by Steve Forbes
Making matters worse was the recent reestablishment of the accounting regulation known as mark to market, which forced banks to unnecessarily write down the value of their capital. Mark to market made banks holding subprime mortgages look even more troubled than they actually were, attracting the attention of short sellers who threw bank stocks into a death spiral. (When mark-to-market accounting was drastically changed starting in March 2009, the bear market promptly ended.)
The financial panic in the fall of 2008 nearly took down the U.S. financial system and pushed the global economy into the severest economic crisis since the Great Depression. Alex Pollack of the American Enterprise Institute points out that much of what was destroyed was artificial wealth created by inflation. “A lot of the . . . wealth,” he explains, “was an illusion—an illusion created by the housing bubble.” The collapse in housing prices brought inflated prices back down to reality. He concludes, “So in fact, the wealth didn’t disappear: it was never really there in the first place.”
John Law had to flee France in disgrace. In contrast, Federal Reserve chairmen Alan Greenspan and Ben Bernanke, whose easy money policies led to the housing bubble, made a great deal of money writing memoirs and giving speeches, and their institution at the heart of the debacle, the Federal Reserve, ended up with vast new powers unprecedented in American history.
Monetary Expansion and Income Inequality
In the storm of recriminations following the Panic of 2008, Occupy Wall Street held months of street protests in New York City and around the country decrying the pain caused by the crisis and assailing the financial sector for reaping seemingly disproportionate gains. The demonstrators were protesting free enterprise. But the Fed was the real culprit.
A little-appreciated reality of inflation, confirmed by a succession of studies, is that it increases income inequality. One Northwestern University researcher found a significant relationship between the expansion of the money supply and the amount of income inequality as measured by indicators of income inequality like the Gini coefficient.
While a weakening dollar hurts people on fixed incomes, monetary expansion delivers windfalls to certain sectors of the economy, like the financial industry, among the first to benefit from the Fed’s bond buying. In September 2012, when Ben Bernanke announced that the Fed would buy around $40 billion in mortgage-backed securities per month for the next three years, Wall Street was ecstatic. Markets closed at their highest level since 2007.
Not everyone was as enthusiastic. The dollar, that barometer of investor jitters, took a hit: the price of gold jumped to $1,772 an ounce, and the dollar’s value fell in relation to other currencies.
Anthony Randazzo, director of economic research at the Reason Foundation, put it this way, “quantitative easing has made it cheaper for the government to borrow, has artificially propped up the housing market (making it take longer to recover), and has dramatically manipulated the distribution of capital in financial markets. And the economy has not been in recovery.”
Windfalls for Authoritarians
Another largely overlooked consequence of the dollar’s decline has been massive wealth transfers to commodity-producing nations often hostile to the United States. Remember, when money is devalued, people invest in commodities and hard assets. Advocates of energy independence should be angered to learn that, thanks to the weakening dollar, the oil-producing countries of the Middle East, Venezuela, and Russia have reaped gains in the hundreds of billions of dollars.
The giant windfalls are not due to America’s increasing use of foreign oil. Consumption has actually been decreasing because of fracking, which has opened up new domestic energy sources. More money has continued to flow to oil-producing nations because of the cheapening dollar—resources that could have gone to job-creating investments, research into medical technologies, and cures for diseases.
Before the end of the Bretton Woods standard, from 1947 to 1967, the dollar price of a barrel of oil rose at an annual rate of less than 2%. After Richard Nixon freed the dollar to float, oil producers started sharply raising prices. On January 1, 1974, the Organization of Petroleum Exporting Countries (OPEC) raised the dollar price of a barrel of oil from $4.31 to $10.11.
Forbes contributors Ralph Benko and Charles Kadlec calculated in 2011 that if the United States were still on the Bretton Woods gold standard:
A barrel of oil today would sell for less than $2.80 a barrel, and the price of gasoline would probably be around 30 cents a gallon. The increase in the price of oil in the past 45 years is not due to OPEC. It is due to a fall in the value of the dollar.
They quote Keynes: “Those to whom [debauching the currency] brings windfalls, beyond their deserts and even beyond their expectations and desires, become ‘profiteers’ who are the object of hatred of the bourgeoisie, whom inflationism has impoverished, not less than of the proletariat.”
The Real Effect of Artificially Lowered Interest Rates
There’s another reason that loose money policies fail as a stimulus. Governments and larger enterprises may be able to borrow more, but the smaller entrepreneurs who are the economy’s foremost job creators often end up with less access to capital, because credit usually ends up being rationed.
The Fed’s monetary policies were a critical reason for the credit drought that persisted for more than five years after the height of the financial crisis. Industrialist Lynn Tilton, CEO of Patriarch Partners, complained in 2013 to the Wall Street Journal that the reason “we haven’t seen a sufficient number of startups” is that “there’s not a lot of financing right now.”
Congresswoman Cathy McMorris Rodgers and others say that the Fed’s zero interest rates were the reason bank lending was so tepid for so long. “This seems counterintuitive,” she acknowledged. However, “there’s a strange logic to it”:
With the private sector engulfed in so much uncertainty . . . banks are reducing credit to businesses, while increasing their purchase of government debt. The banks take in low-cost funds from the Fed and then lend it back to the government at a higher rate. This produces a small profit that—when done on a large enough scale—can become quite lucrative, indeed.
