The good news for the economy and taxpayers has come in the form of a Republican takeover in the U.S. House as well as big gains in the Senate and among governors, prompting President Obama to fold quickly in his opposition to extending the Bush tax cuts. Unfortunately, there also was some very bad news for the economy and taxpayers: the Federal Reserve’s decision to continue down the path of central planning and monetary debasement with another $600 billion of quantitative easing. Here’s why.
For those who may not be familiar with quantitative easing, it’s basically the Fed printing money out of thin air to buy assets. In this case, the Fed mostly will be purchasing Treasuries with maturities of between two and six years. The Fed also may purchase some other assets with the money it prints, but there were limited details released about what those assets would be.
The Fed’s stated objective for these actions is to stimulate the economy by lowering interest rates and increasing liquidity in the financial markets. This is economic nonsense for several reasons.
First, there is no shortage of liquidity in our financial markets. This is especially true in the markets for short term Treasuries.
If anything, there is too much money in these markets, which is why interest rates are at historic lows. This excess liquidity and extremely low Treasury yields have failed to stimulate any real economic growth for years now, so it is clueless for the Fed to think that more of the same is going to have a substantially different result.
Big corporations also have plenty of liquidity. They’re sitting on nearly $2 trillion in cash, which is a record amount. In fact, Germany’s Finance Minister Wolfgang Schaeuble specifically called the actions of Bernanke’s Fed “clueless” because all it will do is reduce the value of the dollar and create asset bubbles rather than do anything to stimulate the real U.S. economy. He’s right. Similar condemnations of the Fed came from leaders of China, Brazil, and other countries.
The Fed’s reckless actions have cost America our credibility when it comes to accusing the Chinese or other countries of currency manipulation or unfair trade practices in general. The timing couldn’t be worse with a showdown and possible trade war about to break out on the eve of the G20 summit next week. The Fed’s actions increase the likelihood of a trade war and further competitive currency devaluations by other countries to offset the impact of the Fed’s debasement of the dollar.
In addition to a potential trade war, the Fed’s policy already is causing a huge increase in the prices of commodities. This is because commodities are mostly priced in dollars. If the Fed pushes down the dollar, it is also pushing up commodities prices. Oil prices are now at their highest point since before the financial crisis even though world inventories of oil are at record levels. Food prices are skyrocketing. Metals prices are soaring. This is a huge tax increase on American consumers, especially low-income Americans who spend nearly 60 percent of their after-tax income on food and energy.
The worst part is that most of the excess liquidity created by the Fed won’t even stay in America. Most of it will end up flowing into emerging markets, which stand to benefit the most from a weaker dollar and higher commodities prices. Emerging economies in Asia and Latin America already are taking steps to restrict the flow of American money into their economies for fear of allowing the creation of dangerous asset bubbles that will crash if that liquidity quickly disappears in the future. With all of these potential dire consequences of the Fed’s actions and probably no economic benefit to most Americans, why would the Fed want to do this quantitative easing?
There are several answers. The biggest reason is that the Fed would much rather create inflation than allow deflation. Currently, the Fed believes inflation in the U.S. is too low. Printing more money is the easiest way for the Fed to create inflation. The Fed wants more inflation because America is a country mired in debt. Inflation erodes the value of that debt and effectively makes the debt smaller.
Additional liquidity also benefits Wall Street traders and speculators. They will make a fortune trading commodities and other speculative assets that will be further inflated in value by the Fed’s quantitative easing. The large banks are another group that benefit from extremely low short-term interest rates because it increases the profitability of the carry trade, which involves borrowing at the short end of the yield curve at ultra low rates and buying at the long end of the yield curve where rates are significantly higher. Long-term interest rates, which are more often used as a measure of expected future inflation and to price mortgages, actually increased significantly in response to quantitative easing. This further helps the large banks and their carry trade even as it signals regular Americans will be harmed by more inflation and higher mortgage rates in the future.
Of course, it’s the U.S. Treasury, the large banks, and Wall Street that control the Fed, so it should be no surprise that their actions benefit these groups. Unfortunately, the Fed is now completely out of control. Fed policies are destroying our economy, rather than helping it. The Fed was created with a mandate to promote price stability and economic growth. Currently, it is doing the opposite of both of those goals. It is promoting inflation and economic paralysis. Among the top priorities of our new, market-friendly Congress should be a full audit of the Fed so that we know what assets it’s holding as well as restrictions on the ability of the Fed to print money beyond a certain percentage of GDP dollar amount per year without explicit congressional approval.
These reforms would be market friendly as well as further the goals of transparency and accountability in government. Basically, everybody would win except the large banks, Wall Street, and the U.S. Treasury.
It’s about time our government started acting in the interests of regular Americans. That’s what caused the election tidal wave this year. There is no example of an entity acting more against the interests of regular Americans than the Federal Reserve. Let’s show voters that this new Congress heard the message loud and clear. Clean up this government. Stop allowing the Fed’s reckless and corrupt actions to damage our economy. Rein in this Fed now.