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The Fed Is a Big Part of the Problem

10/20/2010 12:00 pm EST


John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, says the central bank often causes more problems than it solves, and needs to rethink its mission.

It seems that it is time once again to consider the question as to whether the Federal Reserve Board is the solution or the problem. I think the Fed is at least part of the problem, and maybe more.

The late, great Milton Friedman long argued that the Fed should supply stability, that [it] should see to a steady monetary growth rate of three or four percent per annum and should try to stay out of everybody’s way.

I’ve lived through five Fed chairs: Arthur F. Burns, G. William Miller, Paul A. Volcker, Alan Greenspan, [and] Ben S. Bernanke.

Volcker seemingly single-handedly broke the back of inflation in the most spectacular and gut-wrenching manner possible. Next up was Alan Greenspan, who steered the steadiest course of them all and in the end was reviled for doing so.

Then came Bernanke, who seems to be the most anxious of all of them to be the glamour boy in the headlines. Of all these men, Greenspan came the closest to what I’d like to see, but in the final analysis he, too, became proactive, which proved his undoing.

The problem is that the Federal Reserve Board with its twin goals (“to promote ‘maximum’ sustainable output and employment and to promote ‘stable’ prices”) is really no different than any other group of individuals that forms a crowd. They are too fearful at the bottom and exuberant at the top. Rather than being counter-cyclical, which is their real mission, they end up being procyclical. Rather than being conservative, they are proactive.

In my relatively short investing career, I’ve seen bubbles in gold, real estate, Internet stocks, bonds, energy, mortgage-backed securities, airline stocks and conglomerates, to name a few, and more often than not the Fed was either the cause or played along. I suspect that all of them would have been smaller, or perhaps not bubbles at all, had the Fed been steering a steady course.

In essence, what I’d like is a Fed that is shy, insecure and modest; a Fed that acts rarely and then with circumspection. Today’s Fed is not only pro-cyclical, it is a Fed that believes in its own efficacy when there is precious little in its 97-year history to suggest that they are capable of anything other than causing trouble.

Like Dr. Friedman, I’d like to see the Federal Reserve abolished, or at least tightly hobbled. Lacking that, I’d like them to steer the steadiest course imaginable, at least through three or more cycles, so everybody gets the message that there will be no Fed “put”—the idea that institutions and individuals take excessive risks because they think that the Fed will be there to bail them out.

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