The Truth Concerning Quantitative Easing, Inflation, and the Federal Reserve

What in the World is Quantitative Easing?

The Federal Reserve’s second round of quantitative easing (QE) begun last November is scheduled to end this month and inject another $600 billion into the economy.  According to Bernanke and most high-profile economists, the effect of QE is stimulus, stimulus, stimulus. But what exactly is QE?  It is no surprise that Federal Reserve policy is cloaked in technical jargon, and this is just one more example. To clear things up a bit, QE is simply an economic euphemism for printing money. Think of the economy as a watch. While the gears are all the different markets, policies, and institutions (monetary and fiscal policies, interest groups, political parties, etc.) that make up an economy, money is simply the oil (no pun intended) that keeps the gears from binding.  The Federal Reserve System – against the better judgment of economists and elected officials of the early twentieth century – has become the watchmaker.

Recall the primary issue of 2008 was a liquidity crisis, which was essentially the unwillingness of banks to lend.  The result was a complete international market seizure, whereby cash was no longer circulating to keep the gears lubricated.  Once cash-flow stopped, the watchmaker knew he had only one option to save face.  He claims now, as he did in 2008, that injecting money into the economy will jump-start lending, reduce excess industrial capacity, and lead to more hiring and an eventual return to the natural rate of unemployment (4-5%).  Keynesian economics, particularly deficit financing, is the name of game here.  Keynes saw the inherent benefit of deficit spending as a tool of monetary theory, and consequently, was largely responsible for gaining the necessary acceptance for inflationary monetary policy as such.

Monty Pelerin (pen-name) translates this idea well to highlight what inflation means for the average worker and consumer.  “In his General Theory, Keynes advocated solving unemployment problems by “fooling” workers with higher nominal wages.  He assumed workers were too obtuse to differentiate between nominal and real wages.”  Keynes also recognized inflation for what it truly was.  That is, he was well aware that “The best way to destroy the capitalist system is to debauch the currency.  By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”  This is the hidden tax we call inflation, and its primary avenue of realization is the Federal Reserve system.  By using fiat money instead of pegging the dollar to a tangible commodity such as gold or silver, central banking is able to manipulate the value of our monetary unit, thereby controlling the future of its purchasing power.  The implication of this for us all is staggering.  QE, then, is just an additional mechanism the Federal Reserve and U.S. Treasury is currently employing to devalue our currency and diminish the purchasing power of our paycheck.

But there is, of course, a political agenda hidden beneath the surface of Keynesian theory.  The ability to directly control the money supply places the reigns of everyday life in the hand of our bureaucrats.  Statism is the name of the game here.  As Pelerin states, Keynesian economics (deficit financing)  “is not economics, but political manipulation of an economy. Politicians love it because its underlying thesis is that the economy, left alone, would stagnate at some level below full employment. This false claim is the basis for Statist government enabling government to grow bigger, take more from its citizens and involve itself into all aspects of peoples’ lives.”  I believe reference back to Alexander Hamilton, our nation’s first Treasury Secretary under President Washington, will make a sufficient point.  When debating with Jefferson the matter of a national (central) bank to consolidate the debt of the thirteen colonies, his position was strongly in favor, for to take on such a magnitude of debt would bring with it the power of a strong centralized government.

A Bit of History

A bit of history is needed in order to understand how exactly Keynesian economics was able to grab hold of the brighter minds of America.  Proponents of Keynesian doctrine often cite the Great Depression and the booming years afterward as proof that, indeed, Keynesian monetary theory is sound and advantageous to America.  However, despite the conventional wisdom – written largely by unconventional individuals with equally unconventional agendas – some credit U.S. entrance into WWII as the primary impetus of America’s return to economic growth.  This may seem trivial, but is quite important because our high schools, community colleges, and universities are teaching our children a watered-down version of American history.  This is just another example.  In fact, well-renowned historian Howard Zinn says,

“[T]he war economy created millions of new jobs at higher wages.  The New Deal had succeeded only in reducing unemployment from 13 million to 9 million.  It was the war that put almost everyone to work,  and the war did something else: patriotism, the push for unity of all classes against enemies overseas, made it harder to mobilize anger against the corporations….The war not only put the United States in a position to dominate much of the world; it created conditions for effective control at home.  The unemployment, the economic distress, and consequent turmoil that had marked the thirties, only partly relieved by the New Deal measures, had been pacified, overcome by the greater turmoil of the war.”

A People’s History of the United States, pp. 402, 425

Therefore,  as WWII created a tremendous expansion in wartime production, it spurred enough demand to absorb increases in the money supply that are today associated with monetarism.  In short, demand created by the newly evolving military-industrial complex furnished the necessary goods and services to keep prices and inflation steady. After WWII passed, Washington created an atmosphere of fear among the public – very much similar to today’s war on terrorism – and a general consensus for a “permanent war economy” throughout Congress that allowed the Cold War to continue to fill this role.  This is known officially as the “warfare state.”  It seems, then, Washington has turned its fear mongering toward the war on terrorism to justify its increased military spending.

