It seems to me, Obama’s pick to head the Federal Reserve, Janet Yellen, will continue down the treacherous path Ben Bernanke has put the US and the World on. The huge amount of money printing will continue perhaps at an even faster pace. This has huge implications to the future of the world’s economy. Wall street is excited about Yellen’s pick because she will continue the printing. We are told that this time it will be different because there seems to be no inflation. But if I wind a spring in a clock there appears to be nothing happening, until I wind it too tight and the spring breaks and the clock ceases to function. This may be a good analogy of where we are going with inflation. Once the springs snaps inflation will show it’s ugly head in a hyper way.
Today there is very little inflation despite the 4 trillion dollars the Federal Reserve has added to it’s balance sheet. This money printing has amounted to 25% added to the money supply. In Milton Friedman’s theory of money, if the economy grows at 1% and 3% is added to the money supply, assuming full utilization of resources, there will be 2% inflation. You simply subtract the amount of money added to the system from GDP growth to get the expected inflation number. Over the last 5 years we have experienced no more than 9% GDP growth, while the money supply has grown 25%. This implies that when our economy gets near full utilization we will see 16% inflation. If that was where it will stop, it wouldn’t be that bad, it would be disruptive but the economy would adjust and after a few years the problem could be absorbed.
The conundrum is that the money supply is not only increased by the Federal reserve, the banking system itself also increases the money supply. When the Federal Reserve buys a bond, the person or institution that sells the bond gets a check. This check is then deposited in a bank. That bank returns the check to the Federal Reserve who then adds that amount of money to that bank’s Federal Reserve account. The bank that cashed the check then has more money to meet it’s reserve obligation. This frees up money for the bank to loan. When banks loan money part of the money loaned is made up. It is not depositor’s nor is it the bank’s, the money is simply invented. This magnifies the Federal Reserve’s money printing by orders of magnitude.
Moreover the Federal reserve has been buying US government bonds faster than the US government has been issuing them! That means the private sector is selling their US government bonds into the marketplace. To keep the interest rate government pays low, so the US government can afford the huge debt and deficit, the Federal Reserve must sop up the access bonds. This implies the apatite for US debt is decreasing while the elite argue about raising the debt limit. As nations, firms and people the world over sell US debt, and the Federal Reserve buys that debt, the amount of US government debt held by the Federal Reserve grows. This is called monetizing the debt.
Monetizing government debt has been shown to lead to hyper inflation. The most famous case was Wiemar Germany, but there have been many notable cases throughout history, none of them ended well for the country that nationalized it’s debt. Economists will argue that the US is a special case because the dollar is the World’s reserve currency. It is directly convertible into any other currency and all oil is bought with dollars. This means that if you live in Zimbabwe and want to buy a widget from Brazil, you must convert your currency into dollars then dollars into Brazilian currency. This creates a huge cache of dollars held by foreign nations for purposes of trade in commodities and oil.
Most of the nation’s of the World understand this and the devaluing of the dollars they hold comes directly out of their national coffers. As a result they are selling US government debt and are seeking ways to directly convert their currencies to any other. Thus eliminating the dollar as the World’s reserve currency. When this happens, regardless if the US economy is at full utilization, the US will experience out of control inflation. As the Federal Reserve winds the inflation spring the tension builds. Eventually catastrophically failing and plunging the World into recession.
The only answer is to balance the US budget and reduce the regulatory friction before the spring snaps. The Federal Reserve under Yellen can be expected continue to print money in hopes the US economy will get back on track. As we have seen, even the hint that the free money will slow down has sent the markets into a tail spin. Therefor, to keep Obama’s economy growing at even the pathetic rate it is, the Fed must continue the printing. To get the US Gross Domestic Product growing at the pathetic rate of 300 billion a year the Federal Reserve is printing a trillion. So instead of a magnifying effect the money that is being printed is seeing a negative return in the real economy. If you think about it, these facts make the budget battle in Washington far more important than an obstinately recalcitrant President’s argument with Congress over the debt ceiling and Obama care, it could mean the whole sale closing of all the programs people have become dependent on. If that happens, there will certainly be wide scale social disruption including violence in our streets.
To argue that this or that billion dollar boondoggle is so important it cannot be defunded is absurd, especially when you consider the consequences of a true default, which would happen if the US dollar looses it’s reserve currency status. Imagine the value of your IRA falling to zero? Imagine if the value of your bank account fell to zero? Imagine if the Social Security administration went bankrupt? Imagine the military being laid off? Imagine no welfare, no Medicaid, no Medicare and all the functions of government going away… instantly. Do you think that would generate anger sufficient to promote violence or even war? That is why we have to get government regulation, debt and spending under control, to do otherwise is to run at a real cliff, like lemmings… ignorant of the danger until it’s too late. Now that you are no longer ignorant, what are you going to do about it? Keep running, or stop, and demand fiscal responsibility?