Hanging the Fed Out to Dry Is Not "Good Politics"

-- Posted by Neil H. Buchanan

My Verdict column yesterday focused on the Federal Reserve (the Fed).  Unless something changes, the Senate will vote on Monday to confirm Janet Yellen as the Fed's next chairperson.  In some ways, it is amazing that Yellen's confirmation did not become a big political fight.  She is a "dove" on monetary policy, which means that she strongly supported outgoing chairman Ben Bernanke's series of accommodating policy measures, including near-zero interest rates, expansion of the monetary base, and announcements that those policies would continue until unemployment drops significantly.

Not only are those policies anathema to the financial interests who back the Republican Party, but they also enrage the populist/libertarian right that is suspicious of the very idea of a central bank.  The big libertarian hero, now retired, and his Senator son have spent years stoking the flames of anti-Fed outrage, to the point where "debasing the currency" is now equivalent to "Fed policy" in the minds of their followers.  The "gold bugs" have ever been with us, and the Paul people vociferously refuse to understand how money actually works.  What Keynes called a "barbarous relic" is, in their minds, the magical key to economic nirvana.

These gold evangelists, moreover, hold a great deal of power in the Republican Party.  Their elected members have been placed on key Congressional committees, and they regularly pummel the Fed chair when he makes his statutorily required appearances to testify before Congress.  With one of the likely candidates for President in the 2016 Republican primaries being an anti-Fed extremist, and with everyone else afraid of the Tea Party, there is precious little sober talk about the Fed on the right side of the aisle.

Even so, Yellen will apparently be confirmed on Monday.  It was probably a foolish risk for the Democrats to allow her confirmation to be delayed until this month, but they seem to have gotten away with it.  Peace and reason reign throughout the land.

Early in 2013, I wrote a Dorf on Law post in which I tried to explain the mechanics of how the Fed affects the money supply, how it sometimes creates money and uses it to buy Treasury securities (which is to say, to lend money to the federal government), and so on.  The occasion for that post was to respond to the then-intensifying calls for the Fed to enable the "big coin gambit," the foolish idea that Treasury could deposit a platinum coin of any size with the Fed to avoid exceeding the debt ceiling.

The broader point, as I argued in a Verdict column three months ago, was that "the Fed could save the day," by stepping in to prevent a default, if the Republicans do not relent and increase the debt ceiling before the President faces a trilemmaIf we ever reach that terrible moment, the Fed could -- and should -- allow the President to avoid catastrophe by creating enough money to prevent default, and then lending that money to the government.  Yes, the Fed would be acting in violation of its statutory mandate, and yes, the President would be usurping Congress's borrowing power under the Constitution, but that is the impossible Republican-created environment in which the Fed would be forced to act.

The concern that I express in yesterday's Verdict column is that there would be serious political backlash against the Fed, in response to its efforts to prevent a catastrophic default.  Rather than being viewed as the world's savior, the Fed would be attacked by nearly everyone on the right for having taken sides in a political debate, aiding and abetting the President in his sinister plan to spend the economy into oblivion.

In short, the President can rely on the Fed to save the day, but he should do everything possible not to put the Fed in the position of having to do so.

This argument is in direct response to the political objections often expressed to the Buchanan-Dorf analysis of the debt ceiling.  Even those who agree with Professor Dorf and me on the merits of the Constitutional argument often say that the Obama people are justified in thinking that the politics would simply be too toxic.  I must say that both Professor Dorf and I often ruminate on that question as well, and we understand that politics cannot always be driven by Constitutional law, even by slam-dunk Constitutional legal conclusions.  The political analysis of something as big and unknown as an actual debt ceiling-induced trilemma is, at best, guesswork.

I have responded to the political concerns about the consequences to the President of (in the worst phrasing ever) "blowing past the debt ceiling" in a number of ways, most insistently by pointing out that the Republicans will make political hay no matter what the President does.  (That is why their strategy is an "impeachment trap.")

The point of yesterday's column adds to that argument, pointing out that the idea that the President has minimized political risks by refusing to negotiate (which, by the logic of stare-downs, will all but force the Fed to save the day, if the Republicans stand firm next time) is wishful thinking.  The President is not saying that he is counting on the Fed, of course, but he is surely doing so.

How seriously should the President, or anyone else, take the political threat to the Fed?  I have argued before that "money is magic," by which I mean that the public's profound misunderstanding of money and its creation is both understandable and dangerous.  My initial negative response to the Big Coin Gambit, in fact, was based on my concern that the public would freak out upon learning that the best minds all agree that the Fed can simply accept a platinum disk with a huge number stamped on it, and the Treasury can then avoid default.

Some people might reasonably disagree with my assessment of just how big such a freak-out would be, and how much lasting damage it might do.  Maybe it would not cause a complete financial melt-down and a global economic depression, perhaps because people would not be as surprised and scared as I think they would be.  I continue to believe that the ephemeral nature of money is so difficult for people to understand that we should never engage in policies that rely on people understanding and accepting the arbitrariness of money.  Certainly, seeing so many people imagine that gold is "real," and not just a different way for the social psychology of money to manifest itself, suggests that the degree of misunderstanding is extreme.

My concern here, however, is not with the possible evaporation of the public's collective belief in the social psychology of money, but with the Republicans' reaction to seeing the Fed appear to save Obama's behind.  Not having the Fed act, if Obama's current strategy does not work, would be worse.  But the Republicans' attacks on the Fed's continued independence would be fierce.  Even if one does not think that this will end life as we know it (and I certainly do not go that far), one must at least include this political cost of Obama's strategy in the balance, when deciding whether the President should or should not take a stand now on the debt ceiling.