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Fed's easy money policies will end in tears

Peter Morici
web posted December 17, 2012

Bar the door Nelly—the Fed has abandoned all restraint and will now print money to finance the federal deficit.

To support the weak recovery, the Fed continues to keep short interest rates near zero, purchase mortgage-backed securities and push down long interest rates. To accomplish the latter, since September 2011, the Fed has sold Treasurys with terms of less than three years to purchase bonds with longer maturities.

Now, with its supply of supply of short-term securities running out, the Fed will simply print new money to buy U.S. government debt—at a pace of $45 billion a month. Add in its $40 billion in purchases of mortgage backed securities, it is supplying U.S. capital markets with more than $1.1 trillion annually—that's just about the size of the likely 2013 federal government deficit and 7 percent of GDP.

With the U.S. economy growing at only 5 percent in nominal terms, and 2 percent subtracting for inflation, growing the money supply at that pace sooner or later has to cause a great deal of inflation.

In the meantime, commercial banks enjoy a rock bottom cost of funds, and the elderly who often rely on CDs to supplement their social security must settle for about 1 percent. Only economists running central banks could find virtue in taxing grandma to subsidize Goldman Sachs.

Until now, easy money policies have done little to accelerate inflation. The reasons are simple—banks are not lending enough of the additional liquidity on their balance sheets to cause a lot of new consumer and business activity. With so much idle industrial capacity and unemployed labor, what new spending Fed policies instigate appears to be supporting additional production rather than higher prices for what is produced—but that can't last forever!

So far, the big exception is the housing market, where prices are picking up, despite wages of many young buyers stagnating or falling. And with prices outstripping wage growth nationally and rising quickly again in some choice urban locations, local bubbles and bursts pose new dangers to the fragile recovery.

Globally, central bankers, who meet every other month in Basel Switzerland, have cooperated to pump more than $11 trillion in new money into a global economy since the financial crisis began.

One does not need a PhD in economics to understand the dangers of that much new money chasing goods in a slow growing economy—especially one impeded by so many structural impediments to growth.

Europe is entering a second year of recession, burdened by unresolved dysfunctions imposed by a single currency. In China, the efficacy of mercantilism and crony capitalism is wearing thin—similar to Japan's experience two decades ago. U.S. growth labors under the psychological burdens of endless budget stalemates and an Administration obsessed with extending entitlements and taxing success instead of addressing the economy's flagging international competitiveness.

Therein lies the terrible tragedy: economists that head central banks well know easy money can't overcome flawed government policies and solve the tragic legacy of the financial crisis—chronically high unemployment in the United States and Europe. And blessed with considerable political independence, central bankers are in the best position to point out the failures of national policies to address structural dysfunctions.

Instead of speaking publically and firmly about those problems, central bankers appease political leaders, who demand easy money to paper over their excesses and failures.

Ben Bernanke and other central bankers, like promiscuous parents, compensate and indulge political leaders acting irresponsibly in their stewardship of national economies.

Sooner or later spoiled children turn out badly, and economies juiced with too much money have their bubbles, inflation and collapse.

This will all end badly. ESR

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission. Follow him on Twitter.







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