The Fed, Not the Market, Is Stifling Growth

Trump and Clinton blame economic woes on immigration and trade. They’re wrong.

By Mary Anastasia O’Grady          

A Pew Research Center poll released in July reported that 84% of U.S. voters said that the economy is “very important” to their vote in the Nov. 8 election. It was the top issue for respondents.

Yet it is becoming clearer that Federal Reserve policies are causing great damage to the U.S. economy, and neither candidate has made it a campaign issue. Instead, Hillary Clinton and Donald Trump blame too much economic freedom for the malaise. This is troubling no matter who wins the election.

In three days visiting this resort town last week, I did not meet one person in the local hospitality industry who was born here. Whether it was hotel staff, restaurant employees or transportation detail, all had come from other states—Tabasco, Guerrero, Oaxaca, Morelos, to name a few—in search of work.

This job creation is driven by productivity gains that would have been unimaginable without corresponding increases in free trade and mobility and investments in technology and human capital. It’s how economies grow.

Yet our political class and intellectuals increasingly point to these developments—technology, trade and migration—as reasons for pessimism. It is worrisome logic because it suggests that a better future depends on going backward, against the grain of economic liberalism. It also ignores the Fed’s culpability for slow growth.

Innovation and competition generate what Austrian economist Joseph Schumpeter called “creative destruction.” In a free market with sound money, the wealth created by disruption is redeployed, providing opportunities for those who were displaced. This boosts productivity further.

Fed policies of zero interest rates and bond buying—quantitative easing—have not only failed to stimulate business investment. They have discouraged it through the misallocation of capital. This is contractionary because it starves entrepreneurship and thus productivity growth.

The North American Free Trade Agreement (Nafta) opened the Mexican economy to Canadian and U.S. imports in 1994. Many Mexicans lost jobs. Yet the country gained access to what it needed to modernize. Running water, salmon entrees, California wines and air conditioning were not standard fare here on the Mayan Riviera in 1985. They are now, and tourism has boomed.

Both Mr. Trump and Mrs. Clinton talk about the need for faster U.S. growth. Yet both propose to get there by cracking down on free markets. Both prescribe new restrictions on international trade and a new entitlement program for preschool children.


Mrs. Clinton wants government to take a bigger tax bite from the most productive members of society, a policy that would discourage risk-taking by those same individuals. Mr. Trump demagogues immigration and wants to punish U.S. companies that allocate capital to its highest use if that happens to be abroad.

Left out of their analyses is the gargantuan role of the Federal Reserve’s antigrowth monetary and regulatory policies. Mr. Trump argued in September that the Fed’s eight-year policy of cheap credit is generating asset bubbles. But if he understood the problem he wouldn’t rail against Nafta.

Mrs. Clinton feigns alarm at Mr. Trump’s criticism of the Fed on grounds that the central bank is supposed to be independent. Yet it is well known that Democrats are working behind the scenes to weaken the independence of the regional Fed banks to centralize power in Washington.

Conventional wisdom holds that the Fed has flooded the market with credit by aggressively buying bonds and creating bank reserves on the Fed balance sheet. Yet when the Fed buys assets—such as government debt or mortgage-backed securities—it only records a short-term liability on the balance sheet. The reserves are on the books but don’t create any more credit in the real economy than if the Fed never made the purchase. Meanwhile it creates shortages of medium- and long-term assets in the market.

If there were a glut of credit in the real economy it would likely show up in bank lending as expanding businesses clamored for low-cost loans. Yet credit growth “has been dismally slow,” wrote David Malpass, president of the consulting firm Encima Global in a recent note to clients.

The term structure of bank assets is partly to blame, but so is regulation—by the Fed and Congress, via 2010 Dodd-Frank legislation—which has made it difficult to lend to businesses, especially small ones.

The most creditworthy companies are using cheap money not in productivity-increasing ventures but to pay dividends, buy back stock or engage in other financial transactions. Fed policies, as Mr. Malpass wrote, are “reducing the credit available to smaller businesses and hurting GDP growth rather than stimulating it.”

The Fed is technically an “independent agency” but it is not unanswerable to the public it serves. Blaming the free market for its mistakes will only make things worse.

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