The Truth Concerning Quantitative Easing, Inflation, and the Federal Reserve

What in the World is Quantitative Easing?

The Federal Reserve’s second round of quantitative easing (QE) begun last November is scheduled to end this month and inject another $600 billion into the economy.  According to Bernanke and most high-profile economists, the effect of QE is stimulus, stimulus, stimulus. But what exactly is QE?  It is no surprise that Federal Reserve policy is cloaked in technical jargon, and this is just one more example. To clear things up a bit, QE is simply an economic euphemism for printing money. Think of the economy as a watch. While the gears are all the different markets, policies, and institutions (monetary and fiscal policies, interest groups, political parties, etc.) that make up an economy, money is simply the oil (no pun intended) that keeps the gears from binding.  The Federal Reserve System – against the better judgment of economists and elected officials of the early twentieth century – has become the watchmaker.

Recall the primary issue of 2008 was a liquidity crisis, which was essentially the unwillingness of banks to lend.  The result was a complete international market seizure, whereby cash was no longer circulating to keep the gears lubricated.  Once cash-flow stopped, the watchmaker knew he had only one option to save face.  He claims now, as he did in 2008, that injecting money into the economy will jump-start lending, reduce excess industrial capacity, and lead to more hiring and an eventual return to the natural rate of unemployment (4-5%).  Keynesian economics, particularly deficit financing, is the name of game here.  Keynes saw the inherent benefit of deficit spending as a tool of monetary theory, and consequently, was largely responsible for gaining the necessary acceptance for inflationary monetary policy as such.

Monty Pelerin (pen-name) translates this idea well to highlight what inflation means for the average worker and consumer.  “In his General Theory, Keynes 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 recognized inflation for what it truly was.  That is, he was well aware that “The best way to destroy the capitalist system is to debauch the currency.  By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”  This is the hidden tax we call inflation, and its primary avenue of realization is the Federal Reserve system.  By using fiat money instead of pegging the dollar to a tangible commodity such as gold or silver, central banking is able to manipulate the value of our monetary unit, thereby controlling the future of its purchasing power.  The implication of this for us all is staggering.  QE, then, is just an additional mechanism the Federal Reserve and U.S. Treasury is currently employing to devalue our currency and diminish the purchasing power of our paycheck.

But there is, of course, a political agenda hidden beneath the surface of Keynesian theory.  The ability to directly control the money supply places the reigns of everyday life in the hand of our bureaucrats.  Statism is the name of the game here.  As Pelerin states, Keynesian economics (deficit financing)  “is not economics, but political manipulation of an economy. Politicians love it because its underlying thesis is that the economy, left alone, would stagnate at some level below full employment. This false claim is the basis for Statist government enabling government to grow bigger, take more from its citizens and involve itself into all aspects of peoples’ lives.”  I believe reference back to Alexander Hamilton, our nation’s first Treasury Secretary under President Washington, will make a sufficient point.  When debating with Jefferson the matter of a national (central) bank to consolidate the debt of the thirteen colonies, his position was strongly in favor, for to take on such a magnitude of debt would bring with it the power of a strong centralized government.

A Bit of History

A bit of history is needed in order to understand how exactly Keynesian economics was able to grab hold of the brighter minds of America.  Proponents of Keynesian doctrine often cite the Great Depression and the booming years afterward as proof that, indeed, Keynesian monetary theory is sound and advantageous to America.  However, despite the conventional wisdom – written largely by unconventional individuals with equally unconventional agendas – some credit U.S. entrance into WWII as the primary impetus of America’s return to economic growth.  This may seem trivial, but is quite important because our high schools, community colleges, and universities are teaching our children a watered-down version of American history.  This is just another example.  In fact, well-renowned historian Howard Zinn says,

“[T]he war economy created millions of new jobs at higher wages.  The New Deal had succeeded only in reducing unemployment from 13 million to 9 million.  It was the war that put almost everyone to work,  and the war did something else: patriotism, the push for unity of all classes against enemies overseas, made it harder to mobilize anger against the corporations….The war not only put the United States in a position to dominate much of the world; it created conditions for effective control at home.  The unemployment, the economic distress, and consequent turmoil that had marked the thirties, only partly relieved by the New Deal measures, had been pacified, overcome by the greater turmoil of the war.”

A People’s History of the United States, pp. 402, 425

Therefore,  as WWII created a tremendous expansion in wartime production, it spurred enough demand to absorb increases in the money supply that are today associated with monetarism.  In short, demand created by the newly evolving military-industrial complex furnished the necessary goods and services to keep prices and inflation steady. After WWII passed, Washington created an atmosphere of fear among the public – very much similar to today’s war on terrorism – and a general consensus for a “permanent war economy” throughout Congress that allowed the Cold War to continue to fill this role.  This is known officially as the “warfare state.”  It seems, then, Washington has turned its fear mongering toward the war on terrorism to justify its increased military spending.

