More than  few from the opposition have criticized corporations for sitting on too much cash.  Companies are not in the cash holding or cash management business.  Especially in today’s environment of near zero return on short term holdings, one should ask  why the companies are sitting on so much cash.  The short answer is that they cannot find a better risk adjusted return… yet.

That ‘yet’ answers why they do not just return it to the shareholders.  They are optimistic that opportunities will return.  And they are less optimistic that the banking system can be depended on to supply them with the credit when they need it.  It is safer to keep the cash to finance new projects internally.  It also avoids taxes on dividends to the shareholders.  And then shareholders must decide how to deploy the capital, and they face the same limitations.

But the big reason for this state of affairs is a the inconsistent and self defeating economic policy of this administration.  The Federal Reserve has plied a loose monetary policy to stimulate demand, but at the same time we have been showered with new laws and regulations and other friction costs that have stifled production.   The Federal Reserve has showered us with money and the Congress has made us afraid to spend it.

The bully pulpit war on wealth is not inviting to capital investment.  We are foolish to look at the laws themselves.  Risk is combination of hazard and outrage.  The OMB does not know how to score outrage, but it has become a major factor in the minds of those who deploy capital (and create jobs).

The short term horizon of the tax breaks is useless.  Nobody will take long term risks for short term gains.  Business and individuals do not think nearly as short term as the government that tries to control their actions.

At the risk of repetition the tax rates are secondary to their consistency. If we have to fear that our taxes will go up, deductions will be eliminated, depreciation schedules will be altered, and penalties will be triggered  then we will be hesitant to deploy new capital.  We also realize that we will have to comply with regulations that are yet to be written by regulators that have yet to be appointed.

We have deployed a discordant capricious policy that has brought us to a very liquid state of inaction.

Scott Grannis writes in his blog Calafia Beach Pundit (highly recommended) - Money Supply and Panic Update – 9/9/11.

Excerpt:

And what does all this tell us?

One: If the supply of dollars is not rising faster than the demand for dollars, then this is not an inflation story that is unfolding. The Fed is not making a mistake. In fact, the Fed has been preemptively supplying plenty of liquidity to the banking system, and that’s exactly what the banking system has needed.

Two: If the demand for dollars and the safety of T-bills and gold is huge, there must be something out there that is scaring the bejeesus out of the world’s capital markets. As I’ve been detailing in recent posts, everything points to the Eurozone sovereign debt crisis as the proximate cause for the panic that has overtaken markets in recent weeks. Governments all over the world have grown too big, too fast, and they have squandered the proceeds of all the debt they have taken on; the Eurozone is just the first to be forced to come to terms with this reality.

Three: If there’s one big thing lacking right now in the world, it is leadership. The Greeks need to shut up, grow up, and tighten their belts, or just admit that they are scoundrels and default. The ECB needs to stop trying to bail out the slackers in the eurozone, and maybe that means letting some banks fail; after all, bank failures are not the end of the world. Obama needs to channel Clinton and triangulate, and stop trying to blame the Republicans and the Tea Party for the results of his abysmal economic policies. California’s Gov. Brown needs to just say NO to the unions and their demands for outrageous retirement benefits—let’s have some public sector austerity, please.

HKO comments:

Perhaps the ultimate burden of a reserve currency is the accommodation of the demand for security. Other sound currencies like the Swiss franc are refusing or unable to accommodate the demand for their money.  The Fed is betting that they can destroy the supply of dollars created to end the financial crisis when a real recovery ensues to prevent excess inflation. This was already uncharted territory, at least in the quantities we now face.  Now they must accommodate a huge demand for dollars from abroad seeking security.  Is there a risk that this huge creation of dollars abroad cannot  be controlled when the time comes? If Bernanke can accomplish this he may make the ‘genius’ of Greenspan look like a cashier at a Dollar General Store.

It remains supremely ironic that just as we have elected an administration that has sought to emulate the social and economic policies of Europe, that Europe is collapsing under the weight of its socialistic system .

