Page 1 of 2 Inflationary musketeers
By Hossein Askari and Noureddine Krichene
Amid financial chaos and trillions of dollars in bailouts of the Western
banking system, major reserve banks have renewed their aggressive monetary
expansion in a bid to revive economic recovery.
The European Central Bank has cut its interest rate to 1% and announced massive
money creation "out of thin air". In a similar move, the Bank of England has
set its interest rate at 0.5%, the lowest rate since the bank was created in
1694, and announced a massive money printing program.
This unorthodox monetary policy of distorting interest rates and printing money ex
nihilo, while in line with the super-reinflationary policy of the Group
of 20 (G-20) countries, was also a retaliation
to the US Federal Reserve's reduction of its interest rate to zero and
injections of trillions of dollars for US consumers and mortgage borrowers.
The benchmark London Interbank Borrowed Rate (LIBOR) hit its lowest rate ever,
making credit ridiculously cheap. As called for by the G-20, besides pushing
credit to domestic borrowers, unconditional credit is being pushed to
developing countries. With such low interest rates and uncontrolled money
supply of reserve currencies, the world economy is destined for reach its worst
inflationary bout in memory.
Reserve central banks are interlocked in an irreversible war of competitive
monetary expansion and exchange rate depreciation, and resulting in heightened
financial and economic uncertainty. Although major reserve banks are injecting
trillions in fake money, they have no ability to inject even one barrel of oil
or a pound of rice. Hence, their money printing is pure taxation, pure wealth
redistribution, with the inevitable inflationary result.
In parallel, many industrial countries are adopting the largest fiscal deficits
in their modern history. Notorious among these is the US, with President Barack
Obama's fiscal deficit of $1.85 trillion for 2009, or at 13% of US gross
domestic product (GDP). Thanks to this amazing printing of money and fiscal
deficits urged at the G-20 summits, policymakers relish announcing that
economic recovery is at hand, totally ignoring the sad legacy of their lax
money policy during 2000-2008 - that legacy being a ravaged financial system,
and a dramatic downturn in real economic activity and employment.
The recent "stress test" by the Fed showed that 19 leading US banks faced
portfolio losses of US$599 billion in 2009 in spite of money from the Troubled
Asset Relief Program already covering part of their capital losses. Certainly,
the stress test has not been applied to the over 8,000 banks in the US that
face losses on their loans. If it had, the losses would perhaps have been in
the trillions of dollars.
The money expansion during 2000-2008 pushed interest rates to their lowest
level in the post-World War II period. Combined with large fiscal deficits in
the US and Europe, this policy generated high inflationary demand-led growth
that abruptly ended in 2008. It has financed unrestricted speculation in assets
and commodity markets, caused housing price to quadruple in some countries, oil
prices to soar to $147 per barrel, food prices to skyrocket to levels that
resulted in riots, and exchange rates that showed violent instability.
Cheap-money policy was equated by some economists to inflation and speculation;
that is, speculators make gains only on price appreciation, as the cost of
carry (borrowing in low-interest currencies) is negligible, and on borrowing by
consumers who cannot repay their debt. It often times ended in bankruptcies and
economic disorder as seen in the current crisis.
What have been the real costs of this monetary policy? It has already pushed US
unemployment to 8.9% in April 2009, with double-digit US unemployment on the
horizon, and to higher levels in many other industrial countries. Excess
liquidity injection by central banks has sent credit rising at unprecedented
rates and has pushed massive loans to subprime borrowers, who were swamped with
wealth they will never repay.
Besides bankrupting Iceland, it bankrupted banks in the US and Europe,
necessitating trillions of dollars in bailouts to rescue these from failure. It
wiped out trillions of dollars in share values. It redistributed immense wealth
to borrowers that have never invested anything to earn this wealth and can
never repay it. US homeowners bought houses at inflated speculative prices,
which the US government is now generously paying for. Without the government
takeover of mortgage guarantors Freddie Mac and Fannie Mae, China would have
paid for US mortgage default. Consumers enjoyed free luxury cars and even free
gasoline on credit-card loans.
Policymakers have not addressed many key questions. For instance, why were
there food revolts and energy protests in 2007-08? The answer to these
questions were provided a long time ago by economist Jacques Rueff. He noted
that pure money injection by a central bank can lead to starvation. The money
created by the central bank out of thin air is akin to a pure inflation-tax and
confiscation. It confiscates real wealth from producers and hands it free to
borrowers.
This is also known as unbacked credit expansion. When banks extend credit out
of deposits, they are using available savings to lend and are not creating
excess demand. When the central bank injects money out of thin air, its action
is akin to robbery. Hence, through their money injections, central banks enable
borrowers to consume food and energy products without offering any real goods
in exchange. They divert wealth to borrowers who contribute nothing to wealth
creation.
Consequently, true producers - food growers, wage earners, airlines, farmers,
and industrialists - lost real capital and found themselves with reduced
quantities of food and energy, necessary for investment and production. This
loss of capital in favor of borrowers was translated into skyrocketing food and
energy prices. Thence, poor classes in vulnerable countries bore the tax and
faced dwindling quantities of food and growing starvation, triggering riots.
In the same vein, truckers in the US and Europe bore the tax and faced
dwindling and more expensive fuel that curtailed their operations, prompting
them to protest. Put simply, money injection by central banks destroys savings
and causes a depletion of productive capital, and consequently of growth. It
cuts real wages and pensions and impoverishes the lower social classes.
Could zero interest rates and unlimited money injection by central banks lead
to recovery under the present conditions of the world economy? Certainly zero
interest rates are not market rates. There is no private capital market where
interest rates have become zero or near zero. Zero interest rate means simply
that capital has a zero return and time has zero value. There is no need for
investment and economic growth is zero.
If the real interest rate is negative, capital returns are negative and real
economic growth is negative. Hence, by definition, a zero interest rate is a
central bank forced rate, is highly distortionary, and leads to wasteful and
socially unjust allocation of resources and intense speculation.
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