The Dangerous Policy of “Printing Money”
October 2011
Introduction
Reports from the Obama administration in January of 2009 warned that “without an economic recovery plan… the unemployment rate could hit 9 percent” (Zeleny). Yet after passing a gargantuan stimulus bill, including unprecedented debt monetization, the resulting economy makes the administration’s estimate look desirable. Along with this massive increase in the monetary base, the unemployment rate hit its twenty-six year high of over ten percent in October of 2009. As of August 2011, nearly two years later, unemployment is only one percent lower than the high and still at the top of what the administration warned could happen without their economic action (Bureau of Labor).
With no other sector of the economy doing any better and worries of a second recession, it appears that the so-called stimulus has had nowhere near the positive effect expected by the administration. This comes as no surprise — the extreme monetary policies of the Federal Reserve and congress are repeatedly discredited by historical examples as a solution to economic hardship. Also the inflation caused by the resulting increased liquidity directly hurts the economy. And in addition to the financial reasons is also a moral one; their unchecked actions are misleading and unethical. The current monetary policies of the Federal Reserve and congress cause excessive inflation, hurt the economy, and need to be stopped.
Historical Cases of Inflation
History offers us many examples of dramatic inflation caused by monetary policies similar to that of the Federal Reserve and congress. After World War One for instance, Germany was required to pay reparations for damages caused by its military. Germany had little money to pay these countries; they had just finished fighting a war. So to pay these debts Germany was forced to print money to cover the reparations. As they printed more money and increased their monetary base, the value of their currency diminished at an alarming rate causing inflation. Soon it was so bad that a loaf of bread cost an entire wheelbarrow of money. Citizens raced to the markets after receiving their weekly pay for fear that such rapid inflation rates would limit what they could buy.
Citizens actually burned their money, because it was cheaper than buying firewood (History Learning). This example is perhaps the most extreme in history, but inflation is a real threat to nations with extensive debt, and this comes as no comfort to the United States; US news reports that the US debt is the largest in the world (Kurtleben). It then comes as no surprise that the United States has begun to consider similar policies. And while historically we’ve faced some dire economic situations, most notably the great depression and the recession of the 70’s, we’ve never taken such a measure as recently.
When the Federal Reserve was established in 1913, it immediately began to print money. This increased liquidity boosted the economy and led to a stock market boom. The Federal Reserve then began to pull money back as it realized the over inflated economy wasn’t healthy. The stock market crash of 1929 quickly followed. This reckless behavior hyped the economy and then the pull back of currency that followed lengthened the depression (Cundiff).
In the 1970’s the United States was faced with a similarly bad economy. Despite knowing what happened in the 1920’s, the printing presses rolled out money and inflation went out of control, creating one of the worst inflationary periods in American history (Hossini). As these examples show, inflation clearly has always followed massive increases in the monetary base and leads to harsh economic periods. But the most alarming details are that these past situations are very similar to what we are faced with today, and yet the United States continues to expand its money supply, despite the alarming historical indications. In the United States most recent monetary action, according to a report made by the Federal Reserve Bank of St. Louis, it literally doubled the adjusted monetary base (Federal Reserve). However, the effects of this increase are just beginning to affect consumers. Up until now U.S. borrowing has absorbed much of the monetary increase and large banks have been hoarding cash to increase their reserves (The Economic). However, once the banks start lending and normal economic behavior resumes, the money will make its way back to consumers. The result will be uncontrollable inflation similar to what we’ve seen in the past, if not worse.
Consequences of Inflation
High inflation is bad for any economy, even in a recession. When the monetary base is increased, it eventually makes its way into circulation through the banks and their loans. Once this money gets into the hands of the consumers massive liquidity will follow. Demand for product is increased throughout the economy and the result is demand pull inflation. Demand pull inflation is a result of a sudden increase in circulated currency which creates a demand that outweighs the supply of products (Investopedia Corp). Basic economics then dictates that an increase in demand with a stagnant supply inevitably increases the price of the product. This remains especially true in an economy where most people are barely getting by. According to the U.S. Department of Commerce: Bureau of Economic Analysis, the US savings rate is lower in the past few years than ever recorded (US Department). So any extra money obtained by a consumer will inevitably be used to buy products, instead of going into savings — they just can’t afford to hang on to it. Additionally, once the inflation rates increase, wage increases are expected to keep up with them. However, there is always a lag between inflation and wage increases. Corporations are not quick to give pay raises based only on the higher cost of living, and it takes the US government time to increase minimum wage. Consequently, if inflation is steadily rising then wages are constantly too low, and workers are constantly underpaid.
