Tuesday, March 22, 2011

The Consequences of Money Printing (er, Quantitative Easing) 2

One thing James Grant said Congress could do to help the public understand the Federal Reserve's expansive monetary policy is to call it to start speaking plainly, use truthful language, and stop the euphemisms. A case in point, he said was "quantitative easing." He said we should require the Fed to us the term that is indicative of what it really is--money printing. I think he has a great point.

Regardless of the terminology, however, I was very disappointed to read an article that appeared at Bloomberg News discussing the immediate consequences of Money Printing 2. During the financial crisis and Great Recession, Bloomberg was the best financial news media outlet that gave you the straight scoop. A recent piece by Caroline Salas, however, was sad in how it tried to paint the Fed's inflationary monetary policy as a big success.

Salas asserts that Money Printing 2 has helped the economy and points to the following as evidence:
  • Since the plan was announced in August of last year, the S & P 500 has increased 18 percent.
  • Inflation expectations has increased 44.4 %. 
  • Official unemployment rate has fallen to 8.9%. 
All of these are seen as positive signs for the economy, indicating that Fed policy is working. As the song in Gershwin's Porgy and Bess goes, "It ain't necessarily so."

In the first place if the Fed’s expansive monetary policy was really that wise, one would think the unemployment rate should be much lower than 8.9 percent. In fact, much of the drop in the unemployment rate is related to a drop in the civilian labor force to its December 2007 level. A low official unemployment rate is not per se an indication of a flourishing economy anyway. In May of 2007 the unemployment rate was 4.4 percent. Was the economy strong? No.

Additionally, high stock indices are not necessarily signs of a healthy economy. Back on October 9, 2007 the Dow Jones Industrial Average closed at 14,164 and the S & P 500 closed at 1,565. These were the highest they have ever been. Were they a sign the economy was strong? No.

Inflation expectations up by 44.4% is not to be applauded either. We should not be surprised that they have increased. Expanding the monetary base from $1.7 billion to $1 trillion tends to do that. In fact, inflationary expectations are the first dangerous step toward hyper-inflation. If people expect continual higher prices, they are likewise expecting a continual loss in the purchasing power of the dollar. People will not want to hold on to dollars as much if they think that while they do so, the quantity of goods they can buy with their dollars is shrinking every day. Increased spending increases demand for producer and consumer goods, which raises their prices even more, fueling even more intense inflationary expectations, which encourages people to spend even faster, driving up prices even more sharply, which. . . . You get the picture. It is a recipe for economic disaster. Ask the Zimbabweans.

To the extent that macroeconomic statistics have improved after last August, it is just as likely that the Fed has merely postponed a more full liquidation of malinvestments undertaken in the mid-2000s. At best, the reckoning is merely put off. Any actual improvement is not due to the Fed but rather to a real increase in savings funding productive private investment.

No comments:

Post a Comment