The Fed Bloviates, and the U.S. Economy Suffers
Last week the Federal Reserve announced that it will maintain its near zero Fed Funds rate amid a "pace of recovery in output and unemployment [that] has slowed in recent months." Not acknowledged by our central bank is that its very own policies help explain our economic difficulties.
Regarding its balance sheet expansions, on their face they're not as relevant as is widely assumed. No doubt the Fed can exchange dollars for assets held by banks, but so long as economic uncertainty has businesses and individuals uneasy, the credit will be housed at the Fed owing to low demand for loans in the private sector.
Contrary to the belief among modern Austrian School thinkers that balance sheet expansions are themselves inflationary, the real truth is that money supply only expands when money values and policy are stable such that production stimulates money demand. Many now fear that inflation will be the result when the banks lend the credit added to their balance sheets, but the contrarian reality is that inflation has long been with us (more on that later), and those funds will only be borrowed once the dollar is stronger and more stable, along with policy concerning taxes, trade and regulation.
Contrary to the Keynesian/Monetarist belief that money growth itself is a form of economic energy, the real truth is that money is merely a lubricant meant to facilitate exchange after production. Far from wealth on its own, money is solely a measuring rod meant to foster actual wealth exchange; thus explaining why economies perform so well when the unit of account is stable in value. All three Schools ignore the Adam Smith/David Ricardo/John Stuart Mill view that a dollar should be a like a foot; its supply irrelevant.
The Fed's balance sheet expansions do, however, have a problematic side. In that case it's unfortunate that in its press release last week it was reiterated that the Fed "will maintain its existing policy of reinvesting principal payments from its securities holdings."
To the extent that the Fed's purchases of mortgage securities make them a safer haven for investors, its actions will merely constitute a governmental body doubling down on a subsidy of homeownership that already ended in tears. The modest mortgage/housing correction in 2007-08 signaled an economy on the mend for limited capital finding better uses, but the Fed seems intent on ignoring those market signals.
Instead, and as previously mentioned, the Fed will subsidize more of the same in the way of too much money chasing the dead money sector that is housing. For those who doubt the truth that excessive capital flows to housing weigh on economic growth, they need only ask if investments in housing will cure heart disease, foster technology innovations that make businesses more profitable, or open up foreign markets.
If the answer to the above is "none of the above", as it should be, it will hopefully then become apparent that far from an economic stimulant, housing on its best day is the consumptive result of otherwise productive economic activity. That it also makes us immobile at a time when we need to be very mobile in pursuit of the best job opportunities speaks even more to how unfortunate are the Fed's reinvestment practices.
That this same Fed will also purchase Treasury securities in order to keep interest rates low is evidence of our central bank doing everything it can to halt our recovery. Indeed, while the FOMC release decried the fact that "Employers remain reluctant to add to payrolls", our oblivious central bankers weren't able to tie their own actions to the difficulties faced by employers.
Sure enough, governments can only consume capital taxed or borrowed from the private sector first, and so long as Fed purchases of Treasuries offer investors in same protection from a rise in yields, there will be little incentive among those investors to reorient their capital into the private, productive economy. This is remarkable considering that the Fed is empowered (wrongly) to keep unemployment low. Whatever the foolishness of the Fed's unemployment mandate, it would be nice if these alleged "wise men" could draw the connection between investment and job creation.
Most remarkable about the FOMC's press release is its statement that "Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability." In saner times, it was understood that when gold spikes, and the dollar declines against every foreign currency, that this is inflation.
And when money is debased, meaning we inflate, investors pull back capital given their desire to not see it eviscerated by devaluation. Tragically for those who want to work, this Fed is clueless as to true inflation, and as such, doesn't understand that the dollar debasement it ignores is what's killing the investment needed for jobs.
In our central bank's defense, the exchange value of the dollar is the preserve of the U.S. Treasury, and the latter has made plain its desire for a weaker greenback through its consistent bashing of China; in this case backed by Republicans and Democrats. Importantly, this in no way excuses the Fed.
In seeking to distort market rates of interest with a bias toward low rates, the Fed is exacerbating errors made at Treasury. Not only are savers harmed by Treasury's policy of devaluation, but with the Fed using its powers to keep rates of interest low, they also face reduced compensation for the very delay of consumption that funds the jobs and innovation that grow economies.
Put more simply, it's generally agreed that imprudent borrowing played at least some role in what got us here. Rather than let market rates of interest to find their own level in order to avoid the destruction of even more capital, the Fed is encouraging more of the same.
In short, a Fed utterly bereft of ideas is offering policies that promise to achieve the opposite of its dual mandate of low unemployment and low inflation. In a saner, private sector world, chief architect Ben Bernanke would be forced to resign, but this being Washington, the alleged student of the Great Depression will continue to bloviate economic falsehoods, and the victims will be all of us.