March 15, 2011
Quantitative Easing: Our Tiger by the TailBy Monty Pelerin
Friedrich Hayek's A Tiger by the Tail: The Keynesian Legacy of Inflation was published in 1978. It seems an appropriate description of what Quantitative Easing (QE) has produced. We are far along on a journey that cannot be stopped without enormous damage.
Quantitative Easing is a euphemism for money creation. Money creation is, by definition, inflation. Eventually inflation produces higher commodity and other prices. Inflation can be created by other Fed policies besides QE. However, for purposes of this article, QE will be dealt with as if it is the primary cause (which it has been recently).
According to Chairman of the Federal Reserve Ben Bernanke, we are in phase 2 (QE2) of "money printing." Those knowledgeable of history find this characterization amusing, because the Fed has engaged in almost continuous money creation from its founding in 1913. Since then, 96% of the dollar's purchasing power has disappeared with much of the loss occurring subsequent to the mid-1970s.
Mr. Bernanke initiated his so-called QE2 ostensibly to improve traction for the weak economic recovery. According to Bernanke, the program will end in June. With regard to his promise, Mr. Bernanke resembles Charlie Brown's friend Lucy placing a football.
QE will end but not in June, at least not permanently. It will not end as a result of political decision or Fed mandate. It will fall victim to Stein's Law: "if something cannot go on forever, it will stop."
Why Quantitative Easing?
Money creation is never proper economic policy. It does not improve or create wealth. Its purpose is to fool citizens. As such, it is a fraud employed by governments to deceive and steal. If high enough, QE results in societal disruption. At worst, it produces hyperinflation, violence and government overthrow. History offers numerous examples.
The famed economist John Maynard Keynes did not invent inflation, but he was instrumental in making it seem acceptable as economic policy. In his General Theory, he advocated solving unemployment problems by "fooling" workers with higher nominal wages. He assumed workers were too obtuse to differentiate between nominal and real wages.
Keynes also was aware of the more devastating aspects of inflation:
He probably was not advocating the destruction of capitalism, although his economic system and his elitism were not inconsistent with such an outcome.
What is Wrong With QE?
Inflation, as a policy, is a politician's dream. As Friedrich Hayek noted:
Given the short-term orientation and desire to please, inflation is an easy political choice. From an economic standpoint, however, inflation is always harmful. Keynes' ideological opponents understood the short-term benefits, but knew inflation's dangers. Ludwig von Mises stated:
In a swipe at Keynes notorious short-term focus, Mises stated:
The absurdity that money creation can produce economic benefits was illustrated in this Mises' observation:
All economists recognize that cessation of a monetary expansion will contract the economy. Regardless of how beneficial a cessation might be, it is politically untenable to be seen deliberately engineering such an outcome. That is why QE will not end as a result of conventional political means.
Why QE is Unsustainable
Economic stimulus via monetary expansion has a limited life because inflation, in order to provide stimulus, must continuously accelerate. As described by Milton Friedman:
Friedman's "larger and larger doses" are necessary, but not sufficient. These increases must also "fool" or thwart the expectations of economic decision makers. As Hayek expressed it:
When it becomes apparent what is happening, people anticipate future government action and act to protect themselves. Once enough people understand the game, the charade ends either as a deep recession/depression (cessation of inflation) or a hyperinflation. The latter occurs when people spend money as quickly as they receive it in order to avoid the loss of purchasing power. In effect, money ceases to be used and society deteriorates to a barter economy.
Why QE Will Continue Until Hyperinflation Stops It
From a purely economic perspective, QE and inflation should never have occurred. From a political standpoint, it is a means of hiding the critical economic condition of the country. A stoppage of the program would result in two likely outcomes:
Economic and financial performance has been artificially inflated by QE. A bubble in both areas has developed as a result of QE. Chris Martenson explains:
From the standpoint of economic stimulus, many analysts believe that QE has run its course or even failed. Edward Harrison states:
If QE no longer provides economic stimulus, then why continue it? Quite simply, stopping QE would potentially cause markets to collapse and the economy to enter a depression. Stopping it also would risk bankrupting the Federal government.
The Federal government is insolvent. Without QE it would likely be illiquid. It is doubtful the US could sell enough debt to arms-length buyers to sustain its current spending. The current estimate of the deficit is $1.7 Trillion.
Without QE there would be added distress for government and the economy. Domestic interest rates would rise to whatever level necessary to attract market funding. Higher interest rates would provide a further drag on the economy. They would also dramatically widen government deficits. Kyle Bass quantifies what a return to more normal interest rates would do to government spending:
Added on top of current spending, this cost would increase the deficit to $2.4 Trillion, more than projected revenue collections this year. The government would then be spending more than 200% of what it collected.
Traditional Treasury investors (foreign individuals, other sovereigns and US investors) are likely unwilling to buy the amount of debt necessary to support US deficits. The biggest non-government buyer of Treasuries, Pimco, the world's largest bond fund, has eliminated Treasuries from its holdings as reported by Zerohedge:
In June 2010 Pimco held a record $147.4 billion of US government securities. Since then, these holdings have dropped to zero. Pimco now holds record cash balances.
Serious concerns over continued US profligacy have been expressed by foreign lenders. China, Japan, Britain and other sovereign nations have neither the ability nor the inclination to continue to support our sovereign version of Blanche du Bois's depend-upon-the kindness-of-strangers. Their economic conditions are at least as dire as ours and as much in need of funding.
Money invested in US Treasuries by foreign sovereigns has produced losses. A report issued by the Bank of International Settlements (BIS) in 2008, observed and warned:
The dollar has depreciated since the BIS warning, further increasing losses to foreign investors.
Is There a Way Out?
The fraud that the US government has become over the past several decades is now apparent. Our economy has been hollowed out as a result of "bubble economics." Consider just some of these facts:
In short, our economy is in a shambles despite what the propaganda machine spews. Harry Schultz, famed investment advisor and newsletter author, wrote at the age of 86 in his final newsletter:
Mr. Schultz has seen a lot in his lifetime. His description, unfortunately, is correct. We are on the brink of a massive collapse -- economically and politically. There are only two choices left for our political class. They were laid out by Ludwig von Mises long ago:
Their choice seems obvious. QE will continue until total catastrophe occurs in the form of a hyperinflationary depression. Politicians will then point fingers at everyone but the real culprits - themselves. In the enlightened era of alternative news, their strategy probably cannot work.
If I were a politician, I would resign immediately and head for safety before it becomes apparent to the masses what is going to happen.
A parting caution: While I expect QE to run until a hyperinflationary collapse ends it, an announcement that it has been terminated could cause a severe collapse in financial markets. Be aware of the possibility of this "Lucy football strategy" by a desperate and reeling Ben Bernanke. Expect QE to be reinstated quickly once some pain is felt.
Monty Pelerin blogs at www.economicnoise.com