A Snapshot of the Federal Reserve System

In order to understand this, let us first examine a bit of Federal Reserve history.  Much of this is summation from G. Edward Griffin’s The Creature from Jekyll Island: A Second Look at the Federal Reserve.  Contrary to conventional wisdom of our central banking system – that it uses interest rates to control the money supply in an effort to keep prices and growth stable, namely to avoid economic crises – Griffin’s view holds the Federal Reserve itself responsible for economic crises and the massive depreciation of the dollar we have seen over the past century.  But how does an institution achieve such destructive agendas?  It helps, Griffin says, that the Federal Reserve is cloaked in ambiguity.  It is neither a private nor a public bank.  Although claiming to be politically independent, it is neither a political unit of our government nor a private bank as we typically think of the idea. Rather, the Federal Reserve System is a cartel that is partnered with our government, but not a part of it like the the House, Senate, or Supreme Court.  Most important to realize are its five primary objectives:

(1) limit competition within the banking industry as a whole,

(2) to obtain the rights – which were granted by our government, whence the partnership – to create money out of nothing (fiat money),

(3) isolate smaller banks from banks runs by gaining control over banks’ reserves,

(4) convince Congress to bailout insolvent banks with taxpayer money, and

(5) also convince Congress that the purpose of the Federal Reserve System and bailouts is to protect the public from economic crises (boom and bust cycles).

These, of course, were their unstated goals when the Federal Reserve Act passed in 1913, and the watchmaker has achieved all five. To our central bankers, there have no interest in economic stability (only control), nor on reestablishing it. We are taught in college that its purpose is to mitigate the negative effects of the free-market’s natural tendency of boom and bust. What we were not taught, but becomes prevalent to those who study history, is the Federal Reserve actually facilitates the business cycle.  And with each major crisis, they are able to limit competition even more and concentrate even more wealth.  This is the purpose of our and all other central banks in the world.  That said, any banking system connected to a central government is likely to fall into this trap as history has shown.  Believe it or not, the Federal Reserve System is actually the fourth central bank of the U.S., all others having resulted in the same scenario we see now.  The printing of fiat money and massive inflation to the point that a gold standard is reestablished has been done numerous times throughout history. What makes today’s problem so different is the degree to which globalization has linked the world’s economies. Consequently, when the dollar falls, so too will many other currencies. It is at this point that the idea of a world currency may be introduced to the public under the same guise as the origin of the Federal Reserve – to create stable prices with moderate inflation, which will translate into a stable global economy. It is not to be believed!

But Isn’t Moderate Inflation Good for the Economy?

Moderate inflation, usually around 2-3%, has historically been viewed by economists as a healthy amount.  The purpose is that inflation serves to drive the economy via expanding credit to businesses and consumers.  But inflation from excess money creation without a like increase in the goods and services from which money is needed to circulate is more a political tool than an economic phenomenon.  It is a way to hide the fact that the U.S. government is insolvent.  Monty Pelerin stated, “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.”  This would be devastating for the credit rating of the U.S. Treasury, resulting in government expenditures of nearly three times its revenues.  Thus, in order to remain solvent, inflation has become the only monetary tool left at our government’s disposal.

Yet even as a result of economics, inflation promises no long-run tool for stable prices because in order for it to act as a stimulant to economic growth, it must increase exponentially.  Milton Friedman pointed out, “Inflation is like a drug. Its stimulating effect is temporary. Only larger and larger doses can sustain the stimulus, before the chaos of hyperinflation removes all the gains.”  One need only examine the most fundamental of economic assumption to understand why one bout of inflation must be followed by a new, larger one in order to continue the stimulus-effect.  If I believe the value of my dollar will decline in the near future, I am more likely to spend more dollars now, as they will command more goods and services.  This is simple economic incentive.  If inflation has become the only monetary tools left at our government’s disposal (the Federal Reserve exhausted its ability to lower interest rates long ago), then one sees larger and larger bouts of inflation until eventually the U.S. reaches that dreaded state economists call hyperinflation.

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Oil Prices Mirror Fall of the Dollar

Ryan Swift highlights the often overlooked, yet strikingly poignant, data that stares all Americans in the face.  Below is a visual prepared by Mr. Swift showing that over the past year, the dollar’s decline has inversely matched rising oil prices. This is not a coincidence and the data actually make sense when one considers that our economy requires both a currency and oil.  While currency serves to circulate goods throughout the economy, oil facilitates their production. It makes sense then that the two would be inversely related.  The more goods we produce, the more oil is required and the higher its cost.  Likewise, a higher quantity of goods require more currency to move them.  The problem, however, lies in the fact that consumer demand is still very low while the Fed is printing money in record volumes.  As more dollars flood the economy, the value of each will naturally fall because production has not yet increased sufficiently.

