductive, I will vote to curtail or perhaps discontinue it. As I said, the liquidity tanks are full, if not brimming over. The Fed has done its job. What is needed now is for business to be incentivized to commit that liquidity to creating American jobs. This is the task of the fiscal authorities, not the Federal Reserve.
I was quoted in the Washington Post on Feb. 21 as saying that we had suffered for too long from ‘Lindsay Lohan’ Congresses. Like Lohan, the U.S. Congress is a beautiful creation, blessed with enormous talent. But it has been waylaid by addiction – in the case of the Congress, to spending and debt – and by a proclivity for shoplifting – in the case of the Congress, to pocketing for their immediate gratification the economic future of our children and grandchildren and our grandchildren's children.
Reasonable arguments can be made that fiscal policy must loosen during cyclical downturns to provide an economic environment conducive to growth. Some economic research even points to deficit spending as an essential ingredient for recovery when interest rates are near the so-called zero bound or the Fed has reached the limit of prudent monetary accommodation through other means. We certainly have put that theory to the test during the past two fiscal years, running deficits of $1.3 trillion in 2010 and an expected $1.65 trillion in 2011.
What's troubling about the fiscal situation, however, is the likelihood of persistent large yearly deficits long after the current recession is behind us. The same economic theory that prescribes deficits during recession prescribes surpluses during recovery to help meet the next economic challenge that might develop. If current deficits were exclusively due to cyclical phenomena, one would expect to see surpluses as we distance ourselves from the Great Recession we have just experienced.
Instead, as far as the eyes of the analysts at the Office of Management and Budget can see, deficits will remain slightly above the 3% GDP threshold at which it is feared significant crowding-out of private sector economic activity begins to appear. And other observers, under less optimistic assumptions, foresee significantly higher deficits in the years ahead.Â
The U.S. economy is afflicted with the pathology of structural deficits. This leaves the nation poorly positioned to weather the next recession or shock to come our way. I devoutly hope our next downturn won't come for quite some time, but it surely will come eventually.
Will we follow the lead of the biblical Joseph, storing fiscal grain during boom times in preparation for the lean times that will, inevitably, someday follow? Or will we take the opposite course and run larger-than-normal deficits every year, hindering our ability to respond when the current expansion ends or an unforeseen crisis occurs, thereby undermining the confidence needed by businesses to commit sustainable job-creating capital here at home?
Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas. This article is edited and adapted from a speech delivered March 7 at the Institute of International Bankers' Annual Washington Conference in Washington, D.C. The original text can be found online.
