Monetary policy remedies have gone awry

On September 16, a Wall Street Journal headline highlighted a new class of US millionaires disclosing their preference for renting rather than owning homes. The article’s premise has the potential to induce a drastic change in government and central bank policies that give preferential treatment to real estate in lending.

Central banks are equipped to do two things well. One is to stabilize the value of a nation’s currency. The other is to supervise financial institutions. The fact that the US dollar has lost 99% of its purchasing power in gold terms since the US Federal Reserve’s creation in 1913 suggests it has not done so well on the first count.

The US Savings & Loan crisis, the Long Term Capital Management fiasco and the 2008 global financial crisis show that the Fed did not do well on the second account, either.

The mistake common of these three crises was the financial sector’s extension of too much credit to “junk” consumers, “junk” companies and “junk” countries, with two of the crises related directly to misguided real estate policies.

The Federal Reserve Act embraced the so-called “Real Bills” doctrine in 1913. The doctrine stated that there can never be “too much” money if banks gave credit only against short-term commercial bills, backed by “real” transactions.

The 10th Annual Report of the Fed in 1923 stated: “It is the belief of the Board that there is little danger that the credit created and distributed by the Federal Reserve Banks will be in excessive volume if restricted to productive uses.”

As the world was then on the gold standard, the report did not mention that for the doctrine to work, it needed an “outside” anchor serving as an “alarm signal.” Otherwise, there could be excess liquidity,