Tuesday, November 09, 2010

Fed Governor Kevin Warsh's Straight Talk In The WSJ

Yesterday's Wall Street Journal editorial by Fed Governor Kevin Warsh seemed, at least to me, to be an unusual one for a sitting Fed Board member.

Unlike the double-speak and evasions we've grown used to in testimony on Capitol Hill by Greenspan and Bernanke when asked about fiscal policy, Warsh clearly states,

"Given what ails the economy, additional monetary policy measures are poor substitutes for more powerful pro-growth policies."

Warsh goes further, criticizing the last few years of temporary stimulus measures, culminating with this passage,

"Fiscal authorities should resist the temptation to increase government expenditures continually in order to compensate for shortfalls of private consumption and investment. A strict economic diet of fiscal austerity has greater appeal, a kind of penance owed for the excesses of the past. But root-canal economics also does not constitute optimal economic policy.

The U.S. would be better off with a third way: pro-growth economic policy. The U.S. and world economies urgently need stronger growth, and the adoption of pro-growth economic policies would strengthen incentives to invest in capital and labor over the horizon, paving the way for robust job-creation and higher living standards."

This is, to my knowledge, fairly unprecedented talk by a Fed Governor. In today's environment, it borders on political speech, given the very wide distance between Democrats and Republicans on so many fiscal policies. Warsh clearly sides with the latter.

Toward the end of his piece, he cautiously acknowledges that QE2 is making the Fed a Treasuries price setter, not taker. Something CNBC's Rick Santelli bemoaned on air late last week. Warsh rather carefully shares that concern with these words,

"As the Fed's balance sheet expands, it becomes more of a price maker than a price taker in the Treasury market. If market participants come to doubt these prices- or their reliance on these prices proves fleeting- risk premiums across asset classes and geographies could move unexpectedly."

Volumes are implied in those last two words.

Warsh ends his editorial with a nod to the growing currency wars, triggered by the Fed's own depreciation policy. But he doesn't suggest any solution. Instead, he refers vaguely to FOMC "tools and conviction to adjust policies appropriately."

Trouble is, he began his piece by pointing out that monetary policy can't substitute for good fiscal policies. And can't overcome bad fiscal policies.

So, except for the last line of Fed-style happy talk, Warsh seems to depart from the usual institutional silence or vagueness on macroeconomic fiscal policies.

If you connect the dots in his editorial with rising anger by other central banks and conservative American politicians over US monetary policy, it should cause significant concern. Because what Warsh is really saying is that the Fed is going to be unable to fix the problems caused by reckless US fiscal policies, new, exorbitant debt levels, and rising international anger at both US fiscal and monetary policies.

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