The Lighthouse^®

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The Lighthouse^® is the weekly email newsletter of the Independent Institute.
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Volume 14, Issue 36: September 5, 2012

1. Boom and Bust Banking—Causes and Cures
2. Bad Policies Undermine Job Growth
3. How to Improve Flexible Savings Accounts
4. Iran Earthquakes Prompt Sanctions Relief
5. New Blog Posts

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The twenty-first century opened with optimism, as first the technology sector and then the housing sector boomed. But then came the financial crisis and the Great Recession—the worst economic malaise since the 1930s. Why, after several decades of economic stability, did the business cycle return with such force? Most attempts to answer this question have neglected the impact of the most powerful economic actor on the world stage today: the Federal Reserve. In the new Independent Institute book Boom and Bust Banking: The Causes and Cures of the Great Recession, editor David Beckworth and eleven other economists remedy this deficiency by explaining why the U.S. central bank bears most of the blame for the calamity. After explaining how the U.S. central bank created the Great Boom and the Great Recession, the book proposes fundamental reforms—monetary regime change—to avoid future cycles of boom and bust.

The Federal Reserve, the book shows, precipitated an unsustainable housing bubble; the misaligned incentives in the financial system merely amplified the effects of the Fed’s easy monetary policy. The Fed also took the wrong tack when the economy began to contract: it tightened monetary policy at a time when the demand for money was increasing rapidly. Instead of dealing with this increase in money demand, the Fed focused on becoming “lender of last resort” on a scale so vast that it became a central planner of credit allocation. Because the Federal Reserve is a monetary superpower with global influence, its policies contributed to the boom and bust cycle in other countries. The book’s detailed examination of these and related topics illuminates issues that most analysts and policymakers have misunderstood.

If we are to avoid repeats of the Fed’s mistakes, we must adopt a better approach to monetary policy. Exactly what that approach should be is a matter debate. Some contributors to Boom and Bust Banking argue that the U.S. central bank should adopt a monetary rule aimed at stabilizing total current-dollar spending, a policy that might have avoided the Great Boom and Great Recession. Others are skeptical that such a rule would be adequate to prevent future banking crises, given the information constraints and political incentives of central banks as well as the public’s perception that large insolvent banks would continue to be bailed out. The final chapter makes the case for a radical alternative to central banking: free banking with competitive note issue. Under such a system, individual banks would know on a daily basis, via the level of interbank clearings, whether to increase or decrease their issuance of bank notes in response to changes in money demand; and collectively their actions would tend to stabilize total current-dollar spending. Boom and Bust Banking offers cutting-edge diagnoses of the Great Recession and prescriptions for avoiding future cycles of boom and bust that anyone well versed in money and banking would benefit from reading.

Boom and Bust Banking: The Causes and Cures of the Great Recession, edited by David Beckworth (The Independent Institute, 2012)

Read the book summary.

Read the Introduction by David Beckworth (pdf).

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Business leaders across the United States are frustrated with Washington, DC. No surprise there. What’s noteworthy is that the frustration is, to some degree at least, measurable. According to the Wall Street Journal, a review of transcripts from 500 teleconference calls shows that corporate CEOs are fed up with the uncertain economic climate caused by the country’s political leaders—the uncertainties created by massive federal bailouts and takeovers, new taxes and regulations, and the overhaul of healthcare and the financial sector. In essence, business leaders’ frustrations stem from the same problem that made the Great Depression last so long—a climate of “regime uncertainty,” as Robert Higgs calls it. The net effect has been crippling. If investors and business executives “cannot predict what the rules of the game will be, they will simply adopt a wait and see attitude,” as Independent Institute Senior Vice President Mary L. G. Theroux writes in her latest piece for the Huffington Post.

The frustration can be seen today in the growth of cash holdings. Non-financial corporations have increased their cash reserves to 7 percent of their assets—the highest levels since 1963. “The good news is that such resources, if deployed, could fuel a tremendous recovery in the private sector,” Theroux writes. “But the future policy environment is simply too unpredictable for American CEOs to do so, and current political divisiveness and campaign rhetoric aren’t doing anything to allay these fears.”

