The Federal Reserve Is Now Badly Hooked on Quantitative Easing
September 29, 2013
(This item originally appeared on Forbes.com on September 29, 2013.)
The Federal Reserve surprised most by not changing its present policy of buying $85 billion of government debt a month with the printing press. I suspect that Ben Bernanke himself is not too unhappy with this; nor is his Princeton Keynesian counterpart Paul Krugman.
It looks to me like the Fed is hooked badly now. There’s nothing more addictive than printing money.
I suspect that nothing will be done before the introduction of a new Fed Chairman at the beginning of February 2014 — likely to be Janet Yellen, and likely to be even more dovish, on balance, than Ben Bernanke.
In part this is politics; the Democratic Party has woken up to the idea that the Fed’s money printing is not necessarily just a giveaway to the big bad bankers. It sucks up the deluge of Treasury bonds still being issued by the Federal government. Without that support, and with interest rates likely jumping higher as a result, debt ceiling talks would be a lot more serious.
Wall Street is happy. Large corporations, now enjoying some of the largest profit margins in history, are happy. Middle America is supposedly happy; in any case, the economic advisors say that they would be more unhappy if the Fed wasn’t printing money to keep mortgage rates low and, supposedly, unemployment better than it would otherwise be.
This is what usually happens. In mid-1919, the German government had been printing money for five years to help fund war expenditures. It had gone pretty well. The German base money supply had expanded by six times, but it seemed there were no major ill effects. Yes, the value of the mark had fallen to half of its prewar value by that point, but this was spread over five years, and people were distracted by other issues.
They kept doing it.
We will likely keep doing it too. It may even ramp up further. Some people think the Fed could be printing money at double the present pace by the end of 2014. Why not?
The U.S. has been down this road before, in a way. In 1971, Richard Nixon’s advisors told him that they could solve the minor recession of the time with the magic of the printing press. They actually adopted a Monetarist nominal-GDP-targeting framework.
They decided that they needed 9% nominal GDP growth to get the economic results they wanted. The task of figuring out how much money needed to be printed to achieve this fell, oddly enough, to Arthur Laffer. In early 1970, Nixon installed his friend Arthur Burns at the Fed, and gave Burns his marching orders. Burns marched.
By August 1971, the conflict between the money-printing strategy and the Bretton Woods policy of keeping the value of the dollar at 1/35th of an ounce of gold became too great. Nixon abandoned the gold parity policy, and the dollar became a floating currency.
Thus began the “Nixon Shocks.” All currencies delinked from the dollar, and floated. This turned out to be unacceptable. Only a few months later, in December 1971, Nixon put together the Smithsonian Agreement, which re-fixed exchange rates. It looked like Humpty Dumpty had been put back together again.
In August of 1971, Nixon also introduced price controls. In an effort to enjoy the advantages of money-printing, without the unpleasant consequences, the government began to control all sorts of market prices. Between the price controls and foreign exchange rate lockdown, everything looked great.
The stock market loved it. In 1972, official “real” GDP rose a whopping 5.3%! Nominal GDP rose 9.8% — and the 9%-nominal-GDP-targeters gave themselves a pat on the back. Nixon was re-elected.
It all seemed to work until the government market controls broke down. Foreign exchange rates floated again in the spring of 1973, when governments decided that they didn’t want to be chained to the U.S.’s money-printing policy. Price controls were eventually abandoned, as reality became too difficult to ignore. Our “lost decade” began.
Today, most everyone can see that government and large bank management is dominant in virtually every asset market. Again, the government market controls are keeping any unfortunate consequences of money-printing at bay — while the money-printing itself helps them manage things to their liking. Again, everything seems to be working well, as it was in 1972.
These things tend to end badly. With sufficient negative experience — but not until that time! — people eventually conclude that trying to manage an economy with a printing press just leads to a lost decade or two. They rediscover the principle of Stable Money, which, in practical application, usually means a gold standard system. (For a smaller country, it usually means a link to a major international currency.)
Governments have played their money-jiggering games hundreds of times throughout history. And then, hundreds of times, governments have readopted the principle of Stable Money. (Yes, it does happen.)
We will desire Stable Money too, which is why I have been busy laying the intellectual foundation for such a move. Politically, it is too early.
For the present system, I think it is now too late.