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Less Fed Financial Repression Irrational?

July 13, 2014 in Economics

By Hunter Lewis

In a recent Bloomberg Views piece, mainstream economist Noah Smith accused his Austrian  critics of having “brain worms” and even “anti-semitic overtones.” He then mischaracterized what his critics were saying so that he could ridicule it.

This wasn’t very conducive to a dialogue. His last Bloomberg piece, out on July 10, is better. It offers a specific proposal: don’t raise today’s ultra low interest rates.  Unfortunately it doesn’t say whether this advice is forever, or for now. But it is a specific proposal.

This is all the more helpful because it is difficult to tease specific proposals out of mainstream ( usually Keynesian) economists. For example, during and after the Crash the best known Keynesian economists ( Krugman, Shiller, Romer, Yellen etc.) kept saying we needed more government stimulus of the economy, but refused to give us the exact prescription.

This was very convenient when the stimulus failed; they could just claim that there hadn’t been enough. Never mind that they had refused to tell us in the first place how much was needed or for how long.

In his latest piece, Noah Smith not only says that short term interest rates should stay where they are, close to zero, and well below even reported inflation. He further argues that these giveaway interest rates ( made available to Wall Street, not to Main Street) are not creating a stock market or other asset bubble like the dot com or housing bubbles.

Smith then gives us what he calls Finance 101. Here is what he says: “The value of a financial asset is the discounted present value of its future payoffs, and when the discount rate — of which the Fed interest rate is a component — goes down, the true fundamental value of risky assets goes up mechanically and automatically. That’s rational price appreciation, not a bubble.”

Let’s see. The Fed artificially represses interest rates for now, with no guarantee that they won’t go bounding back up anytime in the future, even the near future, but stocks should be valued as if the artificially repressed rates are permanent. Sorry, this isn’t “rational” and it certainly isn’t Finance 101.

Smith further notes that “bubbles form when people think they can find some greater fool to sell to.” Hm. Why do people expect to find “greater fools” at some times and not other times?

George W. Bush famously said that “Wall Street got drunk” before the 2008 …read more