However, suppose a person was to make enough and save that money, he is still not safe from inflation. Savings accounts yield a very low interest rate, certainly below that of the average inflation rate, and this means the money he saved constantly loses value. For example, if the inflation rate was 5.5% and you saved $30,000, that money could only buy $16,650 of equivalent goods ten years later (Wilson). Loans and interest rates skyrocket to compensate for this exact situation, nobody wants to take future payments and foreign investments are withdrawn for fear of the devaluing currency. Internal investments are also withdrawn and put into safer investments to hedge the inflation. Common investment practice dictates that money should be moved from stocks to gold and inflation adjusted bonds to earn interest merely to retain the value of your money. Overall, the result of high inflation is an abandoned economy where the average citizen struggles to keep up with rising prices, and it cannot be tolerated.
Monetizing the Debt
The recent actions of the Federal Reserve and the United States Congress regarding monetary policy have been misleading and unethical. The Federal Reserve is a non-government financial institution that regulates the US money supply controlled by seven chairmen. These seven people are arguably the most financially powerful people in the world. According to their official monthly report, the Federal Reserve holds nearly three trillion dollars’ worth of assets (Federal Reserve Board). To put that into perspective, the world’s two hundred richest people’s combined wealth was just over one trillion in 1999 (World Centric). These powerful men claim to want to accomplish economic growth without letting inflation get out of hand. As former Federal Reserve Chairman William McChesney Martin famously said, “[the Federal Reserve is] supposed to take away the punch bowl just as the party gets started” (Mankiw 65). However, the recent actions of the Federal Reserve might indicate otherwise.
After the US credit rating was downgraded in mid-2011, foreign investors began to distrust the United States Treasury Bonds, the way the government borrows money. China began to sell their share of US debt and joined other countries opting for even safer investments. With confidence in US Treasury Bonds lost, the Federal Reserve bought off a majority of the debt. Shockingly, the United States now owes the Federal Reserve, its own central bank, more than its previously largest creditor, China. The question that inevitably surfaces here — how does the Federal Reserve get the money to buy nearly two trillion dollars’ worth of bonds? The answer is extraordinarily complicated and best explained by an expert, namely Robert Prechter, founder and president of Elliott Wave International, the world’s largest independent financial forecasting firm. He explains that:
The U.S. Treasury borrows money by selling bonds in the open market. The Fed [the Federal Reserve] is said to “buy” the Treasury’s bonds from banks and other financial institutions, but in actuality, it is allowed by law simply to fabricate a new checking account for the seller in exchange for the bonds. It holds the Treasury’s bonds as assets against — as “backing” for — that new money. Now the seller is whole (he was just a middleman), the Fed has the bonds, and the Treasury has the new money. This transactional train is a long route to a simple alchemy (called “monetizing” the debt) in which the Fed turns government bonds into money. The net result is as if the government had simply fabricated its own checking account, although it pays the Fed a portion of the bonds’ interest for providing the service surreptitiously. (Prechter 124)
So in essence, since the Federal Reserve itself controls the money supply, it can lend money to the US Treasury by creating the money itself. It is then paid interest on the US Treasury Bonds it buys. So the US Treasury ends up with, essentially, a large checking account full of money produced out of thin air, and the Federal Reserve ends up with a virtually risk free investment requiring no capital — it doesn’t even have to print the money; the US Treasury does that for them. But the interesting thing about this is that while the Federal Reserve isn’t a government agency, it supposedly gives all of its profits to the US treasury. So the end result is that the Federal Reserve keeps whatever it decides to deem expenses, giving up the profits on the US bonds’ interest to the US Treasury. That means the US Treasury basically gets to borrow money interest free from the Federal Reserve. That is why it’s called “monetizing the debt”.
