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FOREWORD

Rob Arnott

AS YOU READ this volume, prepare to be surprised. John Tamny makes many controversial and provocative claims that run contrary to the prevailing views of the academic economics community and of the policy elite. Indeed, many of his claims will provoke anger among the guardians of the status quo. Readers should consciously set aside their commitment to mainstream economic thinking and read the book with an open mind. You may not come away agreeing with everything Tamny says, but you will—most assuredly—leave aware of a very new perspective on some very old topics. Your gray matter will be stimulated!

The field of economics was originally called “political economy,” because policy choices have a profound impact on macroeconomic growth. With this latest volume, Tamny encourages us to take a fresh look at money and credit. He writes, as always, with clarity and insight, and skewers conventional economic thinking with great gusto. In so doing, he shows us that economics is no arcane field best left to the experts. The most important aspects of “political economy” can be understood by anyone with a healthy dose of curiosity and common sense. In their clarity and depth of insight, Tamny’s writings remind me of Jude Wanniski’s The Way the World Works. This type of critical thinking forces us to reexamine the prevalent economic theory in both academia and politics.

This is no heavy-handed tome on the evils of central banks. There are no polemics here. Through a series of insightful—yet controversial—observations of the modern U.S. economy, Tamny leaves us with some powerful and important observations about the workings of our modern economy, particularly as they relate to credit. In this slender volume, Tamny reexamines the role of today’s Federal Reserve, the supposed price setter of credit, in shepherding (or not) our country’s economy. He expertly challenges the notion that the Fed can and does stimulate the economy, not with formulas and finance theory but with compelling logic. He explores whether the Fed is truly necessary, as conventional wisdom suggests it is. The reader is likewise challenged to view money and credit from an entirely new perspective.

When we think about credit, it is natural to think first of our own credit. When we want to buy a house or a car, or start a business, a lender will want to see evidence that we have (a) the future resources to repay the loan and (b) a history of repaying past credit on time. In Who Needs the Fed?, Tamny points out that credit is not just dollars and cents; it is access to real resources. This approach hearkens back to that of John Stuart Mill and the notion that money is a veil: It has no meaning except as a means of exchanging goods and services, both across the economy and across time. With money, I can exchange my investment research ideas for groceries or for an auto mechanic’s skill in fixing my car, either now or in the distant future. Credit gives us access to goods and services today, paid out of future income (in other words, paid from our own commitment to deliver future goods and services to others).

Should the federal government have a role in setting the price of credit? Investors and the business media all over the world parse every tea leaf between the lines of Fed statements, looking for some hint about future policy direction, usually as it relates to prospective “easing” or “tightening” of credit in the marketplace. But in reality is credit being eased or tightened by the Fed, or by the marketplace? More fundamentally, can the federal government set the price of credit—defined broadly, not just in the fed funds rate—even if it wished to do so? Put another way, when we apply for a loan, are we basing our decision on the latest quarter-point move in the fed funds rate? Is the bank or other lender basing their rate on Fed policy? Tamny presents thought-provoking examples of credit transactions, ranging from Hollywood to Silicon Valley, from hedge fund managers to football coaches, that provide an iconoclastic perspective on the Fed’s effectiveness in doing that which it is purported, nearly unanimously, to do so well: managing the cost of capital.

Taking it a step further, Tamny asserts that, contrary to modern economic theory (but in line with common sense), the Fed’s actions potentially have the opposite of their intended effect. If the Fed is “easing” credit, it stands to reason that it is redirecting credit away from where the free market would have desired. If that is the case, then the attempted easing can lead to a suboptimal allocation of credit, which is to say, a suboptimal allocation of real resources. Is this strategy pro-growth? Hardly!

