The Pandering And Politics Of The Fed's Punch-Bowl

What’s really driving everything is the American electoral cycle

By Daniel Cloud

People at the Fed are people in politics, who need to promote their allies and maintain their patronage networks. So perhaps it’s significant that the last two times the Fed tightened, it was in a President’s second term. It’s safer to anger an incumbent who is leaving, and dangerous to anger one who may have another six years in office. The party that lost the Presidency after one term, as a result of a crash in financial markets, would never forgive the Fed for its intervention. So if you are in the business of blowing up bubbles to win points with incumbents, and popping them at times when that is less of a concern, of course the President’s second term is when you do the popping.

But why not wait another year or two? The Fed’s mistake, last time, was to believe its own hype, and wait too long. The result was that the crash coincided with the presidential election, and actually decided it in favor of one party, at a time when it was otherwise uncertain who would win. That looked a little too much like direct tampering, and it ended up threatening the Fed’s “independence” (immunity from democratic oversight) by really angering the Republicans, who did little to block an audit they could have stopped if they’d wanted to. The Fed, as an institution, doesn’t really want to do that again. Better to get the crisis out of the way now, while there is still time for people to forget who they are really angry at before the next Presidential election, and sink back into the pointless search for vulnerable scape-goats that is the political parties’ bread and butter.

It’s also better, on an institutional level, to have the crash while Bernanke is still at the helm, so that it can be him, and not his successor, who is discredited by the catastrophe.To ensure his faction’s continued dominance for another long interval, the handover has to happen while Obama is still president – but after the crash. They have just about enough time to accomplish all that, to crash the market, let the Chairman fall on his sword, just as Greenspan did, and replace him with another dove as the renewed demand for a lender of last resort (in other words more and more drastic QE, more opportunities to hand out huge amounts of free money to friends and allies) becomes deafening.

In this scenario, beliefs about an economic recovery play no role in motivating the tapering talk. We may underestimate our opponents by supposing they do. We could, instead, think of them as perfectly rational, on their own terms. Perhaps the Fed has their eyes wide open; perhaps they know exactly what they’re doing, perhaps they knew what they were doing the last two times. It defies logic, after all, to suppose that they could make the same huge mistake twice, and not even notice, learn nothing at all from the experience. Yet this is what they publicly pretend.

It seems more likely that what’s really driving everything is the American electoral cycle. Well, what did we expect?