A Snapshot of the Federal Reserve System

In order to understand this, let us first examine a bit of Federal Reserve history.  Much of this is summation from G. Edward Griffin’s The Creature from Jekyll Island: A Second Look at the Federal Reserve.  Contrary to conventional wisdom of our central banking system – that it uses interest rates to control the money supply in an effort to keep prices and growth stable, namely to avoid economic crises – Griffin’s view holds the Federal Reserve itself responsible for economic crises and the massive depreciation of the dollar we have seen over the past century.  But how does an institution achieve such destructive agendas?  It helps, Griffin says, that the Federal Reserve is cloaked in ambiguity.  It is neither a private nor a public bank.  Although claiming to be politically independent, it is neither a political unit of our government nor a private bank as we typically think of the idea. Rather, the Federal Reserve System is a cartel that is partnered with our government, but not a part of it like the the House, Senate, or Supreme Court.  Most important to realize are its five primary objectives:

(1) limit competition within the banking industry as a whole,

(2) to obtain the rights – which were granted by our government, whence the partnership – to create money out of nothing (fiat money),

(3) isolate smaller banks from banks runs by gaining control over banks’ reserves,

(4) convince Congress to bailout insolvent banks with taxpayer money, and

(5) also convince Congress that the purpose of the Federal Reserve System and bailouts is to protect the public from economic crises (boom and bust cycles).

These, of course, were their unstated goals when the Federal Reserve Act passed in 1913, and the watchmaker has achieved all five. To our central bankers, there have no interest in economic stability (only control), nor on reestablishing it. We are taught in college that its purpose is to mitigate the negative effects of the free-market’s natural tendency of boom and bust. What we were not taught, but becomes prevalent to those who study history, is the Federal Reserve actually facilitates the business cycle.  And with each major crisis, they are able to limit competition even more and concentrate even more wealth.  This is the purpose of our and all other central banks in the world.  That said, any banking system connected to a central government is likely to fall into this trap as history has shown.  Believe it or not, the Federal Reserve System is actually the fourth central bank of the U.S., all others having resulted in the same scenario we see now.  The printing of fiat money and massive inflation to the point that a gold standard is reestablished has been done numerous times throughout history. What makes today’s problem so different is the degree to which globalization has linked the world’s economies. Consequently, when the dollar falls, so too will many other currencies. It is at this point that the idea of a world currency may be introduced to the public under the same guise as the origin of the Federal Reserve – to create stable prices with moderate inflation, which will translate into a stable global economy. It is not to be believed!

But Isn’t Moderate Inflation Good for the Economy?

Moderate inflation, usually around 2-3%, has historically been viewed by economists as a healthy amount.  The purpose is that inflation serves to drive the economy via expanding credit to businesses and consumers.  But inflation from excess money creation without a like increase in the goods and services from which money is needed to circulate is more a political tool than an economic phenomenon.  It is a way to hide the fact that the U.S. government is insolvent.  Monty Pelerin stated, “Without QE it would likely be illiquid. It is doubtful the US could sell enough debt to arms-length buyers to sustain its current spending.  The current estimate of the deficit is $1.7 Trillion.  Without QE there would be added distress for government and the economy.  Domestic interest rates would rise to whatever level necessary to attract market funding.  Higher interest rates would provide a further drag on the economy.  They would also dramatically widen government deficits.”  This would be devastating for the credit rating of the U.S. Treasury, resulting in government expenditures of nearly three times its revenues.  Thus, in order to remain solvent, inflation has become the only monetary tool left at our government’s disposal.

Yet even as a result of economics, inflation promises no long-run tool for stable prices because in order for it to act as a stimulant to economic growth, it must increase exponentially.  Milton Friedman pointed out, “Inflation is like a drug. Its stimulating effect is temporary. Only larger and larger doses can sustain the stimulus, before the chaos of hyperinflation removes all the gains.”  One need only examine the most fundamental of economic assumption to understand why one bout of inflation must be followed by a new, larger one in order to continue the stimulus-effect.  If I believe the value of my dollar will decline in the near future, I am more likely to spend more dollars now, as they will command more goods and services.  This is simple economic incentive.  If inflation has become the only monetary tools left at our government’s disposal (the Federal Reserve exhausted its ability to lower interest rates long ago), then one sees larger and larger bouts of inflation until eventually the U.S. reaches that dreaded state economists call hyperinflation.

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5 thoughts on “The Truth Concerning Quantitative Easing, Inflation, and the Federal Reserve

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  4. “It is at this point that the idea of a world currency may be introduced to the public under the same guise as the origin of the Federal Reserve …..”
    Pretty sure that idea is out the door with the Euro as an example of why not.

    I think that many will agree that the Fed is out of control, and banks have too much power to do as they please. Theoretically they are just a public utility to service the needs of business and society. However, they have become like any other corporation that wants to grow shareholder value and executive remuneration at the expense of their customers. This is despite the fact that they are given a license to run a business that virtually always makes a profit. The reasons for the failure of so many banks is basically greed and false assumptions. They take these risks with the knowledge that if they fail they will be bailed out. That is why banks need to be regulated more than other industries, and that such regulation is essential. It is because they are given such special rights and privileges that other industries in general do not have.

    As for the Fed, its role needs to be restricted and clearly defined to lender of last resort and control of inflation of both consumer prices and asset prices, thereby preventing bubbles. Unfortunately, the governors get carried away with their own egos, for example Helicopter Ben and his wacky ideas.

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