“We’re not supposed to understand how the Federal Reserve works? That’s ridiculous, un-Democratic and why we MUST Audit the Fed and/or End the Fed”, Mike Perry, former Chairman and CEO, IndyMac Bank
October 20, 2015, Adam Davidson, The New York Times
You’re Not Supposed to Understand the Federal Reserve
Credit Illustration by Andrew Rae
Imagine if aliens in a spacecraft were studying the United States from above. Their conclusion, I expect, would be that the single most important decision these inscrutable humans make each year is whether to plant corn, soybeans or wheat. No decision, year after year, transforms more square miles of American land than the choice farmers make about which crops to grow. In some years, those aliens would see huge swaths of tight green rows of soybean; in others, more tall corn with yellow tufts; in others, an unusual abundance of wheat in, well, amber waves. Earlier this month, Rick Stern, who farms 1,500 acres in central New Jersey with his father, told me that he had just spent weeks making this very decision. He carefully studied the global market reports to learn about recent yields in Argentina and Brazil, America’s leading rivals for soybean exports. He grew up watching his father and grandfather face the same dilemma each fall, using as much information as they could scrape together.
But this year, there’s another variable that everyone is talking about — a factor that Stern doesn’t quite understand but knows will have a huge impact on the commercial grain business: whether, or when, the U.S. Federal Reserve will raise interest rates. Stern knows that the Federal Reserve is a powerful group of people who make decisions in Washington, but he doesn’t know exactly how it works. ‘‘That’s something I’ll never be privy to,’’ he told me, standing in a field of soybeans, in front of his enormous combine (‘‘It’s like a rocket ship with wheels,’’ said my son, amazed). ‘‘I just know their decision affects everybody.’’
Here’s what Stern does know: If the Fed raises rates, it would be bad for farmers like him. It would strengthen the dollar against the Argentine peso and Brazilian real, which in turn would mean that importers in China, Vietnam and the Middle East would buy more from South America and less from him. He also knows a rate increase would make it more expensive to borrow money to upgrade his equipment. He points out that his combine is 10 years old: If it broke down and he had to replace it, higher interest rates would make that enormous purchase significantly more costly to finance.
Over all, Stern has learned, a Fed rate increase — and there will possibly be one before the end of the year — will mean more acres of corn and fewer of soybeans, because American farmers won’t be able to rely as much on export markets to sell corn. It also means Stern will pay more attention to the few acres he has set aside for specialty crops, like watermelon, cantaloupe, tomatoes and hay. These he grows for local sale, so a stronger dollar won’t affect them. He just wishes the Fed would leave rates alone, and he can’t understand why they would even consider raising them. ‘‘It’s politics,’’ he says. ‘‘Most politicians forget who they are and why they went to Washington.’’
Senator Nelson Aldrich, who spearheaded the creation of the Fed in 1908, would probably have been thrilled — he might have audibly chuckled — to hear that Americans today have no idea how to influence the Fed’s decisions. Rick Stern sees the Fed as just another group of politicians, but in fact the Fed was exquisitely, painstakingly designed to resist the influence of politicians as much as possible, so as to avoid corruption by the lobbying that politicians constantly receive.
It’s almost as if the Fed were designed to confound explanation of it, precisely so the Rick Sterns of the world could never hope to influence it. Aristotle, in his ‘‘Poetics,’’ described a formula for emotionally engaging drama that screenwriters still consult to this day, with central characters and a plot that moves from a beginning through a climax to resolution. Presidential elections can be molded into this Aristotelian structure perfectly, as can many major news stories. The Fed, by contrast, seems more like somebody sat down with a copy of ‘‘Poetics’’ and carefully constructed its opposite. There is no beginning to Fed action; it’s always there, always acting, even when its action is to not make any changes. There is no natural climax. It’s just an ongoing conference between a group of economists. And it is never resolved. There is no single moment when the Fed is done.
