This week brought surprising news regarding the economy’s performance in the fourth quarter of 2012: rather than expanding, it actually contracted.
According to the Bureau of Economic Analysis, “Real gross domestic product—representing the total output of goods and services generated by labor and properties in the United States—decreased at an annual rate of 0.1 percent in the fourth quarter of 2012.”
What is happening? Shouldn’t we be witnessing a robust economic recovery at this point?
In a statement released by the Federal Reserve, they attributed the slowdown to recent weather-related disruptions and other temporary factors. Yet, blaming a poor economic performance on the weather is rarely accepted in most professions. For the central bank, though, excuses seem to be common practice. A faltering economy supports their strategy of injecting $85 billion each month—essentially out of thin air—into the purchase of mortgages and Treasuries. This enables them to provide loans at virtually no cost, as the federal funds rate will remain between 0 and 0.25 percent.
Clearly, these monetary strategies do not indicate a healthy economy; they instead reflect an ailing one. So, how are these policies expected to facilitate improvement?
Improving Upon Graphs
The Federal Reserve’s compulsion to print more money stems from their adherence to Keynesian theory, which asserts that increased money supply will lead to heightened spending, ultimately resulting in economic recovery. They claim that more spending will spark a boom, create jobs, and enable collective wealth growth.
This disregard for the ineffectiveness of previous quantitative easing measures—QE, QE2, QE3, Operation Twist, and QE4—demonstrates the Federal Reserve’s altered state. They are trapped in a cycle of printing money until reaching a point of disaster. Concurrently, the Treasury continues to run $1 trillion deficits until their currency becomes entirely worthless.
Meanwhile, economist Paul Krugman—a Nobel Prize laureate and staunch Keynesian—is boldly encouraging this trend. In a recent appearance on The Daily Ticker, he stated that concerns about the budget deficit should be set aside, advocating for continued government spending.
However, Krugman’s logic appears questionable. His fixation on aggregate demand and supply oversights has clouded his judgment. He obsesses over GDP figures and how they appear on graphs, erroneously concluding that government intervention and artificially low interest rates can enhance the GDP. He seems to believe that the U.S. government possesses the capability to spend its way to prosperity.
Yet, a crucial problem remains…
The United States Can’t Afford Prosperity
The fiscal and monetary policies enacted over the past five years have maneuvered the financial system and economy to a precarious edge. Something is bound to give—whether that’s the dollar or interest rates.
Here’s a straightforward, though often overlooked, truth: The United States simply cannot afford prosperity. Let me elaborate.
Interest rate cycles can span decades, frequently lasting between 25 to 35 years. U.S. Treasury yields peaked in 1920 and gradually declined until the mid-1940s. Subsequently, they rose alongside inflation, prompting Franz Pick’s famous declaration that “bonds are certificates of guaranteed confiscation.”
What Pick failed to recognize at the time was that an inflection point had already been reached. In early 1982, yields surged again and declined to historic lows by December 2008. Since then, they have hovered at rock-bottom levels, and the Federal Reserve is determined to keep them there.
But can they maintain this status?
It’s possible they could sustain 10-Year note yields around 2 percent as long as the economy remains stagnant. However, eventually, economic recovery will occur—regardless of governmental policies—and with growth will return inflation.
Presently, the Federal Reserve has committed to expanding its balance sheet by over $1 trillion per year until employment rises. Considering the money multiplier effect, each trillion added could ultimately translate to $5 trillion—or more—flowing into the economy.
This influx of money will inevitably inflate prices, depreciating the dollar’s value. Foreign lenders, like China and Japan, holding substantial Treasuries will seek higher returns on their diminishing assets. Consequently, interest rates will increase, rendering government debt payments unsustainable.
Any potential GDP growth and boost in tax revenues will quickly be overwhelmed by surging interest costs. Thus, the most favorable outlook for the U.S. economy may be slow, tepid growth—anything more substantial is simply unaffordable.
Sincerely,
MN Gordon
for Economic Prism
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