Is the Fed Political?

The Fed is supposed to be independent of the political process, but in reality that is probably not possible, given that its head is a political appointee. The chairman of the Federal Reserve Board, Ben Bernanke, was appointed by George W. Bush in 2006. You don’t appoint someone who is not on your team.

At this week’s FOMC meeting, the fed had to decide whether inflation was getting strong enough to justify an interest rate hike, or whether such a hike would depress the domestic economy too much. They decided to talk tough but actually do nothing.

By failing to raise rates, Bernanke allows inflation to creep up, saying (in deed, not in words), “we are not worried about it.” That means he doesn’t care if the weak dollar gets even weaker, eaten away by inflation. But since oil is priced internationally in dollars, failure to make a rate hike, even a small one, raises the price of oil. And that’s exactly what happened. It is up as much as $4 a barrel today to around $138.

The justification I have read for the Fed’s decision is that “core” inflation (exclusive of energy and food) is relatively manageable. Of course that begs the question of what planet FOMC members live on where energy and food “don’t count.”

But I think there was a more sinister motive at work, related to the fact that Bernanke is on the Bush team. To raise rates, even a quarter percent, would likely have prolonged the housing crisis. It would have raised mortgage rates and reduced the number of buyers, stifling any nascent recovery in the housing market.

The housing market is a huge domestic political issue. If housing does not recover by November, the Republicans are toast for sure. Inability to sell a house is not an abstract economic issue. It could mean that you are paying two mortgages, or it could mean you have to turn down a job that involves a relocation. If your mortgage is higher than what your house is worth, you can only pray for recovery of the housing market before you are forced into foreclosure. Big corporations like the new home builders are also feeling the pain. Lennar today posted large quarterly losses.

High gas prices hurt voters too, especially the less well-off who pay a higher percentage of their income on fuel. One of my students says she pays $130 to fill up her SUV and does that three times a week. That is a serious dent in anybody's budget. (Naturally I want to yell at her: “What are you doing with a stupid SUV?” But that’s like saying to a child who is in a fix, “You should have thought of that earlier!” Not helpful.).

But who is to blame for high gas prices? Why, it’s those pesky Arabs! And slithering speculators. And don’t forget those greasy oil companies!

Obviously then, for Bernanke, if he lets the dollar decline further, oil prices go up further, but it’s not his fault! It’s not the government’s fault. It’s not the Republicans’ fault. It’s somebody else’s fault. Easy choice to make.

But if he had raised rates, even a tiny bit, there would have been an effect on the housing market, probably negligible and short term, but the housing crisis then could clearly be pinned on him. Unacceptable choice. Because that means the housing crisis is the fault of the government and that would have repercussions at the ballot box in November. So Bernanke chose the course that least harms his political party.

Paradoxically, even if his choice was politically motivated, it will have a counterproductive effect. At some point of pain, which we are fast approaching, voters will realize that Republicans have no energy policy (other than to drill for oil on beaches and in national parks). That will kill them in November.

Oil and Tax

The high price of gas has politicians in a tizzy, perhaps more so than ordinary consumers. Sure, the recent price increases are unpleasant, but I haven’t seen riots in the street because of it. Instead, we hear about the demise of the Hummer, not a bad thing. High oil prices also hurt in indirect ways, such as higher fertilizer and freight costs and pricier airline tickets, but again, it seems like the economy is absorbing the shock so far. We should consider that the price of gas is double, over $8 a gallon in Europe. That seems to be the point at which people, or at least truckers, riot in the streets.

Although it hurts my wallet, I am hopeful that the high price of fuel will continue and eventually strain the economy severely enough that the government is forced to develop a rational energy policy.

The recent Democratically sponsored bill to increase taxes on US oil companies failed to reach the senate floor when it was blocked by Republicans. The bill would have eliminated $17 billion in tax breaks for oil companies who are reporting historically high profits in the trillions of dollars. It seems reasonable on the face of it that they could afford to pay the true costs of production.

The bill also threatened further tax punishment if the oil companies did not invest in new energy sources soon. That provision seems less obvious, as we know that honey works better than vinegar, but again, given that companies are awash in money right now, it could possibly work.

However, if I were a senator, even a Democratic senator, I think I would have voted with the Republicans on this one. The bill was a simple-minded, short term, knee-jerk response to perceived voter unhappiness over gasoline costs, even though it is psychologically satisfying to vilify those fat-cat oil companies. It also wouldn’t hurt in the fall elections to say “we did something for you,” (or tried to, at least).

The proposed senate legislation did nothing to address fundamental issues, such as inadequate refining capacity, unwillingness to pressure the auto industry to raise fuel economy standards, fund alternative energy sources, develop a nationwide plan for oil conservation, and so on. How about a tax on plastic and synthetic fibers?

Closing tax loopholes for the oil companies is a good idea in principle, but it needs to be part of a comprehensive energy policy. For example, would the revenue from the oil company tax go to fund clean coal technology or public transportation? No such ideas were mooted. And on the down side, taxing oil companies right now might inhibit construction of new refining capacity and at the margins, diminish exploration and production among the smaller, hi-tech companies, leading to higher gasoline prices.

Of course oil companies are among the largest political donors in the country, especially on the Republican side, so corruption no doubt played a role in the vote’s outcome. Still, I think the Republicans were on the right side of this vote in terms of long term strategy. The senate bill seemed more of a political stunt than a well though-out solution to basic problems. The price at the gas pump is only a symptom of a much larger energy problem.

I wonder, though, if I could have voted with the Republicans on this one, if I were a Democratic senator. Would it be career-limiting? Would Harry Reid send over someone to break my legs? I wonder how it works when your own party promotes a hare-brained scheme.

Surrender?

Recently I saw on television John McCain give a campaign speech referring to the Democratic candidates’ plan to pull US troops out of Iraq as quickly as feasible.

To this, McCain vowed, “I will never surrender in Iraq!” As the crowd cheered and applauded, he yelled full-throat, “I will never surrender!”

But what does he mean? We invade and occupy someone else’s country then vow to never surrender it? Does that mean McCain intends to keep Iraq as a permanent U.S. possession?

To surrender is to give up possession of some thing or some power to someone else who asserts a claim to it; to relinquish control. McCain vows he will never do that.

Does McCain propose to occupy Iraq forever? He has already stated that he is prepared for the U.S. to stay there 100 years. Maybe he has now extended his thinking to forever.

What’s even more frightening and bizarre than McCain himself is the roaring crowd apparently agreeing with him. What could they possibly be thinking?