Give Federal Reserve Chairman Ben Bernanke a good shave and he’d look a lot like British Adm. John Jellicoe. The resemblance doesn’t end there: Jellicoe was bright, confident and self-effacing, and so is Bernanke.
This reassures me when I think about what the Fed’s Open Market Committee will do at its meeting today and in the months to come. If Bernanke resembles Jellicoe as much in temperament and fortitude, we have a trustworthy leader.
My concerns about the Fed center on history: Things go to pot when leaders are unclear about what they are supposed to do and exactly what they can do. Confusion about what your mission is and what your capabilities are leads to disaster.
Jellicoe, the British admiral who commanded the principal British fleet during much of World War I, knew exactly what his mission was. He stuck to that mission in the face of much criticism by the press and politicians. Let’s hope Bernanke and other FOMC members do the same.
Winston Churchill pithily described Jellicoe as “the only man who could have lost the war in an afternoon.” This was true because the admiral faced an asymmetrical strategic situation. Jellicoe’s large fleet confronted the entire German navy across the North Sea. If the German fleet could defeat Jellicoe, its ships would be free to circle the British coasts, shelling cities and factories at leisure. Large proportions of British industry, commerce and government were within range of German naval guns.
Moreover, the United Kingdom depended on a daily stream of freighters bringing food and supplies from other nations. Loss of command of the sea would mean rapid economic strangulation, hunger and defeat.
But even if the British fleet defeated the Germans, they would not gain any comparable advantage. Few important German resources lay within range of the sea. The British blockade already had cut most German imports.
So if Jellicoe sought a decisive battle and lost, Britain would lose the war. If he won, Britain would gain little advantage. The situation required prudence and caution — not impetuous gallantry.
The British public, press and politicians, imbued with glorious myths of Lord Nelson at Trafalgar, did not want prudence or caution. They wanted an immediate rousing victory. Jellicoe repeatedly suffered abusive criticism on editorial pages and in Parliament.
He was unfazed. The war ended with the German navy intact but impotently bottled up in its ports. Jellicoe never won a resounding victory, but his prudence avoided possible disaster.
The Fed is in an analogous situation. Americans have unrealistic expectations. They expect the Fed to ward off inflation. But they also want low unemployment, cheap mortgages, a booming economy, a strong dollar and balanced international payments accounts. Some think the Fed should act to alleviate poverty and reduce income inequality.
The harsh truth is that the powers of the Fed or any other central bank are sharply limited. A central bank can maintain stable prices — period. If it manages the money supply prudently it can avoid both inflation, which is defined as a rise in the general price level, and deflation.
But the Fed cannot make the economy grow faster. It cannot keep interest rates permanently low, home prices rising or building robust. It cannot keep the Dow at 11,000. It cannot ensure that everyone has a job. It cannot boost exports or cut imports. It cannot balance the federal budget.
A central bank like the Fed has control over only one thing, the money supply, and in the long run the only thing the money supply determines is inflation or the lack of it.
Yes, Fed decisions influence all these other economic variables. But the Fed does not control them.
The American public — conditioned by Wall Street pundits and politicians with axes to grind — expects the Fed to solve every ill except the heartbreak of psoriasis. It cannot.
Like Jellicoe’s British fleet, the Fed is facing asymmetrical risks. If the Fed focuses on averting inflation or deflation, it can do so. If it dashes off in a mad quest to foster low interest rates, a booming economy and every other possible desire, it would not only fail to achieve those goals, but it also wouldn’t ward off inflation.
U.S. economic history of the 1970s shows what can happen when the Fed tries to have it all. The result was economic stagnation, high inflation and high unemployment.
The Fed is going to get a lot of criticism over the next two to three years, no matter what it does. Like Adm. Jellicoe, it must ignore the hecklers and second-guessers. It must focus on what it can do, carry that out competently, and ignore what it cannot do. History will laud it even if it is criticized today.
© 2006 Edward Lotterman
Chanarambie Consulting, Inc.