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Mo' Money, Mo' Problems

Mises Daily: Tuesday, August 31, 2010 by

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The recent decision by the Federal Reserve to keep its balance sheet stuffed to bursting with whatever the Wall Street banks decide to throw onto it came as no surprise and crushed any hope that the Fed would tone down its policy of quantitative easing (QE) — or credit easing (CE), as Mr. Bernanke prefers to call it. With the US economy stalled despite the trillions of "stimulus" funds larded out to the politically connected, the people who helm the Federal Reserve likely felt they had no other choice. This was too easy to predict; for the past few decades the response of US monetary authorities to any crisis has been the same — print more money.

At this point, the Federal Reserve has morphed into something that even its founders never dreamed of back in 1913. It's degenerated into a deaf, dumb, and blind lender of last resort to any institution with the right political connections, and become an out-of-control machine emitting continuous streams of new money and credit, all to guarantee that the losers who destroyed their firms can still fly around in GV jet planes and appear on CNBC to regale us with their supposed market wisdom. (Lehman Brother's Richard Fuld is the lone exception.) If we are going to listen to the likes of Jamie Dimon and Lloyd Blankfein regarding financial matters, we might as well use the sad-sack New York Mets as a guide on how to run a successful baseball franchise.

Whether this massive emission of new money by the central bank is brought about through direct purchases from the central government (QE) or from the politically connected banks (CE) is immaterial. The results are exactly the same: they both involve "an expansion of the central bank's balance sheet," as Ben Bernanke himself puts it. Both engender a surge in available money and credit. Quantitative easing, again according to Mr. Bernanke, "is most common in poor countries or in countries wracked by war or natural disasters."[1] Or, the jaded might add, in a country wracked by economic illiteracy.

The policy the Federal Reserve has now made explicit is one most often associated with Central American banana republics, and that alone should have given Fed officials pause to reconsider their actions. The mere fact that such a policy has not set off a storm of protest and investor panic highlights the widespread misunderstanding among the Smart Set in regards to the subject of money — specifically, what exactly it is. According to Mr. Bernanke, money, properly defined, must exhibit three characteristics: it must be a medium of exchange, a unit of account, and a store of value.[2] The US paper dollar certainly meets the first two requirements but it fails miserably on the last.

The cause of our current economic crisis and what lies at the heart of its continued strength is the ability of the US monetary authorities to create more "money" at their pleasure. Think for a moment: nobody in their right mind would buy stock in a company that reserved to itself the right to issue further shares in any manner and at any time it pleases, with no concern whatsoever for preexisting shareholders — but this describes our monetary system perfectly.

"You know what I need
Or maybe you don't. …
Gimme some money, gimme some money."
Spinal Tap,
"Gimme Some Money"

The US money supply can be increased at the whim of Federal Reserve officials, with no compensation at all given to those whose current holdings will be debased by the newly created money. But unlike the company stock, which only affects those foolish enough to purchase it (and who can get out from under it by simply selling), the US dollar is forced by law on everyone within our borders.

Say what you will about the "gold bugs," but they have a point — you can't counterfeit gold, which makes it uniquely suited to be a store of value, which makes it uniquely suited to be the bane of Keynesians, which makes it uniquely suited to be money. The US paper dollar, as per Mr. Bernanke's definition, cannot rightly even be called money because it has utterly failed to be a store of value. Had you taken a US dollar in 1913 and kept it under your mattress until now, you'd find that 95 percent of its value has vanished down an inflationary rabbit hole.

Even the "greatest central banker of all time" (Alan Greenspan, remember?) destroyed 44 percent of the dollar's value during his tenure. It is not even possible for the political authorities to "create" money.[3] Frederick Engels, in his masterful The Role of Force In History, hit on this truth when he noted, "force, however, cannot make any money; at most it can only take away money that has already been made."[4]

That 44 percent debasement under Greenspan went into someone's pocket (those lucky enough to be first in line to get their hands on the newly created money before the price inflation took hold) after first being removed from the pockets of its rightful owners (the saps unlucky enough to be last in line), who watched helplessly as the value of their money holdings withered under the inflation.

Despite the multitude of warnings history gives about quantitative easing (or credit easing if you prefer), this country's monetary authorities seem bent on continuing the policy. They disrespect the memory of Alexander Hamilton, the father of US central banking, who warned that irredeemable paper money is "so liable to abuse, and it may even be affirmed so certain of being abused, that the wisdom of the government will be shewn in never trusting itself with the use of so seducing and dangerous an expedient."[5] Yet, the proposed solution to our "credit crunch" is to debase the dollar even further.

To be blunt, the policy decisions of the Federal Reserve since the latest economic crisis came to pass have reeked of panic, and now, with quantitative easing, they remind me of one of my mother's favorite sayings, "When you've gone through all the good ideas and now you're on to the stupid ones. …"

By whatever name you call it, this massive "pump priming" by the US monetary authorities will engender exactly the same results it always has: malinvestment, dollar debasement, and speculative mania. To steal a phrase from the late, great rapper Notorious B.I.G., quantitative easing will do nothing more than give our economy more money — and more problems.

Notes

[1] Andrew Abel and Ben Bernanke, Macroeconomics, 3rd Edition (New York, Addison-Wesley, 1998), p. 224.

[2] Andrew Abel and Ben Bernanke, Macroeconomics, 3rd Edition (New York, Addison-Wesley, 1998), pp. 219–20.

[3] It is true that according to many people what the Fed prints is "money," and they act accordingly. So despite the fact that from a strict economic viewpoint the US paper dollar is not money at all, due to this widespread misunderstanding it is treated as if it was. If history is any guide, time will remedy that defect.

[4] Frederick Engels, The Role of Force In History (New York: International Publishers, 2006), p. 35.

[5] Alexander Hamilton, Writings (New York: Library of America, 2001), p. 592.