So who loses? The American taxpayers, they had no real say in whether the money was borrowed and now have to be responsible for paying the deficit, and they have no say in how it is spent. It’s as if the American taxpayers handed the US government a credit card with no limit and agreed to pay the bill. And additionally, they must now deal with the inevitable inflation. The United States Congress is at fault here. Congress fails year after year to make a balanced budget to manage the debt, and instead they propose trillions of dollars more worth of spending. And then they raise the debt ceiling to cover it, practically begging to continue monetizing their debt. In fact, inflation is in the interest of the US government. Inflation actually decreases the value of United States debt making it easier to pay off. However, it also decreases the value of every citizen’s wealth. The citizens suffer the consequences directly, because they need to create and preserve their wealth while the government can simply monetize more debt in the amount needed regardless of the value of each individual dollar. The more they do this, the more inflation rises and the cheaper the previous debt becomes to pay off. While morally questionable, this would certainly explain why they are not more concerned with their policies.
Auditing the Federal Reserve
The publics’ worries have recently been with their country owing money to China, but now the United States owes the Federal Reserve much more than China. And this wouldn’t be so alarming if the money they lend wasn’t essentially borrowed. Technically the currency in circulation and deposited in banks, through both the government and the Federal Reserve, is a liability of the Federal Reserve. They don’t technically “owe” it to anyone, and if they do “owe” it to anyone at all, it’s the incinerator. All the money, once paid back to the Federal Reserve by the US Treasury, has to be destroyed to settle their liabilities. This leads to the most frightening fact of all — the Federal Reserve cannot be audited. This means that all the claimed “expenses”, created money, and destroyed money go unchecked by an independent body. And this is strangely contradictory since the current administration so strongly supports government transparency. It’s unreasonable and unfair that the institution that controls the entire money supply and has such enormous power over the nation’s economy can’t be audited. Additionally, the strong resistance by the Federal Reserve to recent efforts has been entirely discomforting. There is no credible reason for an organization that serves the public to outright object to an audit, unless they are hiding something. All US citizens are subject to audits to ensure the government is not shorted tax revenue. Should not US citizens require the same of the Federal Reserve? The citizens after all, are the ones who actually pay for the resulting deficit. But this is not the case. The government doesn’t want to bring attention to its questionable dealings with the Federal Reserve, because they fear revealing how the trick monetary policies they employ actually work.
The Inflation Rate
Not only has the government not been transparent; it’s been transformative — with the inflation rate. The inflation rate of the 1970’s hit fourteen percent, an alarming rate no doubt (Graham and Zweig 60). Recently however, rates have been “low” and around two or three percent. This would come as a shock to most consumers who have recently observed prices on everyday staples, such as coffee, as much as doubling. This low inflation rate is the result of a recent change made by the government in the way that the rate is calculated. The new method significantly shortens the time frame upon which it is calculated, and among other things, assumes substitutions in similar products. The current rate of inflation under the new method is about four percent. However, the current rate of inflation calculated using the old method is over ten percent, very near the drastic inflation of the 70’s (Shadowstats). The government made the changes saying that inflation had been overstated in the past, but now the rate seems dramatically understated. This isn’t surprising, as the fight against inflation has always been a primary concern of voters. It only seems sensible that they understate inflation in interest of political image. And even assuming the government was right to lower the rate; the only accurate way to compare the inflation rate of today with that of the 1970’s is using the same old system of calculating inflation. This reveals that either way, the inflation of today is similar to that of the 70’s.
Gold Standard Currency
Finally, the most obvious reason the Federal Reserve is questionable is that its currency is unconstitutional. The United States Constitution states that “No State shall … make any Thing but gold and silver Coin a Tender in Payment of Debts” (art. 1 sec. 10). The designers of the Constitution had problems with inflation as early as 1777 when prices tripled every year in some colonial cities (Graham and Zweig 60). They knew of the danger of inflation and inserted this into the constitution to specifically prevent it, because gold and silver based currencies do not considerably inflate. The government however, decided to ignore the constitution, create the Federal Reserve and do away with the Gold Standard. Now every citizen of the United States’ wealth is constantly under attack by inflation. At the very least, an option to preserve wealth should be offered for the Americans who are presently being punished for saving their money. Perhaps savings accounts based on a gold standard for those diligent enough to set money aside. While many economists are unclear on whether a return to the gold standard would be a good move, it is abundantly clear that the system currently employed is not working. The current monetary management supports unconstitutional currency, outrageous borrowing by the US government without the consent of US citizens, as well as radical mismanagement of the money borrowed, and it needs to be changed.