Regardless of how we arrived at our position, it will take extraordinary measures to extract us from this quagmire while retaining social order.  The Fed was designed to maintain independence because they long understood the difficulty of such decisions in a political realm.  Populist rhetoric and demonization may make legitimate points about how we got into this mess, but they offer little as to how to extract us from it.

We need leaders who can clearly say ‘no’ to worthwhile programs we can no longer afford.

While Europe is swimming in a river of denial, we need to build a bridge over it.  We are living through a period of economic convulsions that will be studied for centuries.

Monetary policy seeks to promote economic growth through the proper management of the currency. The trick is to create enough money to provide growth without losing control of inflation. This is no small task. We are a nation addicted to growth, and we are not a patient people.  In the past it was complicated by foreign trade and the relative value of currencies.  As long as all currencies were tethered to a fixed value such as gold it was easier, but even that did not eliminate complicated problems in foreign exchange.

Monetary policy used the tools of money and credit creation such as buying and selling treasury securities and raising and lowering interest rates.  As complicated as the single task of monetary stability and controlled growth is, it is complicated enormously by the additional mission of providing full employment.

It is the addition of full employment to the mission of the Fed that crosses the line from monetary policy to fiscal policy.  The Congress controls fiscal policy through taxation and regulation. The challenge is to provide the revenue needed without taxing so much that the incentive to produce the revenue is inhibited.

Presidents have long realized that higher tax rates did not necessarily produce higher tax revenues. Calvin Coolidge noted this long before the well known Laffer curve was drawn on a napkin for Donald Rumsfeld and Dick Cheney by its namesake Arthur Laffer, who was simply, yet brilliantly, explaining the work of Robert Mundell (later awarded the Noble prize in economics.)

Part of the reason we have reached the economic pain we are at is because of the success of the Federal Reserve to mitigate the accumulation of bad fiscal policies with offsetting monetary policy.  Alan Greenspan was considered the Maestro because he seemed so adept at using the tools of the Fed to counter problems created in the Congress that the lawmakers were insulated from the results of their own foolishness.

As long as the Fed was able to stimulate the economy with lose money and credit then Congress did not have to face the outcome of higher minimum wages ( higher unemployment, especially among the lowest income brackets), higher taxes and stifling regulations.

We have now reached a point where the accumulation of bad fiscal policies has exceeded the ability of the Fed to mitigate.  Decades of bad policies have accelerated with the addition of terrible bills and policies passed during the first two years of the current administration.  We have been unable to recover from the last bailout before the next bailout is required.  Too many problems accumulate in too short a time frame and the classic responses of inflation and deficit spending no longer work.  Debt is never a problem during the boom, but it is lethal during a bust.

What once worked no longer does.  Success- knowing what worked yesterday- has led to failure.

Then the outcome of higher minimum wages rears its ugly head and the unemployment is no longer hidden by Fed policy.  The effects of onerous regulations and higher taxes brings production to a stop.  Hallow financial instruments collapse.  Money poured into housing no longer supports ever increasing prices.

When we realize that monetary policy can no longer hide fiscal mismanagement we are faced with making adult decisions.  Over generous benefits must be rescinded. Government expenses must be cut. Common sense must return to fiscal management.

Laffer’s mentor, Robert Mundell, warned of the use of the Fed to enact fiscal policy. It is healthy to realize the limits of the power of the Fed, but this entails that the Government must realize the consequences of its policies without the Fed hiding the results with loose money as it has for decades.

Mistakes are undramatic. We all make them, but many would prefer the drama of sinister motives and conspiracy theories  to the realities of bad judgment and human error. It makes for better headlines and fodder for book titles.

Conspiracy theories are often just thinly veiled prejudices. Behind so many such theories is a distrust of Jews who have been the brunt of endless conspiracies, most notably the endlessly enduring fraud, The Protocols of the Elders of Zion.

But conspiracy theories are certainly not limited to Jews.  Neocons, the Federal Reserve, and various councils formed to address social, political, and economic problems are often deemed to be mere conspiracies to achieve power and wealth at the expense of the rest of us.  But that fact that so many of these organizations fail at their mission does not mean they are a conspiracy.

