Today, Ben Bernanke and his colleagues at the Federal Reserve are convening to devise their next strategies for influencing credit markets. Tomorrow, they will unveil their plans for adjusting the money supply and interest rates. As always, expect them to introduce more liquidity at lower rates—it’s their go-to solution.
If only the infusion of money directly correlated with actual wealth, we would all be wealthy by now. The Federal Reserve has added a staggering $2 trillion to its balance sheet while keeping the federal funds rate nearly at zero since mid-2008.
Regrettably, an increase in money does not guarantee an equivalent increase in wealth. In fact, the average American family’s net worth dropped by 39 percent between 2007 and 2010. What’s happening here?
The stark reality is that more money, particularly through inexpensive credit, does not lead to greater wealth; instead, it results in increased debt. When this debt is utilized for consumption, the outcome is often the opposite of wealth accumulation; it leads to diminished prosperity.
True wealth is built through savings and capital investment, not through debt-driven consumption. Gaining real wealth necessitates patience, discipline, and hard work.
The Illusion of Quick Fixes
The Federal Reserve tends to favor quick solutions and low-cost tactics over strategies that foster genuine wealth creation. This is why they have maintained interest rates below inflation levels—they encourage borrowing and spending rather than promoting higher interest rates that would foster saving and prudent credit use.
Amos Bronson Alcott once said, “To be ignorant of one’s ignorance is the malady of the ignorant.” Although Alcott made this observation long before the inception of the Federal Reserve, he likely would have deemed their approach a manifestation of this very malady.
At Economic Prism, we do not claim to know what the interest rate should be. However, we can assert that the Federal Reserve, along with its team of experts, lacks this knowledge as well. The Federal Reserve mistakenly believes it understands which interest rates lenders should charge and what constitutes an optimal interest rate for the economy. They even present yield curve graphs to substantiate their claims.
The belief that government can improve the economy through central planning is what Friedrich Hayek termed The Fatal Conceit. Hayek argued that economic choices rely on price signals from commodities, allowing producers to respond with appropriate supply adjustments and consumers to modify demand. When government policies disrupt these signals, economic distortions ensue.
Even the Soviet Union’s central planners struggled to set the price of something as mundane as toothpaste. Prices set too low led to empty shelves, while prices set too high resulted in excessive inventory. They simply could not keep pace with the rapidly changing economic environment.
Just as the government cannot dictate the price of Peruvian bananas or NYC apartment rents, permitting market participants to make decisions results in supply and demand naturally adjusting to their marketplace value.
The Fundamental Flaw of the Federal Reserve
If Soviet planners struggled to determine the price of toothpaste, what gives the Federal Reserve the authority to set the price of the economy’s most vital element: money?
Clearly, they cannot. This is evident from the damaging consequences of their policies over the past decade. Yet the Federal Reserve continues to grapple with this malady of ignorance, meddling with the price of all goods and services by attempting to regulate the cost of money rather than allowing the freedom of individuals—namely lenders and borrowers—to navigate private contracts that determine money’s price on a case-by-case basis.
Among the items on today’s Fed agenda is whether they should persist with their bond-buying program. This initiative, known as Operation Twist, is set to conclude at the end of the year. For context, Operation Twist differs from traditional quantitative easing; here, the Fed generates money to purchase long-term mortgage bonds and Treasuries while then borrowing this money back from investors for a short period of about one month. This approach effectively removes freshly minted money from the financial system, which helps to control inflation expectations. The Wall Street Journal has described these maneuvers as “sterilized” quantitative easing; we see it as “writing checks to ourselves.”
Theoretically, sterilized quantitative easing is designed to lower long-term interest rates, encouraging increased credit-based spending among households and businesses. By artificially lowering the cost of money, the Fed aims to stimulate demand and promote economic growth. Yet, in the weakest recovery since World War II, their efforts have yielded minimal results.
Of course, the Fed’s actions are driven by good intentions. Unfortunately, they fail to recognize that government price-fixing creates chaos. It’s hard to overlook; the evidence of their disruptive handiwork is apparent everywhere.
For example, Bank of America’s certificates of deposit currently offer a meager 0.25 percent yield over a year. With a minimum investment of $10,000, you would earn just $25 by the end of the year. Clearly, only significant government interference in the financial markets could produce such a dismal outcome.
Sincerely,
MN Gordon
for Economic Prism
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