Summary
Considering the policies of the government and the Federal Reserve, they have been quite ethically questionable. They have twisted the facts and misrepresented the current inflation rate. They have created money out of thin air and pinned the consequential inflation and deficit onto the United States Citizens. They have ignored the Constitution and forced an illegitimate currency onto the United States. All of it has been in the interest of the government and the Federal Reserve and completely unfair to the American people.
Arguments Supporting Current Policies
Inflation-Stimulation Argument
Many support the actions of the Federal Reserve and congress. They claim that monetizing the debt and inflation are necessary to stimulate the economy. Citing the Great Depression, many argue that the deflation that followed the stock market crash prolonged the depression and discouraged growth. They point out that if there had been inflation, the recovery could have been much quicker. They also argue that the economic policies enacted in the past few years have put the United States on the road to recovery. These supporters are quite misinformed. First of all, the Federal Reserve was largely responsible for the Great Depression in the first place. As pointed out earlier, printing the money and then pulling it back is greatly attributed to the stock market crash that started the whole thing.
As for inflation helping the recovery, Benjamin Graham, one of the most revered financial experts of all time, points out that there is no direct correlation between inflation and economic growth. His charts, if anything, indicate that economic growth, as reflected by the Dow Jones Industrial Average, was slowed in historical periods of high deflation and high inflation (Graham and Zweig 65). This then indicates that high inflation would’ve left the economy no better than high deflation did. The economy of the 1930’s depression would have been no better with the policies of today, and these policies don’t fare well today either.
After nearly two trillion dollars spent on the economy, inflation currently is at ten percent and nearing the record highs of the 1970’s. Unemployment still lingers near its twenty-six year high. Investors have flocked to gold in fear of inflation and a failing dollar, skyrocketing gold’s price to more than double what it was prior to the recession (Kirklindstrom). The Dow Jones Industrial Average is faltering and still $3,000 short of its pre-recession high of $14,000. It now sits at a mere $11,000 (Yahoo Corp). It needs a twenty-one percent increase to reach its previous level, and the Dow averages only 10.5 percent a year (Kelly 103). This leaves a solid two years until it reaches its prior economic condition, and that’s assuming an average economy. Now facing even higher inflation and the possibility of a second recession, it’s safe to say the economy is not improving. And even if it does improve in the short term, it is entirely based on money that has been borrowed — money that has to be paid back. Once the debt gets to a point that the government can no longer function, there will be no praise of these policies that led there, and the US government will be left in a situation similar to Greece’s recent and damaging economic crisis. The policies of monetizing the debt would not have worked in the past, and they are not working now.
Inflation-Deflation Argument
Another argument supporting the policies of the Federal Reserve and congress is that printing money doesn’t even cause inflation. They argue that the Federal Reserve knows what they are doing, and that an increase in the monetary base doesn’t necessarily mean inflation. They point out that the Federal Reserve pulls the money back in to prevent just that. However, the United States has never seen such a large increase in the monetary base before. Surely whatever action the Federal Reserve takes will have a drastic effect on the economy. If the money is withdrawn from the economy, then it faces deflation similar to the situation during the Great Depression. If the money is left in the system, the increased liquidity causes inflation. As of now, the latter is the route taken, and the United States inflation rate has skyrocketed. So while printing money doesn’t necessarily cause inflation, it can’t be argued that such a drastic action won’t have negative effects. All of these conclusions point to the fact that the Federal Reserve shouldn’t have been so heavy-handed in their involvement in the first place.
Conclusion
The Federal Reserve has proven itself to be ineffective, and its actions along with those of congress, have reduced the dollar by 96% of its value since its creation (Shadowstats). They have twisted facts to hide inflation and refuse to be audited. Congress recklessly borrows money and pins the consequences on American taxpayers, profiting from the resulting inflation. They destroy the wealth of the nation by neglecting inflation, and borrow money out of thin air. The extreme monetary policy of the United States is not working and needs to be stopped immediately or things will get far worse.
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