Two Decades Of Easy Money

Do we have the wit and the wisdom to restore an environment of price stability without impairing economic stability? Should we fail, I fear the distortions and uncertainty generated by inflation itself will greatly extend and exaggerate the sense of malaise and caution … Should we succeed, I believe the stage will have been set for a new long period of prosperity.

– Paul Volcker (subscription required), 1978, Chairman of the Federal Reserve, 1979-1987

When shall we stop appointing as Fed chairmen either academic economists – out of touch with the messy real world? – or lightweight commercial economists and find someone with solid banking experience? Would a banker with even a hint of John Pierpont Morgan in him have allowed such a sad deterioration of credit and banking standards? Where was Mr Volcker when we needed him? Fired for doing unpleasant but necessary things. So perhaps we get the Fed we deserve.

– Legendary Investor Jeremy Grantham, “Fed needs tough chief in Paul Volcker mould” (registration possibly required), Financial Times, April 29

I want to encourage everybody to read Jeremy Grantham’s fine article in the Financial Times yesterday.  Here’s the money excerpt:

Not believing in bubbles and/or being unwilling to risk unpopularity by moving against them leaves the two Fed bosses with no alternative but to give free rein to speculators on the upside and focus on the downside. But, even on the downside, did they have to be so generous?

It created an extreme form of moral hazard: it allowed risk takers to win too big and too easily; it helped spawn a huge hedge fund industry; and, worse still, it helped turn formerly discreet bankers into speculators. If you even partially bail out Bear Stearns – leveraged at 40 to 1 – next time someone will try 50 to 1.

The Fed must show some backbone. If you always take the friendly way out, no bubbles will ever be pricked and we shall always be reacting to crises in an increasingly speculative world. Paul Volcker, the Fed chairman before Mr Greenspan, had the character to do tough, unpleasant things where necessary. His two successors have not.