In today’s world, free markets face unprecedented challenges. Countries such as Europe, China, Japan, and the United States are all engaging in extensive financial interventions. It appears that individuals in power have taken it upon themselves to intervene in the daily lives of citizens on an alarming scale.
Recently, plans surfaced concerning further price-fixing initiatives. Unfortunately, these proposals go far beyond regulating the prices of items like Peruvian bananas or rents for apartments in New York City.
The ramifications of this latest plan would touch nearly every goods and services price by setting the value of the most vital commodity in the economy—its currency. Below are the details.
According to the Wall Street Journal, the Federal Reserve is considering launching a new bond-buying initiative. In a manner similar to previous quantitative easing strategies, the Fed would create currency to purchase long-term mortgage bonds and Treasury securities. However, this forthcoming initiative would differ from past efforts.
Under this new plan, the Fed would produce money to acquire long-term bonds and then subsequently borrow the money back from investors for short periods, typically around one month. This approach would effectively retract the newly printed money from the financial system, aiming to limit inflation expectations. The Wall Street Journal has labeled these monetary maneuvers as “sterilized” quantitative easing, but we prefer to refer to it as “writing checks to each other.”
Government Price-Fixing
In theory, sterilized quantitative easing would enable the Fed to decrease long-term interest rates, thereby promoting credit-based expenditures by households and businesses. The Fed believes that by artificially lowering the cost of money, they can boost demand and invigorate economic growth from its current stagnation.
At Economic Prism, while we do not doubt the Fed’s good intentions, we remain skeptical about the potential outcomes. Historical trends demonstrate that government intervention in pricing usually results in significant complications.
“Now we cannot hold the price of any commodity below its market level without in time bringing about two consequences,” Henry Hazlitt wrote in Chapter XVII, “Government Price-Fixing,” of his classic book, Economics In One Lesson.
“The first is to increase the demand for that commodity. Because the commodity is cheaper, people are both tempted to buy and can afford to buy more of it.
“The second consequence is to reduce the supply of that commodity. As demand rises, the available supply is quickly depleted. Moreover, reduced profitability discourages production. Many marginal producers may be forced out of business, and even the most efficient producers could be operating at a loss.”
The Fed’s Next Price Fixing Scheme and You
When governments suppress the price of a commodity, the incentive to produce it diminishes, leading to its eventual withdrawal from the market. Conversely, government manipulation of money prices can yield unpredictable results.
Several years ago, after the dot-com bubble burst, then-Fed Chairman Greenspan lowered the federal funds rate to a historic low of 1 percent and maintained it for over a year. While his intention was to stimulate economic activity, the unanticipated result was a booming housing market.
This boom was initially mistaken for a genuine economic revival, but soon it became clear that it was merely a bubble fueled by excessively cheap credit.
Simultaneously, Greenspan’s policy was not stimulating the U.S. economy; rather, it supported the Chinese economy by ramping up U.S. consumer demand for affordable Chinese imports. By 2006, the U.S. trade deficit soared to $817 billion, meaning the country was spending $2.23 billion more every day than it earned, financed primarily through debt.
Currently, the Federal Open Market Committee is convening to explore its monetary policy options. However, one should not anticipate the introduction of sterilized QE any time soon. They are likely waiting for a 20 percent drop in the stock market, which would provide a justification for almost any drastic measure.
It’s important to note that Greenspan’s strategies seem mild compared to those of his successor, Bernanke, who drove the federal funds rate to nearly zero in December 2008 and declared it would remain there until late 2014, all while generating over $2 trillion from thin air to lend to the government.
The next round of intervention is bound to exacerbate the detrimental distortions that these price-fixing strategies inflict on every facet of the economy—and unfortunately, there’s little that individuals can do to safeguard themselves from these effects.
Sincerely,
MN Gordon
for Economic Prism
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