The misallocation of credit was also encouraged by QE’s Operation Twist strategy of pushing down longer-term rates by purchasing long-term Treasuries and mortgage-backed securities. For the first time not only short-term but also long-term rates were at near-zero levels.
Distinguished economist David Malpass, Stanford University economist John Taylor, and a growing number of others make the disturbing observation that these Fed purchases have badly skewed credit markets. QE’s focus on buying longer-term bonds means that mainly large companies end up getting cheap credit. Also benefiting are those so-called government-sponsored mortgage enterprises Fannie Mae and Freddie Mac, the originators of mortgage-backed securities. As mentioned, the federal government also benefits from lower interest rates, which allow it to run up deficits at virtually no cost.
In the meantime, commercial banks get Fed-created excess reserves and earn interest on those deposits. Bond underwriters and traders benefit too. Everyone benefits except smaller businesses that mostly rely on credit, along with ordinary citizens who are savers and investors, who are being paid the lowest interest rates ever.
The credit rationing that is a result of this process inhibits the formation of new capital needed to finance the Apples and Googles of tomorrow. Stock markets may reach dramatic highs and lows, but in the end they produce lower returns for investors during periods of unstable money. There’s lots of activity, but it amounts to much less than it would have in a system with a stable dollar.
Meanwhile, Average Net Worth Is Declining
The artificial windfalls created by loose money can create the appearance of prosperity. After all, aren’t people getting rich? Many may appear to be, but society as a whole is getting poorer. The cheapening of money destroys the purchasing power of every dollar you earn. It reduces the value of assets
owned by individuals and businesses. Today’s dollar buys less than 20% of what it did in 1971. In 2014, it was worth just 17 cents in 1971 dollars.
Findings by the Pew Research Center attest to this decline in the dollar’s purchasing power: the median net worth of households headed by Americans 35 and younger has plunged from $11,521 in 1984 to just $3,662 in 2009—an astonishing 68% decline in wealth.
Thanks to improvements in technology, we may have a higher standard of living today, but a middle-class family with two incomes can barely afford what a middle-class family with one income did in the late 1960s and early 1970s. Kadlec and Benko point out:
When the dollar was as good as gold, working people—not just rich people—prospered. Between 1950 and 1968, real median incomes of males rose steadily, climbing to $32,310 from $19,989 [in 2009 dollars]. That’s an increase of 2.7% a year. But ever since 1968, real incomes went flat. Incredible as it may seem, the debasement of our dollar has taken away every penny of nominal pay increase for 41 years, leaving the median income in real terms in 2009 at $32,184, virtually the same as it was in 1968.
The dollar’s decline is not the only cause of this. Over the past four decades, state governments as well as the U.S. federal government have steadily piled on taxes. Federal payroll taxes have soared. Couples have found that their combined salaries push them into higher tax brackets. States and municipalities have boosted property and sales taxes. A number of states have imposed income taxes since the 1960s. By one count, Uncle Sam imposes more than 50 taxes on Americans. Little wonder that it takes two incomes to do what one could have done 40 years ago.
Loose Money Addiction: Cautionary Tales
When talking about the perils of weak money, advocates of stable money frequently use the addiction analogy. Because it enables government borrowing and spending, it’s easy for politicians to become dependent on artificial liquidity. As with all addictions, however, there are consequences, and ultimately a price to pay. Monetary expansion can be hard to stop. Politicians don’t like to face the political costs of clamping down on inflation, especially when its false prosperity comes to an end.
In the early 1980s, the Fed under Paul Volcker swiftly boosted interest rates to draconian levels to end inflation. Texas’s oil-based economy slid into depression. Big oil companies had to merge to stay alive; numerous wildcatters went under. Other parts of the country dependent on agriculture experienced a similar upheaval. Anger at the Reagan administration turned Iowa from red to blue.
The cure for inflation can be bitter medicine, but the alternative is long-term malaise and decline. More than a century ago, Argentina was the eighth-largest economy in the world, a vibrant frontier nation much like the United States. But the Argentine government in the twentieth century resorted to manic money printing to finance its welfare state. In recent decades, Argentina has endured a succession of currency crises with hyperinflation that has reached as high as 5,000%. It’s hard to know definitively what the inflation rate is today because the administration of Cristina Fernández de Kirchner in Argentina has long been suspected of faking the numbers. The government actually tried—and failed—to make it a crime for anyone outside the administration to publish an inflation figure that contradicts its own statistics. Private sources put the annual rate at about 25%, more than double the government’s numbers.
Argentina’s devaluations and flagrant dishonesty have all but destroyed public confidence in the Argentine peso. These days people literally go into the street to exchange pesos for dollars in black markets. The real-world value of the peso is said to be anywhere from 35 to 50% lower than the official exchange rate. The Kirchner government, however, has refused to stop trashing the nation’s money, which would necessitate an end to manic spending. Its “solution” has been imposing capital controls in a desperate attempt to halt the flow of hard currency out of the country.
