The Fed In the Echo Chamber

By Robert J. Samuelson
Tuesday, January 29, 2008

Jim Cramer -- the hyperactive, loud and opinionated host of CNBC's "Mad Money" -- is no fan of Federal Reserve Chairman Ben Bernanke. If you'd tuned into "Mad Money" any time in recent months, you might have caught one of Cramer's outbursts against the former Princeton University economics professor. "Defend us from Uncle Ben Bernanke's relentless march to recession," went one rant. "You know what Bernanke is? He's the General Sherman of monetary policy. He's waging total war against the American economy."

Call this the rise of financial populism. Cramer is its biggest star, and, in some ways, it has fundamentally altered the climate in which the Federal Reserve makes economic policy. Throughout its history, the Fed has rarely been popular (the peaceful period in the 1990s under Alan Greenspan was an exception). People often blame the Fed for recessions or high interest rates. But traditionally, politicians, business leaders and unions have been the most vocal critics.

No more. In recent months, the noisiest criticism of the Fed has come from Wall Street. Hordes of money managers, commentators and economists have joined Cramer in ridiculing Bernanke and other Fed officials. They're "clueless" and "behind the curve." The blunt message: Cut interest rates; revive the economy; boost stock prices. But these custodians of capital no longer speak only for small numbers of the superwealthy. From 1980 to 2005, the share of U.S. households owning stocks or mutual funds went from less than 19 percent to 50 percent.

Just as the late-19th-century populists, mostly farmers, wanted the government to provide cheap money and curb the railroads' power, today's financial populists think government should somehow guarantee that the economy always expands and that stock prices always rise. Whenever either seems threatened, there's a clamor for action. Last week, Bernanke's Fed seemed to capitulate by cutting its overnight Fed funds rate from 4.25 percent to 3.5 percent (as recently as mid-September, it had been 5.25 percent). Another cut could come this week.

Of course, the Fed doesn't think it was surrendering to critics. Instead, it was trying to avert a financial stampede. Before the Fed took action, global stock markets were plunging; they were already down 12 percent for the year, says Howard Silverblatt of Standard & Poor's. The paper loss totaled $6 trillion. There were signs of a huge sell-off of U.S. stocks. The Fed rate cut aimed to prevent a panic that would feed on itself. Lower rates would improve confidence by cushioning any economic slowdown.

Fair enough. The trouble is that this may be a distinction without a difference, because market sentiment -- what sends prices up or down -- is heavily shaped by the financial populists operating through the business cable channels, Internet-distributed commentaries and the print press. There is a vast echo chamber in which if something is repeated often enough, it becomes its own reality. When there's mostly cheering, stock or bond prices rise; with boos, prices fall. Either way, the Fed must deal with what "the markets" are saying. The present panicky climate results, at least partly, from all the invective heaped on the Fed.

What Cramer and many talking heads offer are selective and sensationalized views that favor short-term conditions and immediate gratification: higher stock prices tomorrow; better trading profits. By these appraisals, the U.S. economy is in dire shape. Who knows? Maybe a calamity lies just ahead. But as yet, the evidence is unconvincing. For all of 2007, profits of nonfinancial corporations were up 6 percent, says Silverblatt.

Of course, the economy has serious problems. But not every problem -- even a recession -- is the apocalypse. In the late 1990s, the electronic echo chamber promoted unrealistic euphoria that fed the "tech bubble." It's not just that these portrayals, in both directions, exaggerate. They may also encourage self-defeating economic policies.

The Fed's first responsibility is to keep inflation at low levels because, without that, its other goals of maximum economic growth and low unemployment become impossible. We learned this lesson painfully in the 1960s and the 1970s. Political pressures then to avoid all recessions led the Fed to relax money and credit too often. The perverse results were higher inflation and more frequent and harsher recessions. Annual inflation peaked at 13.3 percent in 1979 and annual unemployment at 9.7 percent in 1982.

Some economists think that the Fed is already repeating its previous error, now prodded by "market pressures" and the specter of financial panic. If the market constantly demands to be stimulated by lower interest rates and easier credit, and threatens to go into an uncontrolled tailspin if it isn't, then the Fed is in a treacherous position. Trying to make matters better now may make them much worse in a few years if higher inflation emerges. This danger is easily overlooked.

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