In the 1970s in the United States, with an electorate upset over the high price of gasoline, the government thought it sensible to give its citizenry a break by imposing wage and price controls. On the face of it, this seemed logical—paying less for gas would give drivers a break, spurring renewed economic growth with the money left in their pockets. However, price controls always have unintended consequences. In the 1970s that meant that in addition to the artificially low cost of filling your tank, you had to pay with your time, waiting in a daunting line of cars at the pump, hoping to get to the front of the line before the station was pumped dry. Worse still, once the gas station (whose revenues were artificially low as a result of being forced to sell its product below the market value) ran out of gas, they closed their doors to save on operating costs, thereby decreasing their employees’ income and further inciting panic at the sight of the closed doors. The increased panic made lines even longer, further increasing the price of the gas, as measured in time spent waiting in your car. So, exactly as common sense would suggest, price controls delivered economic contraction, not growth.

Credit has its price, just like gasoline. Seeking to control this price with easy credit is a futile endeavor at best; at worst, it can be a growth-destroying, resource-misallocating, and credit-tightening experiment in unintended consequences.

Tamny defines credit as access to real resources. He succinctly points out that the federal government has no credit of its own; rather, the fed is empowered to redirect credit—that it extracted from the private economy, through its ability to tax its citizens—namely, our credit. When the Fed seeks to stimulate the economy, by way of monetary policy, it renders the cost of carrying a national debt artificially low. However, as the Federal Reserve attempts to keep U.S. borrowing costs (and resulting deficits) down, it becomes an enabler of bad behavior, tacitly encouraging overspending, which drains the private sector economy that stands behind the nation’s credit. Exchanging lasting economic growth for a short-term discount on interest payments is a losing deal.

On the campaign trail in 2012, President Obama famously quipped “You didn’t build that” in reference to business owners who were helped along the way by government investment in infrastructure. His logic was that local, state, and federal governments educate the individuals who become the labor force, build the roads and bridges that our businesses rely on, keep us safe with military and police forces, and so forth. The irony is that the president had it backward. The government can’t spend without taking resources from the private economy first. The government didn’t build the roads; they were funded by taxes extracted from the private economy and built by private contractors (who fought through government agencies and a morass of red tape to do so) in locations that the free market deemed necessary. In addition, when these public works projects become a boondoggle, the amount of money spent on them by legislators tends only to go up.

Tamny correctly points out that money government wastes is gone; forget the notion of a Keynesian multiplier on wealth destruction. In the private sector, money and credit run from failure rather than being attracted to it. Real resources rarely lay idle. Left to their own devices, market forces would no doubt have built roads the way they have built cars, planes, shopping malls, and skyscrapers, but with less chance of building a bridge to nowhere. This point may seem tangential to the discussion of credit, but it is very relevant. Unless government is completely dysfunctional, its agencies don’t fully control where and how that infrastructure is built; rather, they attempt to react to market demands.

In much the same way, the Fed doesn’t fully control access to credit. Furthermore, just as state and federal legislators can misallocate resources and overinvest in marginal projects, dissipating national treasure, the Federal Reserve can distort credit markets by unintentionally misallocating the nation’s resources (credit equals goods and services!) by setting an artificial price for one swath of the credit market. In so doing, the Fed steers resources away from wherever the market would otherwise have sent them. Do the Fed’s monetary “price controls” successfully loosen our access to real resources? No. Do they create a drag on economic growth? Based on the somewhat startling observations in the following chapters, we can only conclude that price controls on credit cannot lead to economic prosperity.

Tamny’s conclusions are controversial. He suggests that the Fed is unnecessary and has the potential to do far more harm than good. He suggests that the protracted “zero interest rate policy” cannot possibly have helped to fuel the second-largest equity bull market in history. He suggests that artificially controlling the government’s cost of capital guarantees a misallocation of resources away from the private sector to the public sector, funding current public-sector spending at the expense of future growth. He also suggests (as does Milton Friedman) that deficits are irrelevant; what matters is the level of public-sector spending.

Readers may agree or disagree with each of Tamny’s conclusions. If we approach this important and highly readable book with a spirit of curiosity and a willingness to reexamine our beliefs, then we are guaranteed an intellectually stimulating adventure. Be prepared to reconsider your core assumptions about the nature of money and of credit.