It seems to me that the US FED and the ECB, are not as much sowing the seeds of the next financial catastrophe, as they are planting, watering, and fertilizing them. Economists today have far too much confidence in the ability of monetary policy to save a faltering economy. We see this in the way the equities markets eschew real economic data, for perceived changes, or “easing,” of monetary policy. The market rises on hopes the US FED will print money and falls on a rumor the FED will stop printing money. This state of affairs not only endangers our economy in the US, but threatens economies around the world, with becoming addicted to smoke and mirrors and ignoring economic realities.
There is an economic theory that is relevant to this discussion… it is called the neutrality of money. I believe it was Milton Friedman who coined the term. This theory states that money is neutral to an economy, in that if the amount is increased, prices will rise in accordance to the increase, and long term economic output will remain unchanged. For example, if an economy is at full utilization of it’s resources, a state called equilibrium, and more money is added to the economy, after the initial economic disruption caused by the “helicopter drop of money,” the economy will return to equilibrium, and the only change will be inflation.
In the short term, the printed currency might cause people to spend the additional money, thus driving up demand and economic output. This “stimulus” if you will, is a short term phenomenon however. The short term “stimulus” of added money, is undermined if people expect higher inflation, or put another way, they anticipate what the FED is doing. People aren’t stupid, they will horde the extra money, in “anticipation” of the higher inflation that will inevitably result.
We see inflationary pressure in QE1 and QE2, in the dramatic rise in commodity prices, that resulted from these FED actions. Operation TWIST, the FED buying long term assets to drive down long term interest rates, didn’t have nearly the same asset price inflation as Quantitative easing did, (printing money). This may be because the rate of anticipation was higher, the global economy had dropped so low it was irrelevant and the risk aversion of people, (in this case small businesses), had dropped so low, the cheap money wasn’t taken advantage of, or perhaps due to people’s assumption of a negative economic future.
People in government, the media and economics, are reluctant to blame Obama, or the democrat’s policies, for the anemic economic recovery, even though the FED has done more to “stimulate” the economy in this recession than at any other time in history. Interest rates are at historic lows and the US Dollar has lost 40% of it’s value in the last decade. According to the Keynesian… this should result in an extremely fast economic rebound. That this hasn’t happened is, at least anecdotal evidence, that monetary policy has minimum ability to raise economic outcomes.
In fact, in 1920 the US economy was in a deep recession, perhaps even deeper than the “Great recession.” At that time Warren Harding committed the greatest of economic sins, he cut spending, cut regulation and cut taxes! While at the same time, the FED raised interest rates, (destroyed money), possibly to undermine Harding’s reforms. The result was staggering, the Roaring Twenties happened. Possibly the fastest rate of economic expansion the US has ever experienced. If we examine this period in US economic history, as well as the Reagan years of fast economic expansion, the effect of the FED to use contractionary monetary policy, to effect growth in the economy, pales in comparison to the ability of the executive to expand it.
The firestorm that Nial Ferguson has come under, for even hinting that Obama’s economic policies have anything to do with our miserable economic rebound, is clear evidence there is a price to pay for telling the truth. There are some people calling for the tenured professor to loose his tenure and his job. The reaction from the eggheads in academia, is more telling of their political position on the matter, than any real statement on economics. This might explain why so few economists are willing to point out that it may very well be, Obama’s vilifying of businessmen, his draconian regulation, his constant push to increase taxes, blatant partisanship, his out of control spending, his gutting of Medicare to fund Obama care or his overreaching Constitutional bounds, that has been such a drag on our recovery. The economic malaise we are experiencing, despite the historic exertions of the FED, are entirely due to factors outside the control of the FED.
The results of the FED’s actions will inevitably lead to runaway inflation… as economic theory says it will. The continuing printing of money by the FED, and now potentially the ECB, will end up damaging the ability of people, the world over to have real economic growth. Bernanke will go down in history as a villain, even though he was instrumental in saving the World from economic collapse, in 2008. The exchange rate of the World’s currencies will be forever reset, The World will go into a great recession and China’s economic miracle will be crushed by the resulting tsunami of worthless dollars… All so that Nobel laureate Obama can escape the blame for his actions. Pretty pathetic if you ask me.