Without a reliable currency, meaningful investment in Argentina has become virtually impossible. Devaluations also mean exports that bring in less revenue and a slowing economy. In the fall of 2013, the nation’s economy had stalled and was teetering on the brink of yet another major crisis.
The story is much the same in socialist Venezuela. The country has suffered 10 major devaluations since the early 1980s. Under the late president Hugo Chavez, the bolívar was devalued 992%. This ocean of easy money has only managed to meet the short-term needs of the country’s voracious government. Ultimately, it is never enough.
Decades of cheapening money have devastated Venezuela’s economy and impoverished its people. Venezuelans have all the cheap gas in the world, which costs about 12 cents a gallon. However, they can barely afford cars or anything else. The Financial Times reported in 2013:
The currency is woefully misaligned . . . a burger at McDonald’s [costs] $12, two pounds of chicken $13 and a Volkswagen Golf $45,000. Buying a car—even at those exorbitant prices—is very difficult. Shortages are common for many staples: rice, oil, flour, milk, medicines and toilet paper—and cars. Even would-be buyers with money in hand need to join long waiting lists.
Brazil, along with a number of other South American countries, made an attempt in 1999 to wean itself from easy money and maintain a stable currency through “inflation targeting.” The effort enabled Brazil to strengthen its currency and achieve a 7.5% growth rate in 2010. But the government’s inability to stop spending, along with the strengthening dollar, has recently caused the Brazilian real to weaken along with the economy. Growth slowed to 1% in 2012.
Easy money sooner or later means stagnation, and not just in South America. One sees the same phenomenon in nations flooded with excess liquidity as a consequence of the “resource curse.” Loose money from an overabundance of natural riches translates into economic lassitude.
Saudi Arabia, for example, is a massive welfare state. The jobless rate is nearly 11%. Ninety percent of the employees in private companies are expatriates. The situation is so bad that the Saudi government now fines companies that have too many foreign employees. One of the characteristics of countries with easy wealth is that people are not motivated to take jobs they may perceive as having low pay or being less than desirable. They don’t have the drive to innovate or move up in the marketplace, because there is no need.
Why have the Middle Eastern region’s immense oil riches failed to produce the growing entrepreneurial enterprises you find in nations like Singapore, Taiwan, South Korea, and Israel, countries with far fewer—or even no—natural resources? Why are there no high-tech or textile industries of the kind you’d find in those countries? The reason is that nations that rely on the riches from natural resources rarely develop the habits of commerce that are the real engine of wealth.
Tight Money Causes Problems Too
As mentioned, Keynesians see the economy as a closed system, an engine. In reality it operates more like a Rube Goldberg contraption. A single event sets off a succession of unintended consequences. This is why monetary bureaucrats get into trouble when they try to act as puppet masters.
We saw this in 1997 when the United States cut taxes. Among the highlights, the Clinton administration cut the capital gains tax from 28% to 20% and barred new Internet taxes. The economy took off, as did the stock market. Demand for the dollar rose. The Fed didn’t meet the demand by supplying enough dollars. The gold price fell. The central bank inadvertently began a deflation. Commodity prices tumbled. Corn, for example, plunged from over $5 a bushel in 1996 to under $2 a bushel in 1999. Oil got as low as $10 a barrel. Agriculture and traditional manufacturing buckled.
The result: investments moved away from those traditional sectors, and not because of genuine market forces. Where did investment money go? Into the tech sector. Thanks to the growth of the Internet, technology was in the midst of a boom. The Fed’s tight money set off a chain of events that ended up inflating this boom at the expense of traditional industries.
In early 2000, the Nasdaq hit 5000, a level it has not yet touched sinc
e. Shortly thereafter, stocks started to wobble. The high-tech bubble was starting to deflate. By 2001, the economy had slid into recession.
Had the Fed allowed the economy to recover on its own, we might not be writing this book. But naturally, it didn’t. Faced with the bursting of the tech bubble in 2001, two weeks before the inauguration of incoming president George W. Bush, Federal Reserve chairman Alan Greenspan changed course and began loosening. He cut rates from 6.5% to 6%.
He should have stopped easing when gold reached $350 an ounce. When the precious metal went above $400 an ounce in late 2003–2004 it was clear that the economy was going in an inflationary direction. But he continued lowering interest rates that were now inflating the housing bubble. We all know where things went from there.
Greenspan might have been able to avoid some of this had he kept an eye on the price of gold. But he did not appear to do so, which was surprising given his past support of gold-based money. In addition to being an anchor of value, the price of gold is a vital barometer whose fluctuations tell you if there is too much, too little, or the right amount of money in the economy.
Unfortunately, not only Greenspan but also nearly all recent Fed chairmen have failed to appreciate the importance of gold as a barometer. Decisions are made too often on what are essentially hunches—and what the political climate is.
All this raises the larger question: Should the Federal Reserve really be in the business of fine-tuning the economy? The Fed was conceived during an agricultural era, when banks making crop loans could face seasonal cash squeezes during harvest time. It was supposed to provide a source of liquidity and also, like the Bank of England, be a lender of last resort. That is a very different role from the one that it has today: attempting to modulate normal business cycles.
