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The conventional thinking of Ben Bernanke, Tim Geithner, and others who control our money supply and financial system is that lower interest rates and more liquidity pumped into the economy create jobs and growth.
Unfortunately, their thinking is dead wrong.
Historically, both in the U.S. and in other countries such as Japan following a similar path of manipulating interest rates to artificially low levels and printing money via quantitative easing, excess liquidity has the effect of reducing future economic growth rather than increasing it. This may be counterintuitive, but it has a basis in sound economic principles. There are several reasons why.
The most obvious reason is that artificially low interest rates and money printing inflates asset prices and creates a higher rate of inflation than would occur naturally. This doesn’t necessarily mean inflation or asset prices will be extraordinarily high. It just means they are inflated from where they would be if their prices were being set by the market rather than manipulated by the central bank and Treasury.
Artificially high asset prices and inflation caused by monetary games rather than market supply and demand reduce economic growth by misallocating capital from productive uses to overpaying for assets, goods and services whose prices have been inflated in this way.
The less obvious reasons are more complicated, but even more important. Excess liquidity and extremely low interest rates allow bad investments, bad companies, and bad investors to survive because the cost of capital is so low and the opportunity cost of a bad investment is also very low. Think of this as preventing the market’s creative destruction that is the most basic premise of capitalism itself. There’s a reason that Lenin, who led the Bolshevik revolution to found the Soviet Union, famously said that to destroy capitalism you must first destroy the value of money. By destroying the value of money, capitalism no longer can function properly. Capital is misallocated to projects that produce near zero or negative returns because capital is treated like trash rather than treasure. We can see this happening more and more in our economy as insolvent banks continue to operate, people allocate more and more capital to speculation in commodities, and less and less capital is allocated to starting and growing productive businesses.
Many investors in an environment like this either retreat to assets that have no risk such as cash or assets that have no productive value such as precious metals. In either case, the long-term return on capital will be extremely low. Recent high returns in precious metals are a result of speculation and are not sustainable. Over the long term, precious metals have been one of the worst asset classes. They are performing well right now exactly because investors have no confidence in the financial system.
This has created price momentum in precious metals because they’re viewed as an alternative currency, even though the reality is that they never will be allowed to gain that status by any major government. In an environment of extremely low interest rates and excess liquidity, investors follow any asset that shows price momentum, regardless of fundamentals. The intent is not to hold the investment long term, but rather to make a quick buck and move on the next hot asset showing price momentum as soon as the momentum slows down.
Recent price action in gold and silver mimics the price action in other high beta stocks such as Apple, Netflix, Salesforce.com, and Google even though the fundamentals of these assets have nothing to do with each other except similar price momentum. This pattern further confirms the current fixation of investors on following price action in assets rather than investing on fundamentals. Excess liquidity and artificially low interest rates are the cause of this increasingly momentum driven and speculative market.
The worst part, though, is that truly good long-term investments are paradoxically starved for capital in this environment of excess liquidity. This happens because there are only a few truly good and high-return investments even as there are an infinite number of low return and bad investments.
If interest rates and liquidity are at normalized levels, many of the bad and low return investments are immediately rejected. This allows investors to focus on the fewer number of better long-term investments. However, in today’s environment, the few truly good investments are crowded out for attention by so many bad investments that seem reasonable to many investors because there is so much excess liquidity. A great explanation of how this happens is detailed in Forbes.
The article’s conclusion is that excessive liquidity and extremely low interest rates do long-term damage to the economy by reducing investment in good projects and increasing investment in bad projects. The result is lower growth and fewer jobs. See Japan for an example of this policy in action for 20 years.
My business at CapLinked is helping investors and private companies and ventures to find each other, close deals, and manage investments together. I believe that the market, individual investors and entrepreneurs should decide how to allocate capital.
Countries that promote free market capitalism have prospered throughout history and continue to prosper. The most recent success stories are in Russia, China, India and Brazil. Many of these countries used to be socialist and poor. Now they are getting richer and we in the United States are getting poorer because we are embracing socialism, both in fiscal and monetary policy, as these countries are embracing capitalism. We need to change course, stop quantitative easing, force the Fed to sell off assets on its balance sheet, and raise interest rates to a normalized level of at least 2 percent as soon as possible to avoid falling into the Japanese trap of 20 years of low growth and a declining standard of living.
Sarah Palin recently joined John Boehner, most House Republicans, several Fed governors, Nobel Prize-winning economists and the leaders of Brazil, Germany, and China in calling for a change of policy at our Federal Reserve.
Bernanke, Geithner, and Obama shot back that quantitative easing is necessary to create growth.
History is not on Bernanke’s side. Let’s start a grass-roots effort of citizens rising up against this tyrannical fool running our economy into the ground and stop Bernanke’s printing press before he can do any further damage.
Contact your representatives in Washington and urge them to use all means necessary to either replace Bernanke or shut down the Fed’s authority to print unlimited amounts of money.