Money is supposed to be a store of value in part due to its scarcity. When a government can create an infinite supply of money at will, it is no longer valuable. There are numerous examples in history of a country deciding to print as much money as it needs; none have ended well.
In late 2008, ongoing deleveraging in the financial sector finally led to a panic. Rather than allowing the panic to destroy the weak firms, the world’s central banks decided to support the entire financial system, good and bad, by printing unprecedented quantities of money.
Once large-scale monetary intervention begins, it cannot stop. Ceasing money printing will allow the financial panic to restart and run its course. Whoever is in office at the time of the panic will be blamed and have a more difficult path to reelection; hence, there is great political pressure on the Fed to deliver economic growth or at least its perception by money printing.
Additionally, central bankers have decades of intellectual capital built up in Keynesian models. These models tell them that creating enough money will eventually lead to sustained growth. If money printing is not working, then the answer is more money printing, not a different course of action. The Fed Chairman is the high priest of a cult, and high priests can never admit that they are wrong.
While the economy, measured by the workforce’s job prospects, is not improving, at least it is not getting worse. The reason for this is that the world is enabling the Federal Reserve’s bad behavior.
There are two ways that the Fed’s intervention is supposed to spur economic growth. First, lower interest rates should lead to more business loans and more business activity. Second, printing more dollars increases their supply while demand remains the same lowering the exchange rate. A cheaper dollar should lead to more exports.
Our trading partners do not wish to lose business to a cheaper dollar. While they cannot affect the supply of the dollar, they can certainly raise demand, and they accomplish this by purchasing dollars and investing them in U.S. treasuries.
The largest currency manipulators are Japan, Taiwan, Switzerland, Hong Kong and China. Only China has reduced its U.S. treasury holdings in the last year. The rest of the countries have increased theirs in order prevent their currencies from rising against the dollar.
While the article discusses the end of the Fed’s power, this system has survived for years and shows no danger of failing any time soon. All of the world’s central banks are soaking up dollars and preventing them from reaching markets where they could do a great deal of mischief .
This can go on forever, or it can stop tomorrow. We entered experimental territory in late 2008 and have not looked back, and the system remains in a state of equilibrium. All the dollars (and euros, yen, sterling…) printed prevent the system from crashing, but they also seem the prevent it from healing. The economy may not improve, but at least it is not getting worse.
There are two types of Fed watchers. There are the fedophiles, who believe that central bank action can solve any problem, as long it is performed on a sufficient scale. The other group are the contrarians, who point to examples of hyperinflation caused by debt monetization in Zimbabwe or Weimar Germany.
My greatest fear is not hyperinflation. Rather, it is that we wind up like Japan caught in perpetual stagnation caused by central bank action. With a crash, we would realize the error of our ways and construct a new, more resilient financial system. Stagnation can endure for decades with no action being taken, because things are not getting worse until they do all at once. At that point, it is too late for reform.