by Steven Prescott
The Federal Reserve pledged $40 billion per month in money created out of thin air to purchase mortgage bonds in hopes this will stimulate the economy. The last two attempts, called Quantitative Easing (I and II), have failed to meet their objective, but Chairman Ben Bernanke believes this one will stick. As a student of the Great Depression, Bernanke believes all our economic ailments can be healed through the power of the printing press, paying little attention to what actually caused the 1929 crash. Used to justify further monetary expansion is a historically low consumer price index (CPI), which in reality underestimates inflation by focusing on prices rather than real harm the creation of new money inflicts. QE III will punish savers and those living on fixed incomes like Social Security, while rewarding those who speculated in an artificial housing boom. Though the Fed will try to deflect criticism once these effects are felt, they are ultimately the cause of the upcoming economic shock the world will endure.
Federal Reserve Chairman Ben Bernanke is showing off all the big monetary policy guns he has at his disposal. He brought the interest rates that banks lend to each other at down to essentially 0% and pledges to keep it that way until 2015, he introduced Quantitative Easing (QE I) that injected $1.25 trillion newly created dollars into banks by purchasing various forms of bonds and assets; after failing to hit his target he fired off QE II which created another $600 billion out of thin air to buy US government bonds. These attempts to get banks to open credit lines and make loans for people to buy homes, as though mortgage debt is the ideal, have landed flat on their faces. Banks have, for the most part, held this new pile of cash in their vaults as home prices continue to stagnate and lending standards tighten. This seems like perfectly rational behavior in the post “irrational exuberance” era, yet Bernanke keeps on firing. The Fed’s latest round of asset purchases, QE III, pledges $40 billion per month indefinitely to buy up mortgage bonds held by banks and government sponsored enterprises like mortgage giants Fannie Mae and Freddie Mac in an attempt to re-inflate the housing bubble. While Keynesians like Paul Krugman and Federal Reserve private banking cartel sympathizers draft their posts and prepare statements blaming QE’s failure on the premise that it just wasn’t big enough, Americans on fixed incomes or those who choose to save their money in Federal Reserve Notes, aka dollar bills, will suffer from a diminished purchasing power and the accompanied upsurge in prices.
As a student of the Great Depression, Bernanke concluded that your run of the mill recession became a depression because of the Fed’s unwillingness to create new money and inflate prices to their peak 1929 levels. The ‘deflation caused the Great Depression’ argument actually has some merit. The 1920’s were a highly speculative era, that is to say, many banks started making loans to Americans at some interest rate, say 15%. These lenders would in turn invest in the stock market, looking for gains upward of 20%. This expansion of credit, though it did not manifest itself in consumer prices, bid stock prices up to incredible highs and led economist Irving Fisher to assert stocks had hit a “new permanent plateau” just weeks before the crash of 1929. With insufficient earnings and a lack of fundamentals to justify the high stock prices, the liquor stopped pouring and the money supply contracted in spectacular fashion. In turn, debtors holding on to land, homes, and stocks valuated at pre-crash levels fell underwater, i.e. they held on to an asset in which the amount owed exceeded the current value. Whether printing more money would have alleviated the Depression by keeping asset prices high enough for the music to keep on playing, or if it would have driven up consumer and commodity prices to induce a more painful monetary overdose, remains unknown. We do know, however, that the Fed’s current policies have produced the latter.
This same process played out in 2008 with the expansion of credit for housing and the subsequent contraction; rather than allowing prices to readjust, the Fed tried to recreate the conditions of the bubble. Simply looking at the government’s consumer price index (CPI) to gauge inflation, it would appear as though inflation is tame and even historically low at 2.4%. This is pure fantasy. Excluded from the CPI are rarely purchased items like food and energy, which have both seen sharp increases in recent years, but the prices of which are considered too volatile to be included. If a good is downsized, say for example a box of Kleenex now comes with 58 tissues instead of 72 yet the prices remains unchanged, this is not reflected in the CPI. Besides the blatant underestimations of pure price increases, the CPI also fails to take in to account falling prices that never materialize. Imagine we find a way to produce a computer more efficiently, which seems to occur every year, but the big yellow price tag at Best Buy stays the same due to the increases in the supply of money and credit. This cannot be measured of course and does not appear in the consumer price index. Throw in a healthy dose of product substitution and the CPI becomes nothing more than a measure in the change of the price of goods handpicked to reflect a number that policy makers believe will appease creditors and the public at large.
Even if we accept the idea that prices can provide an adequate measure of inflation and recognize the 1970’s as a period of high inflation, then we must do the same for today. Why though? Simply because the way the Bureau of Labor and Statistics calculates the CPI has undergone 2 changes since 1980. However, if you use the same method used in the 70’s, when inflation stood consistently above 10 percent and posed a great enough threat for then Fed Chairman Paul Volcker to bring it to a halt by raising interest rates, price inflation today stands between 8 and 9 percent. Quantitative Easing, not one, not two, but three will simply make matters worse. It’s analogous to owning a rare 1952 Mickey Mantle rookie card, valued at around $130,000, and if you were to discover an entire warehouse full of them, they would lose their value overnight. The success of QE hinges on the wealth effect, or the belief that if the value of your home rises you will feel wealthier, spend more, and stimulate the economy. This should more properly be called the illusion of wealth, as any positive gains from increasing home values will be erased by rising oil and food prices; your house may be worth $500,000 but you will be paying upwards of $5.00 at the pump.
With rising tensions in the Middle East, policy makers will be quick to blame rising prices on these disruptions and speculators, but this is simply a smoke screen for the true cause of the increases; QE III.