Quantitative Easing: The Monetary Policy Of the Adolescent
For the naïve mind there is something miraculous in the issuance of fiat money. A magic word spoken by the government creates out of nothing a thing which can be exchanged against any merchandise a man would like to get. How pale is the art of sorcerers, witches, and conjurors when compared - Ludwig von Mises
With the economy continuing to limp along, the Federal Reserve announced in the Wall Street Journal last week its intent to further "stimulate" the economy in 2013; this after announcing a third round of quantitative easing (QE) in mid-September. The forward implications of such a move include currency depreciation, price increases in commodities such as oil, and a continued flow of limited capital into the hard, commoditized assets least vulnerable to the dollar's decline.
The naiveté of the Bernanke Fed's reasoning would be funny if it weren't so sad, and if it didn't bring with it such negative implications for real people. The case for its initiatives is based on a belief that mass creation of the "ticket" that is money will somehow produce economic growth. This is how an adolescent thinks, to borrow a line from frequent reader Brent Rice, and from a column on the Fed a little ways back by the Wall Street Journal's Robert Pollock. Parents often tell their children that "money doesn't grow on trees," but that's exactly the assumption on which the Bernanke Fed is operating.
Money without capital. Credit derives from the productive activity of households and businesses when they exchange the fruits of their efforts for money-tickets. By banking those tickets, they place capital at the disposal of those who can use it to fuel the economy.
Fed thinking, inexcusably, has left the production side of these linkages out of the equation. QE creates new money-tickets out of nothing and deposits them in the banking system in return for interest-bearing assets. Its actions create no new capital, and cannot add anything to the circulation of capital through the economy. The entire increase in reserves that the banking system has obtained from the Fed's actions since 2008 still sits, idle and identified as "excess," on banks' balance sheets.
Empirical evidence reveals that new money creation leads directly to devaluation of the dollar. That's already been a visible result of the Fed's actions. The Fed is mistaken to presume, as a child might, that money is wealth. By producing vast quantities of it, backed by no real economic activity, it has reduced the meaning and value of each new and pre-existing ticket. In the four years since QE-1 was announced in the middle of the financial crisis, the gold value of the dollar has sunk more than 50 percent.
An inverse relationship between the issuance of paper by the state and the hard-currency value of that paper has been recognized for centuries, and it can be observed in U.S. history. Though the quantity of new money created in recent years is beyond precedent, there was already a longstanding inverse correlation between the monetary base and inflation, expressed in terms of official indices as well as gold.
Policymakers have been captured by the adolescent fantasy that money can be had free of labor. In reality, the greenback has value only to the extent that financial markets judge it to be a reliable store of that value. By divorcing money creation from the productive economy the Fed has reduced the markets' trust in the role of paper money as a future store of value and medium of exchange. It has devalued the dollar.
Children seek to get their hands on as many dollars as they might in return for doing very little. Briefly dreaming of counterfeiting dollars in order to have more of them to spend, they learn from adults that private money creation is against the law. Later they come to understand that, if printing money by itself were enough to boost the economy, counterfeiting would be legal and widely encouraged.
Money and economic vitality. Investors do not ask themselves often enough how the economy's producers will logically respond to the Fed's childlike ways. In the real economy, our individual and collective labor and production is the source of our demand, and we therefore produce to attract as much income as we can in return. But if money is depreciating, the incentives for mutual exchange are compromised. Consider a contractor who does kitchen remodels. Why remodel a kitchen for $25,000 if the eventual payment for services rendered will come back in devalued dollars? An environment of unsound money fosters disharmony in production and trade. That is sand in the wheels of the economy.
After that, there are quite simply no companies and no jobs without saving. Someone, somewhere, must delay consumption and place part of his or her income with a financial intermediary in order for there to be credit for businesses eager to grow. In quantitative easing, the Fed acts as though credit can be created simply through low interest rates, and that no business or startup will go wanting. Near explicit in the Fed's rationale is the charitably juvenile assumption that saving is superfluous when it comes to credit, that savers are almost irrelevant when the central bank is ready, willing and able to create dollar credit out of thin air. This is the stuff of economic fabulists, and should horrify us all considering the world's foremost central bankers actually believe what is so plainly absurd.
One of the Fed's QE goals is to drive up stock prices, at which point newly flush stockholders are supposed to exchange their shares for cash in order to spend the proceeds on consumer goods. Here too, the role of production and exchange is ignored in the belief that financial wizardry can take its place. Commentators point to the 2.4 percent advance in stock prices that took place in September, anticipating and following the announcement of QE-3 on September 13. They have paid less attention to the fact that the price of gold advanced by more (7.7 percent) in the same time frame. Investors should not need to be reminded that, over the four years during which QE-1 and QE-2 were at work, the S&P 500 is up zero while the price of gold has doubled. In short, investors have lost ground since QE began; any increase in the dollar value of the S&P having been more than fully erased by dollar devaluation.
Money and saving. Missed by our central bankers is the fact that we stand on the shoulders of parsimonious giants. Past saving has led to the creation of the cars, planes, computers and medical innovations that make our lives more productive, easier, and healthier. The message from a policy of zero interest rates and devaluation to those whose prudence might otherwise fuel future production, and with it a true multiplication of credit, is that saving is for fools. Better to consume now and reduce the capital stock. Fed policy does not reward thrift; and worse, it results in dollars that buy even less down the line.
That's how young people view thrift similarly. Unformed in terms of experience yet full of wants, they spend with abandon until they realize that consumption not only leaves them penniless, but puts bigger-ticket items out of long-term reach. They first require parsimony.
Prodigality weakens the individual. We know that rampant consumption on its best day empties our pockets, and on its worst day will reduce us to beggary. Our government lacks that insight. Sadly, the Fed acts to nullify the lessons about saving that we learn as children. Spend with abandon, because "in the long run we're all dead."
Just as a lack of thrift compromises the economic freedom of the individual, spread over the economy the Fed's attempt to stimulate consumption leads to hardship for all, followed by reduced production and, as a result, a reduction in society's standard of living. The drivers of economic advancement include thrift, sound money in exchange, and future production opportunities fueled by capital from the fruits of past enterprise. We can ill afford to blunt them.
Money and the reputation of the Fed. Childhood is a dress rehearsal for adulthood, an opportunity to begin to learn from past mistakes. But the Fed's actions are those of a child placed in the driver's seat of the family car. On the bright side, right now the U.S. economy is the victim of central bank errors that are happily alerting the electorate to the damage that a quasi-independent monetary authority can do.
The silver lining amid these troubled times is that the Bernanke Fed is being discredited right before our increasingly adult and wary eyes. The country's prolonged malaise will be the undoing of the Fed as we know it.
Indeed, largely hidden ahead of the looming failure of a new round of quantitative easing may be relief from this most destructive of governmental entities. The unflattering light to which the Fed is being exposed by its own flashlights points to eventual reform that will ensure, at least until these lessons are once again forgotten, great restraints on the destructive powers of our central bank. In time, the correction of today's mistakes will contribute to our economic revival.