We have been told over and over again that the Fed's monetary policy of Quantitative Easing (QE) is inflationary; that it's responsible for creating artificially higher stock prices; and that it keeps interest rates low and stimulates the economy.
It was the fear of an artificial boom accompanied by hyper-inflation that was one of the main factors behind the move to the $1900 dollar level in Gold during 2011. Since then gold has fallen back as it became apparent that there was no artificial inflationary boom in the making.
All of the above has been proven just plain wrong. Take inflation: no major nation has an inflationary problem today. But plenty have a deflationary problem. Who would have thought five years ago that after all the money printing that has gone on around the world disinflation would be the worry, not inflation.
If the Fed accomplished anything with QE they may have been able to prevent deflation, something that Japan was unsuccessful at for decades. Almost everybody now agrees that the huge increase in bond buying was not hyper-inflationary -- it was neutral at best.
But let's move on to the charge that the Fed's bond buying led to the stock market rally we've been experiencing since QE began. If so, why has the market continued to rally even though not one new dollar has been created by the Fed through quantitative easing? QE has ended, yet the market has increased as it always has. Logic dictates that if QE was responsible for the market rally, certainly the end of QE would lead to the rally's end. It has not.
Perhaps another reason is responsible for the stock market rally. Perhaps it is earnings. The market tracks company earnings and always has over time. After all, we had an almost non-stop stock market rally from 1982 to 2007 and there was no QE. Again, at best the Fed's monetary policy was neutral when it comes to stimulating the stock market, but certainly not the cause of it.
The same is true of the notion that it was the Fed that caused low interest rates. QE has ended yet interest rates are about as low as they have ever been. Why aren't they soaring if the Fed is not supplying money into the bond market to keep them artificially low? For the same reason that Germany's interest rates are not soaring. Germany's interest rates are less than half what ours are with no QE. It’s not an increase in bond buying by central banks that create low interest rates. It’s the market. Interest rates are at historic lows throughout the world because of low growth, low inflation, and low demand for money. That is what determines the level of interest rates, not central bankers.
Again, here in America, from 1982 to the present, interest rates have fallen to lower and lower levels year after year as inflation fell from 14% to 1%. The Fed had nothing to do with low interest rates, and that's the reason why the low interest rate policy never stimulated the economy. Interest rates are an effect, not a cause. Interest rates rose to 21% when inflation rose to 14% in the 70's and fell to 2-3% when inflation rates fell to 1%.
That brings us to the last myth, that the Fed can stimulate the economy with QE. The Fed is mandated to create maximum growth and high employment. They along with every other central bank have failed to fulfill that charge. And no central bank has been able to bring down unemployment to normal levels. If they could we would and we would have prosperity and full employment throughout the world.
It can be claimed that through the Fed's actions, the US has a more vigorous economy, lowered unemployment, and prevented deflation, something that others have not been able to achieve. And this is true; but relative to other countries in today's world. Relative to US economic history, this is the worst recovery since the Great Depression. Employment has not grown in six years even though the unemployment rate has fallen. Today, approximately the same number of jobs exists as when Barack Obama took office. In January of 2008 the figure was 146,595,000 employed, and in September of 2014, employment was 146,600,000.
This is not to imply that the Fed has not acted constructively. It prevented us from falling into another Great Depression and has so far prevented a deflationary implosion, such as the one that occurred in 1929 that led to the closing of all American banks and a devaluation of the dollar by more than 40%. The Fed is by no means impotent, but its policy of quantitative easing was, and that's why it had to end. The question now is, what should replace it…if anything?
The erroneous theory that central banks have the power to create prosperity and higher employment is one of the reasons that QE failed. It was doomed from the beginning. Just because Congress charges the Federal Reserve Bank to do something doesn't mean they can. The two things the Fed have proven it can do are, they can be a bank of last resort, providing emergency liquidity in the form of bridge loans to systemically significant institutions; and they can cause inflation and deflation.
So the mandate of the Fed should be changed to what they can do rather than to what they have never done. The Fed's mandate should be to be a bank of last resort and to keep the price level stable. Period. The biggest problem today is that the Eurozone, Japan, China, and most other central banks are following the lead of the Fed, not in what it succeeded at, but what it failed at. They are embarking on QE and lowering interest rates which are already historically low without their help. Low interest rates obviously have not increased demand, velocity of money, or created jobs or prosperity.
If one wants to accomplish these conditions, central banks need only to keep the money supply growing at a reasonable rate. For the rest, it is up to central governments to allow greater freedom – and that will lead to increased productivity, which will lead to prosperity, which will lead to increased employment and to higher wages and an increased standard of living for all.
This is not opinion, this is historical fact.
This is why central bankers’ powers are limited. They cannot do what politicians can do, which is free people from the stranglehold of government regulations, taxes, and dictates that prevent individuals from producing. It is ironic that after governments throw up every barrier they can get away with to producing and prospering, they complain about the lack of employment and GDP growth.
Regardless of ones views on monetary policy and political philosophy, surely we can all agree that central bankers have been struggling since the financial crisis throughout the world to stave off deflation, recession, debt crises, and unacceptably high unemployment. The least central bankers should have learned by now is the wisdom of Albert Einstein’s definition of insanity, which is “doing the same thing over and over again and expecting different results”.
Buying bonds to lower interest rates in an attempt to create prosperity, lower unemployment, and fight deflation fits that definition perfectly. And yet, Europe is moving head long into QE regardless of its dubious results.
The one thing for sure is with the initiation of QE by Japan and Europe we see the persistent fall of the Japanese yen and the euro. The big question then is: will governments destroy their currencies in an attempt to save their economies? Perhaps the answer lies in the move of more and more governments wanting to take physical possession of their gold held by the US.
Germany, Switzerland, and France -- all historically hard money nations -- are moving in that direction. Evidently there's a serious doubt in somebody's mind.