In the autumn of 2010, the United States economy had ostensibly been on the mend for about 18 months. This was the official stance of the National Bureau of Economic Research, which marked the recession’s timeline from December 2007 to June 2009. However, for countless individuals, it felt as though genuine recovery was still out of reach.
If recovery indeed occurred, it was far from the vigorous growth that one might anticipate following a significant recession. Instead, it resembled the slow recovery of an elderly person recovering from pneumonia; while enough antibiotics might help combat the illness, the individual continues to struggle for breath after a short walk to the corner mailbox.
Similarly, with enough easy credit in circulation, the U.S. economy managed to achieve a few quarters of positive GDP growth. Yet the misallocations from the bubble years lingered like an unwelcome guest long past midnight. If recessions are meant to purge the remnants of prior expansions, this one notably failed in that regard.
The recovery experienced during this time was unusual upon closer examination. It did not stem from spending savings accrued during the recession, nor was it a result of capital investment.
In truth, it was largely reliant on deficit spending, funded by Federal Reserve lending to the Treasury through the purchase of Treasury Notes. But that’s only part of the story. Where does the Federal Reserve obtain the funds to lend to the Treasury?
We know the answer: they generate it out of nothing. This reality not only raises moral and ethical concerns but also renders the recovery fundamentally fraudulent. Thus, in the fall of 2010, the Federal Reserve embarked on generating another $600 billion of artificial money to sustain this feigned recovery.
This initiative, known as QE2, is set to conclude next month. Recently, markets have shown signs of unease regarding its impending end. As we reflect on what QE2 signifies in the coming weeks, let’s first explore the motivations behind its inception.
Business Cycle Review
Federal Reserve Chairman Ben Bernanke faces a daunting challenge. His responsibilities include safeguarding the value of the dollar, fostering long-term growth and employment, and attempting to eliminate the business cycle altogether. This sets him up for an almost impossible task.
The business cycle naturally ebbs and flows, featuring periods of economic expansion followed by contraction. After a recovery phase, new growth should ideally follow.
Typically, as growth accelerates, interest rates decline, making borrowing more affordable and amplifying asset prices. However, the boom inevitably exhausts itself; borrowers overreach, and the economy struggles to sustain its debt.
This transition leads to a bust, resulting in bankruptcies and a market that penalizes those who acted recklessly. Asset prices take a downturn, interest rates rise, borrowing becomes more expensive, and economic growth falters along with consumer spending. Unemployment rises, and savings accumulate, prolonging the recession or even leading to a depression.
Government intervention, however, distorts this natural cycle. Monetary policy attempts to control the money supply through the central bank, while fiscal policy utilizes taxation and deficit spending to redistribute wealth in the economy.
Ending the Business Cycle with Guesswork
Such intervention sends misleading signals to consumers, businesses, and investors, causing distortions and misallocations of capital. For instance, one entrepreneur may borrow to expand his chain of retail electronics stores, responding to apparent demand for flat-screen TVs and iPods. Yet, he remains oblivious to the fact that this demand is artificially inflated by consumers extracting equity from their homes, buoyed by the Fed’s low interest rates.
Meanwhile, an ambitious entrepreneur in China also borrows to enhance warehouse production of these popular electronic devices flooding the U.S. market. This chain reaction of distortions continues, creating an overextended capacity that soon proves unsustainable.
When the inevitable downturn occurs and credit tightens, the illusory demand’s distortion becomes glaringly evident. For example, in the remote California desert—far from the Pacific Ocean and its favorable climate—a speculative developer, misled by the housing boom and the Fed’s cheap credit, saturates the area with sprawling housing developments that fail to attract buyers. Consequently, a furniture store that opened in a newly erected strip mall to cater to this nonexistent demand ends up shuttered, following corporate bankruptcy.
Regrettably, government intervention can temporarily stave off declines during the business cycle by propping up the economy with cheap credit. However, delaying these natural downturns ultimately leads to larger consequences when the collapse inevitably arrives.
The absurdity lies in placing the responsibility of eliminating the business cycle on a central banker…
Can a physicist defy gravity? Can a doctor extract cancer from a patient’s lungs entirely? Is it possible for a mathematician to make pi a rational number? Can a chemist boil water at 200 degrees Fahrenheit?
To pretend that the business cycle can be eradicated would be equally remarkable. All businesses would be profitable, money could be borrowed without risk, and stock prices would only rise. It would be akin to eliminating night from day or reaping a harvest devoid of labor.
Faced with this unachievable task, the Fed Chairman approaches the concept differently than a carpenter would meticulously measure and cut wood. While a skilled carpenter measures twice and cuts once, a central banker creates money based on mere conjecture…
“Let’s try $600 billion this time. If that doesn’t yield results, why not attempt $1 trillion?”
Sincerely,
MN Gordon
for Economic Prism
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