My old friends Jeffrey Rogers Hummel and David R. Henderson continue to argue that the Fed had little or nothing to do with fueling the housing bubble during the first five or six years of the present decade. Their latest article along these lines appears in Forbes. This is the third rendition of their argument that I have read, and I am no more persuaded now than I was previously.
Hummel and Henderson base their argument mainly on the claim that the Fed was not an engine of inflation between 2001 and 2006 because the rate of growth of the monetary base and the rate of growth of various monetary aggregates were declining during that period. Indeed, they were declining. Computing the rates of growth for the December value relative to the preceding December value, I find the rates to be as follows for the monetary base: 2001, 8.7%; 2002, 7.5%; 2003, 5.8%; 2004, 5.0%; 2005, 3.6%, and 2006, 2.9%. The rates of growth of M2, computed on the same basis, were as follows: 2001, 10.3%; 2002, 6.3%; 2003, 5.0%; 2004, 5.7%; 2005, 4.0%; and 2006, 5.4%.
It does not follow, however, that simply because these (and other monetary) rates of growth were declining, the Fed bore no responsibility for fueling the housing bubble. If we begin at a high rate of growth, as indeed we did in 2001, then rates may fall and still be “inflationary” in their effect on certain asset markets. Consider, for example, that during the entire period from the fourth quarter of 2000 to the fourth quarter of 2006, real GDP rose by only 14.9%, whereas during the same period (December-to-December monthly figures being used) the monetary base increased by 38.3% and M2 by 42.7%–or, by 2.6 times and 2.9 times as much as real GDP, respectively.
In pondering the Hummel-Henderson thesis, I keep coming back to various analogies, such as this one: I walk onto the street and I’m hit by a car going 50 mph; the next day, I walk out and I’m hit by a car going 45 mph; and, being a slow learner, I walk out during the next three days and I’m hit in daily succession by cars going 40 mph, 35 mph, and 30 mph. After five days, I am pretty nastily banged up, but Hummel and Henderson come along to comfort me by informing me that my being hit repeatedly cannot actually have hurt me because each day the car that hit me was going slower than the one that hit me the day before.
Hummel and Henderson also continue to endorse Alan Greenspan’s story that the real culprit was a surge in foreign savings that was invested in large part in housing-related securities, such as Fannie and Freddie’s bonds. I confess that I have never understood this story. In order to invest in securities of any kind, foreigners need to acquire dollars. And all dollars ultimately come from the Fed, because every dollar consists of either a circulating Federal Reserve note or a dollar deposit account subject to a variety of Fed controls. Was the Fed really powerless to “sterilize” the inflow of foreign savings? Or did it simply not attempt to offset this inflow, which it might have done by, for example, selling securities on the open market or by increasing required bank-reserve ratios?
In raising these questions, I assure my readers that I harbor no ideological or personal animus whatsoever against Jeff Hummel and David Henderson. Indeed, I love each of them as I would love a brother (which, in a sense, each of them is to me). I am puzzled by their persistence in attempting to persuade us with a story seemingly aimed at vindicating the Fed (while insisting, however, that, all things considered, the world would be better off without this central bank). I continue to believe that the Fed deserves a major part of the blame for the housing bubble because, however we tell this whole sorry story, our interpretation must inevitably include a plausible answer to the question: where’d the money (i.e., the dollars) come from?