The Real Effects of Printing Money and Creating Debt

“Debt delenda est,” we told our audience in London this morning. “This is a debt story. It’s not a liquidity story. It’s not a ‘capitalism has failed’ story. It’s not a regulatory story. It’s the story of debt. Too much debt. Too much to pay back.

“So how does the story develop? That’s what we’re watching. Ultimately, when you have too much debt, there’s no point in refinancing it. There’s no point in rescheduling it. There’s no point in delaying the inevitable. You need to destroy the bad debt. As fast as possible.”

The Dow was down 73 yesterday. Where is the follow through?

Hmmm… The Fed promises $600 billion to speculators. Alan Greenspan, writing in yesterday’s Financial Times, says the Fed is out to lower the value of the dollar. Ben Bernanke says the Fed wants to increase asset prices.

And still stocks don’t go up. They go down.

What is the meaning of it?

The whole idea of pumping money into the bond market – Bernanke admitted himself – was to get asset prices up. What else could it be?

Higher asset prices are supposed to make people feel richer. Then, they’re supposed to act richer. What do rich people do? They spend money! And before you can say “prestidigitation” they WILL be richer.

How exactly does that work? Oh never mind the details…it’s…like…magic!

Ben Bernanke, one of the world’s leading economists…and certainly the most powerful economist in the world says it works.

Do you believe it, dear reader?

We don’t. If you could make people richer simply by printing money well, heck, we’d print it night and day. Maybe even weekends too.

But of course, it doesn’t work.

So what DOES all that money printing do? Well, that’s what we’re going to find out.

One thing it doesn’t seem to do – at least not yet – is the very thing it was supposed to do: raise asset prices. Instead, investors seem to be wary. It is as if they didn’t trust it.

And why should they? Investors aren’t stupid. They can put two and two together. Sometimes. They know as well as we do that all this money printing MIGHT do is to create a speculative, short-term bubble. As it looks now, they don’t seem to have an appetite for that kind of thing.

So, as near as we can tell, our Great Correction hypothesis is still the best explanation of what is going on. The US (and other nations) went into bubble mode in the 2002-2007 period. The bubble blew up. And now they’re paying the price. It will take years to clean up the damage – even under the best of circumstances. With Bernanke and the Feds doing even more mischief, it could take decades.

But the big risk is that the Feds will make so many mistakes…and such big mistakes…that it will be impossible to correct them in a calm, orderly way.

The private sector can fix itself up. All the feds have to do is to get out of the way. The banks and corporations that can’t stand on their own two feet will fall down; we’ll be better off without them. That’s the way it has always worked. The markets can destroy bad debt. They don’t need any help from the feds.

It won’t be painless. It may not even be fast – about 7 to 10 years was our estimate. But if it is allowed to happen, the economy can once again get on solid ground.

But enter the feds…the ever earnest, world-improving meddlers…power-mad and reckless. They really believe the economy would be much better if it would just do as they say. “Stop destroying debt,” they tell us.

So, they stopped the wobbly banks from going bust. They saved Fannie and Freddie – at a cost of a third of a trillion dollars, according to the latest estimate from the Federal Housing Finance Agency.

They pumped. They bailed. They jury-rigged. And they commanded.

“Let there be light,” they say. And darkness covers the economy.

The economy responds to these commands – just like any economy would respond to such central planning: it slumps and gets worse.

While the private sector cuts debt, the feds add to it. This latest $600 billion from the Fed sounds like free money. But it is debt. These are Federal Reserve Notes they’re issuing. They are claims against the wealth of the US government directly and against taxpayers indirectly. If you have these notes, you can exchange them for goods and services. They’re lawful tender…it says so right on the green paper. You can use this “money” to get toaster ovens or granite countertops…or a cup of coffee.

But the more of this “money” there is…the fewer goods and services are available to it. Simple, huh?

A classic case, right? The dollar goes down; the price of stuff goes up.

Private debt goes down. Public debt goes up. And then, the markets destroy public debt too.

Bill Bonner
for The Daily Reckoning

The Daily Reckoning