It is a maxim among those who study the circulation of money that the price of borrowing governs, in some material degree, the disposition of those who hold securities. Raise the cost of credit, the argument runs, and the speculator — finding his borrowed capital dearer, his future profits discounted at a less flattering rate — will retire from the field. The beast, so to speak, shall be tamed. I find this argument worthy of examination, for it contains within it a proposition I have long observed to be imperfectly supported by the actual behaviour of merchants and men of enterprise.
Mr. Kevin Warsh, newly elevated to the chairmanship of the Federal Reserve, is reported to entertain the possibility that he need not act at all — that the credible promise of action is itself a species of action. This is not, I confess, without precedent. In The Theory of Moral Sentiments I observed at some length that men are moved not only by the actual pleasures and pains before them, but by their imagined futures; the anticipation of loss may weigh upon the mind as heavily as the loss itself. In this sense, a governor who commands belief may govern with whisper where another must govern with deed.
And yet the evidence of past cycles of rising rates presents a complication. In several of the great episodes of monetary tightening recorded across the last four decades of the present era, the prices of publicly traded shares did not fall upon the occasion of rising rates — they rose. This is not so paradoxical as it first appears. Rising rates, when they accompany a vigorous and expanding commerce, may be read by the proprietied classes as confirmation that trade flourishes, that the engines of manufacture turn briskly, and that the sovereign's revenue will support the general order of things. The medicine, taken as a signal of health rather than sickness, emboldens rather than chastens.
I do not say that dearer credit is without eventual consequence. In The Wealth of Nations I was at some pains to demonstrate that the rate of profit and the rate of interest bear upon one another across time, and that no expansion of paper claims upon future produce may proceed indefinitely without meeting the hard resistance of real things — of warehouses, of labourers, of harvests. The reckoning comes; only its hour is uncertain.
What is remarkable in the present discussion is the degree to which learned men argue not about the economy itself — its output, its employment, the wages of the labouring poor — but about what Mr. Warsh may say, and what the holders of securities may believe he means, and what they may then do in consequence of that belief. We have constructed, it appears, an elaborate machinery for the management of expectations, which machinery is itself the principal object of expectation. A governor who must navigate such a hall of mirrors occupies an office more philosophical than I had previously supposed. Whether philosophy, in this instance, shall prove sufficient is a question the markets will, in their customary manner, answer at their own convenience and without consulting him.