Also note in the Wall Street Journal The Fed and the Crisis: a Reply to Ben Bernanke

If one can not take responsibility for a mistake, one risks repeating it.

Recent postings on the growing spread between private sector and government sector employment elicited some protest, many who claimed that most government workers could make more in the private sector.

This is true for some. Many of the people who work in top positions for the Treasury or the Fed could make more in private employment. So could many lawyers who decide to work in the Federal legal system?

Some work for the government to get experience to use in the private sector. Many private sector environmental attorneys use their years in the EPA on their resume.  Their contacts in the EPA help them solve legal issues for their clients in the private sector. The same is true for many tax lawyers and accountants whose experience working for the IRS improves their value in the private sector.  Many of these could have made more in the private sector during their tenure in the government, but their tenure served to increase their pay in the private sector.

The same is true for many elected officials. Tom Daschle made so much money as a lobbyist after losing his Senate seat that Obama had to remove him from consideration for his cabinet.  Sam Nunn is making much more as a private sector attorney than he did as a Senator. Would Bill Clinton be making $500,000 for a speech if he didn’t have President of the US on his resume? Would Al Gore be worth $100 million were if not for his political contacts and experience?

Federal employment for many is worth far more for its future value that it is for its current paycheck.

But I contend that the vast majority of the lower level workers could not make as much in the private sector as they make in government.  Thirty years ago it may have been different.  Today these workers are getting higher pay, better benefits, and far more job security.

There is not ten percent unemployment in the federal system.  Many companies have instituted across the board pay cuts, suspension of matching 401k contributions, and reduced hours.  I doubt if any federal workers have experience such setbacks.

The growth in government and the growing disparity from the private sector is creating a bureaucratic ruling class.  It remains to be seen how long it will last when the private sector can no longer afford to support it or when they morally refuse to support it.

George Copper writes in “The Origin of Financial Crisis” that our economic thinking is regimented for failure in a world that is more influenced by the bubbles in financial assets.

The efficient market hypothesis contends that prices find their natural levels from the normal forces of supply and demand. This is true, Cooper contends, for market items and services such as cars, bread and auto repair, but it is largely untrue for financial assets.  We have seen that rising prices for houses incites a boom that attracts more buyers. Once could argue that perverse government incentives also drove the housing bubble, but this is also true of other financial assets.  During the gold boom in the 1970’s unit sales peaked at the market top, the opposite of a true supply and demand curve.

He notes that the central banks in Europe worry more about fighting inflation because of the impact it had in the road that led to World War II. Our Central Bank worries more about a Depression since that segment of our history haunts us more.

Cooper contends that the bank would be wiser to control credit creation than the money supply for it is the excessive amount of credit that creates our bubbles.  Our system demands that the bank maintain credit levels to sustain business peaks. We would be wiser to deflate credit induced bubbles more frequently and earlier to avoid bigger more destabilizing bubbles later. It is our inability to accept the smaller pains that led us to the larger pain we face today.

Our regulation is targeted toward the last crisis and does not address the next one.   The tighter accounting standards in reaction to the dot.com bubble did nothing to stop the housing bubble.

Cooper suggests that instability is not necessarily bad; we would probably prefer a volatile growing economy to a stable stagnant economy.

William McChesney Martin, the longest serving head of the U.S. Federal Reserve , famously suggested, “The job of the Federal Reserve is take away the punch bowl just when the party gets going.”

Obama has posed this question and seems to think we can.  William Dudley the new president of the New York Federal Reserve thinks they can and should act to identify and prevent asset- price bubbles.  I remain very skeptical.

The Federal Reserve was formed in1913 to bring stability to the financial system.  Yet in its first test, responding to the Great Depression, its actions made the depression last longer than any previous recession.  The Fed had problems controlling inflation from the 1960’s until Reagan and Paul Volcker painfully wrestled it under control in the early 1980s.

Should all bubbles be contained?  Is gold in a bubble now? If it is should we be concerned? Or should we just let gold prices take its course as it eventually did in the 1980’s?  Bubbles seem to be clear only in hindsight.

Is it possible for the Fed to be truly independent of politics? I doubt it.  The recent housing bubble was largely caused by political pressure to make  housing more affordable.  President Clinton thought this was a more progressive approach than just building more government housing projects.  While this idea had considerable merit the devil is in the details and the execution of the laudable goal was a great driver of the housing bubbles.

Fannie Mae was driven by political goals and Congress fought efforts to bring it under control, almost along distinct party lines.

We had bubbles before the Fed and we have had bubbles after its formation. They seem to be more drastic since the Fed was created.  The market forces may have popped bubbles quicker without the intrusion of political objectives into the mix.

But can the Fed even foresee and manage bubbles? If they can why haven’t they before?  Greenspan noted that growth in wealth creation and savings in foreign countries had a great influence in the last bubble and was largely outside the control of the Fed.

Governments try to fight the last battle, leaving them wholly unprepared for the next one.  It is like trying to play a board game when the rules and the board surface constantly changing. That is just the nature of the market.  Those who think this beast can be tamed assume that all of the unknowns are known when the unknown unknowns are the real problems. Government always thinks they can analyze the last problem well enough to prevent the next one and they are rarely correct.

Efforts to contain bubbles may create such stagnation that the true cost of such policies will be hidden.  While we desire stability do we really want it at the expense of economic growth?   If the government is so willing to engage in economically destructive behavior such as massive debts and intrusion into markets how can we truly expect them bring such discipline to our economy to ‘manage’ bubbles, especially given their role in creating them?

“Nobody wants sound money.”  It requires a discipline that our leaders clearly have not shown before, and this administration certainly doesn’t seem to have any. Trying to segregate politics from the management of credit and the money supply may be another utopian dream that costs far more than anyone is willing to pay.