Click for Swift’s Article →

What this means is a double-punch to the American pocket-book.  As oil climbs, prices for all other goods rise as transportation and production costs increase.  In other words, higher prices for crude is akin to inflationary pressures all its own.  Add the Fed’s so-called “needed” QE2 (and talk of QE3) and one sees the printing press running at overtime to devalue the dollar further.  The overall result is a lag in production and a delayed recovery for the economy as a whole. As oil surpassed $113 a barrel on Friday, Time reported a fall in annualized GDP growth from 3.1% in the fourth quarter 2010 to a meager 1.8% in the first quarter this year.  Moreover, rising oil prices are likely a result of unrest in the Middle East and OPEC’s mysterious tendency to cut supply while demand clearly indicates the opposite response.  This last factor, Swift points out specifically along with Obama’s declaratory announcement to go after speculators responsible for inflationary pressures.  What Obama will not do – and what the mainstream media still refuses to recognize – is to reign in the Federal Reserve System’s QE policies that are responsible for nearly $2 trillion dollars of inflationary pressures.  So once again, we see the mainstream media attacking the usual foe – the market itself – thereby initiating a call for more government intervention.   One may wonder then, at what point will government meddling in the economy effectively push us beyond the point of no return.  Or are we already there? M9EZ497NU9QH

Inflation News: Federal Reserve’s QE Policies Cause Rising Food and Oil Prices

via Google Images

The following excerpt is from Righteous Investor and discusses the out-of-control spending in Washington and what to expect when inflation hits. For instance, February’s deficit was $223 billion dollars.  That translates into $26 per person per day according to Righteous Investor.  Moreover, the government’s insatiable demand for dollars spurs on the Federal Reserve’s Quantitative Easing (QE) programs, which does nothing more than create fiat money for government use.  This translates into more dollars being pumped into the economy and, of course, the inevitable result of inflation.

“Now here is what has been happening: (1) the US government borrows money but doesn’t find sufficient lenders whether domestic or foreign, so the Federal Reserve bank lends to them the remaining shortfall. This is called quantitative easing because the money is created out of nothing. But that is not the end of QE: for Bernanke is also buying old debt as it turns over and finds no new borrowers (see “Hyperinflation when?“). QE greatly increases the amount of greenbacks that are in the money base: view (chart below) and be afraid and weep. (2) Next, commodities go up in price because too many dollars are chasing too few goods–food riots start happening in poorer countries. (3) Then, consumer prices go up. (4) Lastly, workers will get cost of living adjustments if indeed their employer can pay them at all. In any case, the last thing to adjust to this whole mess is people’s take home pay. But unfortunately, the adjustments will be too little too late because the next round of QE has already taken place and the spiral of hyperinflation has reached the next stage even before they receive their next pay cheque.”

 

Click for Full Article→

Important to note is the Federal Reserve’s recent announcement that it may have to begin its third round of QE in response to sky-rocketing oil prices.  Atlanta Fed President Dennis Lockhart stated at the National Association of Business Economics in Arlington that “If [the rising price of oil] plays through to the broad economy in a way that portends a recession, I would take a position we would respond with more accommodation.”  As oil increases, so too does the cost of most, if not all, goods and services. This includes anything that requires petroleum in the production process, not to mention increased transportation costs for moving the product to market.  Such is the rationale for QE3.  Add to this recent reports of record food prices and subsequent riots from increased oil prices, and one begins to see the picture. Here we have three of the four points listed above: QE2 by the Federal Reserve last November when they purchased $600 billion in Treasury bonds; increases in food prices leading to disruption in the global oil supply via riots, and thus subsequent increases in food prices; and finally talks of QE3 if and when oil hits $150 a barrel.

The question is, how much longer until the banks begin lending at a healthy rate again.  Despite the media’s on-and-off questioning of large financial institutions’ refusal to lend money, banks still hoard record levels of cash.  Why? According to Project World Awareness, a part of the Emergency Economic Stabilization Act of 2008 encourages banks not to lend. They are not lending because the Federal Reserve is paying them interest not only on their required reserves, but also on their excess reserves.

“But as of October 9, 2008, the Fed began paying interest on all reserves, required and “excess” alike. And not just nominal interest, but interest at a rate which is higher than the “Fed Funds Rate” (the rate banks pay to each other for overnight loans), and even higher than current short-term Treasury yields. At a stroke the Fed eliminated for banks interest-rate risk, principal risk, counterparty risk, and even the capital cost of maintaining an extremely high degree of liquidity. The “cost” to banks of non-lending was driven down substantially.” (I strongly encourage those skeptics of hyperinflation to read this entire article.)

In short, the Federal Reserve is paying our banks not to lend our money to us, and this was signed into law by our government.  Furthermore, once that cash does enter circulation, despite initial feelings of a recovery, prices for all goods and services will leap to a degree that will effectively destroy the greenback’s credibility.  Despite the Fed’s notion that they will be capable of withdrawing excess funds from circulation, many believe otherwise.  According to Monty Pelerin (pen-name), withdrawing the excess funds is not feasible because that would entail selling the toxic waste they bought from insolvent institutions.  Not only did they overpay for those assets, but they have no means of establishing current values.  In this sense, the Fed is simply incapable of withdrawing billions in excess funds from the economy. Consequently, those funds will stay in circulation, continuing to drive up prices.

Additional Notes: I recommend the following article, as it ties in Fed policy to foreign markets and higher food prices around the world with a slant toward U.S. manipulation of currency…an interesting read.

Also, for those not familiar with Federal Reserve Policy, I recommend a previous post of mine written for the interested novice in Fed, money, and inflation matters.

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