Clearly, to date, the inflation hawks (the "experts" who promised that an expanding Fed balance sheet means ever-growing inflation), had it wrong (operative words being "to date"). The thing about inflation being a monetary phenomenon, a la M. Friedman, is that the money has to be doing something: As I stated in Little Chasing Going On, all that new money continues to do nothing in bank excess reserve accounts.
We can speculate on what the Fed governors are thinking: how it appears as though they're not at all interested in seeing those trillions make their way into the economy---not while they're paying the banks interest on those excess reserves---but that's not my message for today. Today I'm going to take a shot at those who, on one hand, shout for free-markets while, on the other, lobby for more QE. That---to name just two---would be the likes of CNBC's Larry Kudlow and The American Enterprise Institute's James Pethokoukis (I like them both btw), who apparently view the White House-appointed Ben Bernanke's intervention into the marketplace vastly different than they do that of his (re)appointer.
So why fret when free-marketers, like the aforementioned gents, support this Fed intervention? I mean how does the simple exchanging of cash (that'll do nothing in bank excess reserve accounts) for bonds (that [presumably] would've done nothing on bank balance sheets) impose on the "free market"? Well, for starters, we're talking about an "investor" (the Fed) buying up the supply of an asset with no personal profit motive. And while forcing up the price (and down the yield) of bonds, the Fed is forcing those who normally would have invested in said bonds (like retired folks) to look elsewhere for yield (which, by itself, is a QE objective). And, let me be clear, "elsewhere" can be a very risky place.
I'd like to remind those self-proclaimed free-market types that there's a reason we call the bond market the bond "market". That's right, "market"; the place where buyers and sellers come to transact. Where, when we're talking bonds, those seeking capital compete on terms and their credit ratings for the investment business of those seeking a (generally safe) rate of return---and, as well, where the holders of existing bonds sell to willing buyers. When the government (yeah, let's here call the Fed "government"), spending newly "printed", or other people's, money (not being the least bit concerned with return) enters the "market"; whether it be the market for mid-western grown beef, corn, solar power, residential real estate or bonds, pricing---as I suggest above---becomes profoundly, and dangerously, distorted.
The free-market/small-government/big-QE advocates' most glaring contradiction is their railing against the seemingly unbridled growth of government while pushing for yet more QE. Do they not understand how the Fed, by scooping up trillions in treasury notes, and thereby suppressing interest rates, is directly facilitating our policymakers' thriftlessness? With rates this low, why the hell not borrow out the wazoo? My goodness!! Can they not foresee what will happen (as I'll explain below) when God knows how many trillions in debt begins to rollover amid future budget deficits and inevitably higher interest rates? Do they not understand that bigger government begets bigger government---that a growing public sector begets a shrinking private sector?
You gotta love how Bernanke calms the market by proclaiming that they'll unwind their titanic balance sheet without sparking the mother of all bond sell-offs. He says they can choose to simply allow those notes to roll off at maturity. Well, now, let's think about that: Let's say that a hundred billion in treasury notes is maturing, say, tomorrow. That means the Treasury must pony up a hundred billion dollars. Of course it ain't got a hundred billion dollars, so it must, yes, borrow to pay back what it borrowed. Do you think for a microsecond that the Fed (today's Fed anyway), after facilitating the borrowing of trillions at crazy-low interest rates, is going to subject the Treasury to the real world, and, consequently, the taxpayer to higher taxes? Not on
Ever-higher inflation? But the last few years have proven, a la Kudlow, that QE doesn't equate to rising inflation, so am I not thus dancing under a cloudless sky? Well, not ultimately. You see, in my never-ending QE scenario the Fed continues to facilitate utterly wasteful government spending (the notion that government spending [largely] equals waste is something virtually all free-market types agree on), which means that even if banks remain willing to buy from the treasury then sell to the Fed for newly "printed" dollars (that remain idle in excess reserve accounts), resources---through government
Here's the analogy I used in Leaving Liberty? (forgive the shameless plug):
If you and five others are stranded on a desert island and you have a granola bar for sale, what’s it worth? If your famished fellow castaways have one dollar among them, it’s worth a dollar. If they have ten, it’s worth ten. Now, you tell me, when we print trillions, what ultimately happens to the prices of gas and granola? As Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.” But what if the castaways have ten dollars and you happen to have two granola bars? Well then, they’re worth five each. Then, if a chimp steals and eats one, the remaining one, experiencing 100 percent inflation, is worth ten. Now wouldn’t that be a supply disruption, as opposed to a monetary phenomenon? Yes, that would be a supply disruption, and a monetary phenomenon. In that the supply of money did indeed increase—on a per-unit basis.
Gladys, my assistant, stepped into my office yesterday morning and asked how I control my sugar intake. I said "what's up?", she said "my doctor says I have to cut down on sugar, but I don't put sugar on anything!" So I pulled up a website featuring the glycemic index and explained how certain foods, once in the body, will spike a person's blood sugar. Gladys was none too happy to discover that she needed to give up, among other things, bananas (for a moment I thought she was going to cry). Now Gladys is the picture of 65 year-old health. In fact clients are forever shocked to find out she's medicare eligible. So, from the outside, there's absolutely no evidence that her QB (quantity of bananas) is doing her any harm whatsoever. And, besides, she loves them and justifies extending QB because she thinks she needs more potassium. My advice was to stop the QB cold turkey, find a healthier potassium source, suffer through her cravings, and get her body back to its normal insulin production.
(Note: I just asked Gladys for permission to include the above and all she could talk about was how much she loves bananas. She was, again, on the verge of tears.)
My advice to the Fed is to stop QE cold turkey, allow the economy to suffer withdrawals and adjust accordingly (which it will), and find its way to healthy free-market productivity. Yes, I know, the distinguished Kudlows and Pethokoukises would tell me I'm crazy; that the markets would freak and we'd be right back in recession. And they could very well be correct. But I say, whatever it takes, and the sooner the better! We do not want to be sitting here years hence with a trashed dollar and a huge deficit, while bonds are maturing left and right. But don't hold your breath, for---as Gladys will attest---old habits are very hard to break.
"Free-market capitalism is the best path to prosperity" Lawrence Kudlow