The resumption of prosperity in the past century came not with the onset of World War II, as Keynesian economists often claim, but rather with its end, as Truman allowed the resources that the federal government had commandeered—including conscripted labor—to return to a private sector that was free to focus on production for the civilian economy. “Washington today . . . needs similarly to reverse the past decade’s pattern of runaway federal spending and mounting debt—settling monetary, tax, and regulatory policies to predicable, reasonable levels that encourage investment in enterprises large and small,” Theroux writes. “That truly would get America back to work.”

No Job Growth under “Regime Uncertainty,” by Mary L. G. Theroux (The Huffington Post, 8/27/12)

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More than 35 million people in the United States have tax-free Flexible Spending Accounts (FSAs) for healthcare. Unlike regular Health Savings Accounts and Health Retirement Accounts (used by about 25 million people), FSAs are “use it or lose it”: the account balances are forfeited at year’s end (or after a grace period). FSAs therefore can distort healthcare-spending patterns. “They encourage employees to purchase designer eyeglasses with pre-tax dollars, for example, rather than purchase other goods and services with after-tax dollars,” writes Independent Institute Research Fellow John C. Goodman, author of Priceless: Curing the Healthcare Crisis. In his latest piece for The Beacon, Goodman examines the benefits of undoing the use-it-or-lose-it feature of FSAs and allowing the balance to carry over year-to-year, tax free.

If FSAs could roll over and become use-it-or-save-it accounts, the account holders “could save for more valuable future healthcare spending,” Goodman writes. “Employers across the country would consider integrating these accounts into their health plans, making employer contributions to them, and experimenting with some of the new health plan designs described [in Priceless]. Many of the companies that currently have HSA or HRA plans might discover that the FSA approach is better for controlling costs.”

Moreover, such a reform seems simple to carry out. Because the use-it-or-lose-it feature is the result of a ruling by the Treasury Department, that agency presumably has the authority to change the ruling. How about it, Mr. Geithner? A little more flexibility for 35 million FSA account holders and their employers?

A Simple Way to Control Healthcare Spending, by John C. Goodman (The Beacon, 9/4/12)

Priceless: Curing the Healthcare Crisis, by John C. Goodman

Video: John C. Goodman on C-SPAN2’s Book TV (8/12/12)

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Iran’s Tabriz earthquakes early this month have done more than kill 300 or so people and injure 3000 more. They’ve also shaken loose the U.S. government’s economic sanctions—at least partially and temporarily. Until October 5, selected nonprofit groups will be allowed to collect donations for earthquake victims. Independent Institute Senior Fellow Ivan Eland hails this measure by the White House, and calls on the administration to further scale back its sanctions.

“The Obama administration should extend this compassion and realize that many of the United States’ more general economic sanctions against Iran for its nuclear program, which would not be lifted by the temporary relaxation, are also harming the Iranian people,” Eland writes in his latest op-ed. “Unlike more defensible targeted sanctions against items that can be used in the nuclear program and against Iranians who are connected with it or terrorism, more general economic sanctions—such as bans on the importation of Iranian oil or financial transactions associated with such trade—are blunt instruments of statecraft that do hurt the Iranian people.”

Although economic sanctions are frequently touted as a tool for avoiding open warfare, Eland argues they often presage war, as happened when sanctions failed to work against Manuel Noriega and Saddam Hussein. The failure of economic sanctions, according to Eland, puts the prestige of the sanctioning nation at risk—or rather the prestige of the sanctioning administration—and the loss of this prestige may be too large a psychological blow for national leaders to tolerate. “If policymakers want to avoid war,” Eland writes, they should just do so rather than try to delay it using grinding but ineffectual economic measures, which only increase suffering in the meantime.”

Obama Should Extend His Compassion, by Ivan Eland (8/28/12)

No War for Oil: U.S. Dependency and the Middle East, by Ivan Eland

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From The Beacon:

From MyGovCost News & Blog:

You can find the Independent Institute’s Spanish-language blog here.

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