Conspiracies usually are the result of preordained conclusions that read for confirmation rather than information.  If I want to believe that George W. Bush was responsible for 9/11 I will be able to collect reports of meetings and events that appear to confirm that theory, and simply ignore any contradictory evidence.  There were similar claims that FDR intentionally grouped our ships in Pearl Harbor to drag us into war.  Many in the Middle East believe that Israel caused 9/11 to drag the U.S. into a war against Islam. They repeat the falsehood that the Jews knew not to go to work at the World Trade Center on the day of the attack.  This theory persists even after Bin Laden took credit for the attack.

If you find yourself falling for a conspiracy theory remember the following:

• Never attribute to a conspiracy that which can be explained with simple incompetence or error.  Humans do tend to err, often dramatically.
• There are few people who can keep a secret.  Just witness the leaks of confidential and privileged information.
• Ask yourself what information would you accept that disproves this theory.  If every bit of evidence that disproves the theory is twisted to just further prove the theory; if  your theory can not be disproven then it is likely a conspiracy theory.  When a Swiss court in the 1930’s determined that the Protocols of the Elders of Zion was a fraud the Nazis just claimed that was proof that the Jews controlled the courts.
• In the face of irrefutable evidence you can still reach the wrong conclusion. Many conspiracy theories are believed because they rely on facts that are true. But part of the truth can be more misleading than all of a lie. By reading for confirmation, the theorists ignore the conflicting evidence.
• We often prefer the comfort of lies rather than to question our own beliefs.  It is easier for us to believe in a villain than to accept the uncertainty of human fraility.  Unwavering certainty in explaining very complex events is the hallmark of a conspiracy theorist.
• Just because one is well read does not mean the theories they espouse have validity.  The very intelligent and the well educated are not immune from the intellectual biases that accept evidence that supports their views, while rejecting evidence that refutes it.

The best remedy for conspiracy theories is an open mind, skepticism, and curiosity.

The most misunderstood aspect of the success of the Reagan led supply side revolution was the monetary aspect. The idea adapted from Robert Mundell’s theory was that the Fed should focus ONLY on monetary matters and that fiscal policy should focus on policies such as employment and economic stimulus. The effectiveness of the supply side revolution was the restoration in the value of the dollar by monetary means COMBINED with the stimulative effect of lower taxes and less regulation, which is just another form of taxation.

Simply making the dollar worth a dollar is a daunting task in an age of fiat current and rapidly changing global competition.  The Fed was not formed to stimulate the economy and it was often blamed, sometimes justifiably, for contributing to periodic weakness and making cyclical recessions worse.  Milton Friedman and Bernanke both believe that improper Fed action made the recession much worse. But one cannot ignore the contribution of an even greater lack of understanding on the impact of fiscal policies like trade protectionism, higher taxes and a massive expansion of the government mandate.

In the Wall Street Journal Opinion Journal Online this point is given its necessary importance in The Fed’s Bipolar Mandate – Time to repeal the Humphrey-Hawkins Act of 1978.

An excerpt:

But with Humphrey-Hawkins, Congress ordered the central bank to “promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” The political context in that age of Jimmy Carter will sound familiar. U.S. unemployment was stubbornly high and the fiscal policies (tax rebates) of a Democratic Congress had failed to stimulate. So the politicians decided to conscript the Fed in its job creation mission by ordering the ostensibly independent central bank to target employment as well as prices.

The larger problem with the dual mandate is that it inevitably makes the Fed a political actor. Fed governors are forced to pretend they can be economic saviors, able to rescue workers and business from the consequences of failed fiscal and regulatory policies. This is precisely what the Fed is being asked to do today, using QE2 to save the Obama Administration from a 9.6% jobless rate despite trillions spent on economic stimulus, foreclosure mitigation and cash for clunkers. Mr. Bernanke has too often made the Fed appear to be an agent of the Treasury, as he did again yesterday in Frankfurt by blaming China’s pegged currency for U.S. economic ills.