A fool's paradise By Hossein Askari and Noureddine Krichene
What is monetary insanity? It is akin to going down a remote and narrow country
lane and expecting a super highway around each and every corner. The US Federal
Reserve pursued a highly expansionary monetary policy during 2001-2005,
lowering money market rates to 1% with rapid liquidity injection.
While this policy has brought about the worst economic crisis in the post-World
War II period, still the Fed continues to pursue the same with the expectation
that full employment is just around the corner.
Historically, whenever central banks adopt highly expansionary policies, the
inevitable results are debt crises and general bankruptcies. Fed policies have
ruined the banking system - they
pushed the credit ratio to 350% of GDP, distorted the price structure, fired up
housing and commodity price inflation, and increased exchange rate volatility.
Housing prices spiked by a multiple of 2 to 4; oil prices rose from
US$18/barrel to $147/barrel; gold prices rose from $250/ounce to $1,250/ounce;
and in 2010 staple food prices were three to four times their 2002 level.
In the face of such results, the Fed has kept on boasting of its success in
achieving price stability, measured by the core price index (that is, excluding
energy and food, but including rents, which have fallen as a result of the
housing bubble), ignoring millions of foreclosures or the 50 million Americans
living on food stamps.
Loose monetary policy has robbed pensioners, reducing their living standards
dramatically, with the sad stories of millions of retirees on fixed incomes
around the US having no end. This is not all. Fed policies pushed unemployment
to more than 10% in 2009, ballooned fiscal deficits to unseen peacetime levels,
and brought economic prosperity to a screeching halt.
Continuing with the same policies and expecting a dramatically different result
is simple insanity. When will our policymakers and experts admit their
mistakes, acknowledge the shortcomings of their econometric models, swallow
their pride and chart a new course?
Inflation from John Law to John Maynard Keynes to Ben Bernanke, the present Fed
chairman, has been a favored policy for walking away from debt crises.
For Keynes, inflation would help reduce real wages and restore full employment.
For Bernanke, the purchase of $1.5 trillion in mortgage securities should
prevent house price deflation and maybe push home prices even higher. By
supporting bubbles, through setting interest rates at near zero and mounting
massive injections of liquidity, Bernanke has inflicted damage to the US
economy and increased uncertainty, distortions, speculation, and outlook for
inflation in the future.
What the Fed is doing is imposing an invisible tax on holders of dollars.
Printing money must not be confused with the creation of real capital; printing
vast amounts of money can be akin to counterfeiting and confiscation of real
purchasing power from the poor and workers in favor of the government and
borrowers.
The Fed's unorthodox monetary policy has no foundation. There is no economic
theory that supports the assertion that interest rates have to be zero for real
savings and economic growth to be forthcoming.
Politicians, academics, and the media are supporting inflationism. For
politicians, the Fed is magical as it finances unrestricted government spending
that cannot be financed by direct taxes. Academicians equate inflation with
high employment, via the Phillips curve, and economic prosperity. Since it
costs nothing to print money, why deprive the government from large spending
programs and why deprive the economy of prosperity and the unemployed of
income? It would thus seem difficult to dissuade a central bank away from
inflation, even in financial collapse and economic recession as enduring as the
recent turmoil.
In spite of the great economic recession and collapse brought about by its very
loose monetary policy during 2001-2008, the Fed is now looking for even more
inventive ways to continue its policies. But with the credit ratio at 350%,
banks can no longer push credit except to borrowers who are already deeply in
the red. This would amount to banks simply handing out money that will never be
recovered. For this reason, banks have accumulated over $1 trillion in excess
reserves. The only innovative solution remaining is money helicoptering.
Over the past decade, the US economy has become addicted to low interest rates,
piling more debt on top of debt, and leveraging. The US government must finance
record fiscal deficits; average homeowners have come to rely on it to enjoy
subsided housing and equity borrowing to compensate for their stagnant real
incomes; consumers need it to overspend above their disposable incomes;
speculators need it to reap large speculative gains; and producers need it to
run large profits and have access to working capital at negligible cost. This
policy has caused widespread financial and economic distortions, with record
fiscal and current account deficits that are simply unsustainable.
Three years into the economic and financial crisis, Bernanke continues to say
that his unorthodox monetary policy will be maintained until full employment is
restored and the economy is on a strong growth path. Forget about Japan's lost
decade; it is inapplicable to the US. There is no economic theory that applies
to all countries; instead, economic theory changes from one country to country.
Forget about the financial crisis, he says; it was due to defective regulation.
Forget about inflation, since the US economy is suffering from deflation, even
though housing, energy and food prices are at multiples of their levels eight
years ago.
The Fed is desperate for short-term success, even though its policy is only
spreading more chaos and paving the way for an even bigger financial calamity.
What the Fed achieved was simply the creation of a short-term credit boom
during 2002-2008 that ended with the worst post-war financial and economic
crisis.
Why does the Fed continue down the same narrow lane? The reasoning may be
simply something like this. If the Fed creates $1 trillion out of thin air,
this is exactly as if the Fed had injected an equivalent amount in food
products, oil, clothing and so on into the economy and with no incidence on
prices. Prices are insensitive to Fed-created liquidity. With such additional
capital, the economy can invest and grow, and consumers can enjoy more output.
Unfortunately, one has to live in a fool's paradise to believe that money
creation out of thin air gives rise to an equivalence in real goods. African
countries should not remain in abject poverty when the Fed's economics policies
offer a super-highway for accumulating wealth at the stroke of a pen.
Inflationary experiences in Europe, Latin America, and elsewhere have left
behind economic despair, rapid impoverishment, and social disorders, if not
wars. The Fed's money creation ex nihilo is a pure redistribution of
wealth, a taxation, and could translate in a destruction of real capital as
illustrated by the financial crisis.
An alternative to the Fed reasoning could go something like this. Zero-interest
rates will promote speculators and speculation; real supply will be
dramatically reduced especially for storable commodities since the cost of
storage and the cost of working capital become negligible; producers will be
enticed to increase prices and reduce quantities; price increases will be
validated by abundance of liquidity. Recently, commodity prices such as sugar,
coffee, soybeans, wheat, and meat have surged at an annual rate ranging between
15% for meat and 83% for wheat.
With zero-interest rates, speculative prices will be high and price distortions
ever growing. At zero-interest rates, savings pay no return, possibly a
negative real return, and pensions incomes are reduced significantly. Capital
will have to migrate to higher-yield economies. Investments will migrate
towards low-productive sectors. The specter of high inflation, or possibly
hyperinflation, will keep investors in search of safety.
The Obama administration has failed to break from the previous administration's
failed economic policies. Instead, it has prolonged the economic agony and
enhanced the specter of inflation. It has subscribed to unsustainable fiscal
and monetary policies in the name of simple Keynesianism. The administration
has even claimed that economic progress has been made thanks to its policies.
Such policies the world over may bring about a short-lived economic boom, but
are invariably followed by bankruptcies, government deficits, and prolonged
mass unemployment.
The administration has failed to restore sound fiscal and monetary policies and
expunge the huge distortions and the redistribution of wealth that has
impoverished so many Americans over the last thirty or so years. The
consequences of this administration's policies may be even more onerous than
the legacy of George W Bush-Greenspan-Bernanke era in terms of unemployment,
impoverishment of workers and pensioners, and social inequities. It is truly
akin to living in a fool's paradise.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist with a PhD from UCLA.
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