The current atmosphere in financial markets is fraught with anxiety. Investors are on edge, and the chorus for immediate action—“The markets need stimulus now!”—grows louder.
It’s becoming increasingly common to hear urgent calls for help as market fluctuations intensify. The DOW has dropped significantly by 1,258 points from its high of 13,359 on May 1, leading many to speculate that a significant market crisis is imminent. Besides managing the country’s money supply and promoting full employment, many now view the Federal Reserve as responsible for ensuring that stock prices consistently rise.
According to a report from Reuters, “Federal Reserve Chairman Ben Bernanke is scheduled to testify before a congressional committee regarding the U.S. economy.” He is not expected to face an easy round of questions.
“The blue-chip Dow average (.DJI) is now in negative territory this year. Job growth appears to be slowing significantly, while Europe remains entrenched in crisis,” reported the source.
Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York, noted that “this puts the Fed firmly in play, and they will likely feel compelled to respond,” especially after recent data indicated that U.S. job growth in May was the weakest it has been in a year.
“The missing piece that has so far prevented the Fed from taking action was the stock market. But now we are witnessing a downturn in this area,” he explained. “With equities falling, the last obstacle for Fed intervention has been removed, as all other conditions for action have been satisfied.”
A Quest for Free Market Principles
There is a universal desire to embrace free markets. Policymakers, leaders, academics, and various political figures often celebrate their benefits. However, it appears that the enthusiasm for free markets tends to fluctuate—especially when economic prosperity is at stake.
When becoming wealthy simply requires investing in an index fund and real estate, and then watching values rise year after year, the concept of free markets is adored. Fools get rich, politicians are reelected, and consumers leverage their inflated assets to fuel spending.
However, when free markets begin to reveal mismanagement and poor investment choices, public sentiment quickly reverses. People start to resent these markets. Fools incur losses, politicians face ousting, and consumers may find themselves drowning in debt.
During times when free markets clear out corruption and inefficiencies, the demand for bailouts, market interventions, and, most importantly, stimulus intensifies. But what exactly does “stimulus” mean?
Monetary stimulus, which refers to actions taken by the Fed, often equates to currency debasement. By manipulating credit costs and inundating financial markets with inexpensive capital, the Fed ultimately devalues the dollar. Unfortunately, generating a surplus of dollars diminishes the worth of each existing dollar over time, eroding the wealth of savers and retirees living off their lifetime earnings.
In the short term, currency debasement might seem like a quick fix to the debt dilemma. However, the ramifications of inflation often slip beyond the control of those managing the monetary supply.
The Cycle of Stimulus and Economic Instability
Initially, stimulus efforts can give the economy a temporary boost. Business activities may thrive, unemployment rates decrease, and stock prices temporarily rise. Yet as this artificial currency permeates the system, the economy frequently ends up in a more precarious position than before, necessitating an ever-increasing amount of stimulus just to prevent further decline.
This unfortunate scenario is now familiar to many western economies, including the U.S. It’s a pattern that has played out numerous times throughout history, one notable example being during the French Revolution.
As Andrew Dixon White observed in his seminal work, *Fiat Money Inflation In France*, “In spite of all the paper issues, commercial activity grew more and more spasmodic. Enterprise became stifled, and business activity stagnated.”
“Initially, the abundance of currency seemed to spur production and invigorate the manufacturers, but soon the markets became saturated and demand dwindled.”
Each economic downturn in France was met with increased issuance of paper money until public confidence in the currency evaporated. From 1790 to 1795, flour prices skyrocketed by 11,250 percent, while other prices followed a similar trajectory. By 1797, France’s currency had become worthless, leading to a catastrophic economic state.
While drawing parallels to the French experience may seem simplistic, it’s worth reflecting on the events since the 2008 recession. The Federal Reserve has consistently countered each economic downturn with enormous infusions of stimulus: first with QE in 2008 and 2009, followed by QE2 in 2010, and then Operation Twist in 2011. Each time, after a short-lived recovery, the economy has plummeted once more.
Consequently, it is not surprising that economic weakness is reemerging. Nor is it unexpected that demands for more stimulus are mounting. As we approach a presidential election year, bold proposals to rescue the economy will likely dominate the discourse. On Thursday, we may gain insight into the Fed’s forthcoming strategy.
Sincerely,
MN Gordon
for Economic Prism
Return from Stimulus and Spasmodic Economics to Economic Prism