Credit Illustration by Andrew Rae
Eight times a year, usually on a Wednesday, always precisely at 2 p.m., the Federal Reserve makes an announcement. Its crucial Open Market Committee has just wrapped a meeting and chosen one of three options lettered A, B and C: whether to raise, lower or leave unchanged one specific type of interest rate, namely the interest that banks charge one another to borrow money for one day. That’s it. That’s the main power that the Fed has over all our lives. But it’s a key power, because that overnight borrowing is one of the least risky activities in our economy. When that activity is made more costly, all other risks people might want to take are made more costly, too, and so banks and businesses and people take fewer risks: They make fewer investments, lend less money. There is less economic activity everywhere.
Journalists try to personify the Fed by talking about its chairperson — a role filled since February of last year by Janet Yellen — as if she had all the power. In truth, the Federal Reserve System is so enormous and diffuse that there is only a minimal center of gravity. Aldrich created this system deliberately, because he didn’t want there to be any single point of power and influence, any single protagonist who could be swayed one way or another. If someone wanted to take control of the Fed, she would need the president to fire the governors he appoints (though it’s not even clear he has that authority), Congress to impeach the chairwoman and each of the 12 independent boards to fire their regional bank presidents. This diffuse system does not eliminate unfair influence; the banking industry certainly has far more influence than any other. But it does mean it’s extremely hard for the Fed to make decisions designed to benefit one interest group over the rest.
Interestingly, a previous chairman, Alan Greenspan, cast himself for a time in the role of protagonist, single-handedly driving the action forward. He clearly didn’t read about the inevitable destiny of the tragic hero; after decades of being revered around the world, he saw his hubris lead to the near collapse of the entire global economy. (Lin-Manuel Miranda, please call me; I just got a really good idea for your next hip-hop musical.) Greenspan’s successors, Ben Bernanke and Janet Yellen, have reverted to the Fed norm of trying to be the human embodiment of an Excel spreadsheet: gray, data-driven, personality-less, passion-free decision makers.
As Stern said, the Federal Reserve’s decisions about interest rates will affect every single person and company in the United States. Walmart will like having cheap imports. Boeing won’t like that its planes cost more to foreign buyers. Family farmers won’t like it; big agribusinesses, like Cargill, will. For banks, a Fed rate increase can be good and bad news: In a recent report on the subject, Goldman Sachs argued that some banks, like M&T and Wells Fargo, are going to be in a bit of trouble, while others will make more money from interest rates on loans. On an individual level, Fed rate increases are better for older people who live on savings and worse for younger people who tend to borrow more.
If the Fed added up all the ways a rate increase helped people in the short term and subtracted all the ways it hurt them, they would never raise rates. While there are winners and losers, on balance a Fed rate increase means the economy will slow down, which on average is worse for everybody. The entire point of a central bank like the Federal Reserve is to empower one group of people to do something as unpopular as slow the economy down. That’s because, from time to time, an economy grows so fast that it leads to a bubble, inflation or both. The Fed’s job is to predict when this is going to happen and stop it before it does by slowing the economy just as people feel the most excited.
When the Fed eventually does raise rates, it will be covered with near hysteria. It will be on the front page of every paper, on every cable-news show. And most Americans won’t understand what any of it means. Their confusion won’t be helped by the media’s — and their own — instinct to understand the process through single significant moments. But trying to understand the Fed that way is like trying to make sense of a long marriage, with its small daily compromises, joys and miseries, by watching one big fight or one romantic dinner.
I happen to believe the Fed would be better off waiting a few months before it raises rates. But if it does raise them in December, I won’t be too upset. The committee will meet again in January and again in March, and then April, and then June. At each meeting, its members can look at the latest data about the economy and then choose A, B or C. And at the next meeting they get to choose again, so any one decision doesn’t really matter all that much. What matters is how those small decisions add up over a long time. That isn’t the stuff of high drama. It is much more like something else: real life.
Adam Davidson is co-founder of NPR’s ‘‘Planet Money’’ and a contributing writer for the magazine.
A version of this article appears in print on October 25, 2015, on page MM18 of the Sunday Magazine with the headline: You’re Not Supposed to Understand the Federal Reserve