The Federal Reserve is supposed to promote full employment and stable prices, yet its actions cause jobs to disappear and prices to rise. This should come as no big surprise, at least it shouldn’t if you’re not inclined to think government intervention is either desirable or productive. The Fed is government intervention at its purest: the central bank with the legal monopoly on the creation of new money.
The Fed has essentially one trick. It can legally conjure new money whenever it wants. With this one trick it manages to force interest rates down. Mainly it lends the new money to the U.S. government. That is to say, it buys government bonds.
The artificial demand the Fed creates by throwing billions of dollars at government bonds has a depressive effect on interest rates. But these lower interest rates are not a result of those free market forces we champion at the Whiskey Bar. Rather, they are the result of the machinations of a government-chartered bank with a monopoly on the issuance of currency.
The Federal Reserve’s goal is to make borrowing more attractive because of the lower interest rates…but the boom that results is one built on debt that must eventually be serviced…and inevitably at higher rates.
The Fed also loves it when lower rates make lending money or putting it in interest bearing savings accounts less attractive to investors. People instead seek returns in other markets…like stocks. This is supposed to be a good thing. Notice Ben Bernanke points to a rising stock market as proof that his orchestrations were masterful.
But all he really did—all central bankers really ever do—is create new money and shovel it into circulation. Creating money to encourage mass indebtedness and speculative investing, however, isn’t exactly a winning strategy. It’s like taking up smoking so the nicotine will help your concentration when you’re picking the ponies. Or something like that.
You’ll notice that the stock market is responding less and less to the byzantine stimulus of lower bond yields. And people are up to their eyeballs in debt, and interest rates are rising despite the Fed’s efforts. This is your classic “pushing on a string” scenario. It’s rather like the point at which more alcohol starts shutting down the imbiber’s autonomic functions instead of producing more drunken bliss.
The stimulus of treasury-buying with new money is now having the opposite of the intended effect. After the initial euphoric response, things are getting worse.
And then there’s the matter of all that new money…
We’re not sure why central bankers and so many economists believe that new money can be created out of thin air—without any corresponding increase in economic activity or actual wealth—and inflationary results somehow be avoided…as if the new money will conveniently behave itself and keep from being used to bid up general price levels!
There wouldn’t be much of a problem if the Fed had only created just a few hundred new dollars…even thousands. Enough, say, to buy the legal counterfeiters cool new cars and some snazzy threads. But we’re talking about the creation of billions upon billions of new dollars here. Those dollars are sloshing their way through the economy and they’re going to show up more and more in the general price levels. (Their very creation also makes some of the other big holders of U.S. debt—like the governments in Asia—worried about being paid back with money that’s worth far less in real terms.)
Those new dollars have to get spent into circulation to do their damage, but that’s never a problem. Whoever gets them first will get to benefit before prices go up (and those prices go up at all because the new money is being spent in the first place!)
Cui bono? Why, those to whom the Fed hands the dough first. Traditionally that’s meant the government whose debt the Fed buys with the money it wills into existence, but lately the Fed has seen fit to hand new money straight to banks, because after all this is a crisis. Apparently you fix crises you engineered in the first place by bailing out your cronies in the big banks.
The government uses that money to pay the staff in its countless departments, contractors, military and others counting on a government check. The banks use the money to pay their senior members enough to keep them in million-dollar Manhattan apartments.
The rest of us get to beg our employers to give us raises that keep up with this mysterious price inflation. But it’s really not so mysterious. It happens as the first-users of new money drive up the prices on the things we all need…like food and energy.
The new money doesn’t simply go into the prices that the Fed would like it to, like stocks. It gets all over the place. The least connected, the very poorest farthest away from the new money feel the effects first. In our modern global system, that means that a family in a “developing country” will find themselves paying around half of their meager daily income for the food that used to take only a quarter of it. Eventually they may find that they can’t afford much food at all.
The typical middle class American is only just barely feeling the pinch now, but there’s a lot more pain to be felt. In 2010 Americans spent around 5% of their incomes on food. Things could be a lot worse. In fact, they likely will be soon enough. Increased food and energy prices are currently only a drag on consumer spending. Eventually, however, the essentials could get costly enough to cause serious privation.
The threat of mass starvation tends to lead to all sorts of unpleasantness. Individuals can do prepare by saving in real money (gold and silver and copper-nickel), but that does nothing to remedy the discontent and likely rioting from the millions of others who will not be so prepared.
We can’t say how much of this future woe is already baked in. We do know that more quantitative easing will just make a bad situation worse. It’s not idle speculation. History shows again and again that unbacked money creation by governments and central banks only leads to misery.
The pundits are debating whether or not QE3 will follow anytime soon or if will even follow at all. Let them hash it out. In the meantime, if you can’t or won’t get out of the U.S. entirely, you might want to consider at least not being in the middle of any large population centers.
Gary GibsonManaging editor, Whiskey & Gunpowder
Gary Gibson is the managing editor for Whiskey and Gunpowder. He joins the Whiskey staff as a long-time fan and reader of both Whiskey and Gunpowder and the Daily Reckoning. A graduate of Fordham University, Gary now spends his days reading about and writing on limited government, sound money, personal responsibility and resource investing.
I was a non-believer in the fiscal viability of LBJ’s Great Society, and by the late 1980s it seemed to me that our entire society had embarked upon some sort of financial Saturday night spree. I didn’t really know the jargon nor the causal relationships, but Saturday nights have always been followed by Sunday mornings–and coming down can be rough.
The last ten or so years have been a good learning experience, from an intellectual standpoint, but it was nothing more than old-time preparing for a comfortable old age which made the big difference for me.
Gasoline at $5 or $6? Well, as Rhett Butler said to Scarlett O’Hara…Availability is likely to be more of a problem than the price.
As you alluded, we are exporting our inflation on an international front. Only the U.S. can do this because the dollar is still the international currency standard in which energy transactions are conducted. This can and probably will change in the near future. I live in a population center but I own a home in a rural agricultural region, I own silver and guns, and I have a foreign bank account. I am not naive enough to think that these measures will make much difference when our currency collapses.
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