The Debt Dilemma Is Only a Symptom of the Real Problem

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Rep. Ron Paul (R-Texas)

Why do politicians believe they can finance anything they may choose to, welfare, war, or whatever may come to mind, regardless of the cost? The availability of easy money created out of thin air is just too tempting, and the power associated with the ability to create money this way is also too tempting, for those in power to resist for long. Thus we have the Federal Reserve masterminding all sorts of crony-benefiting bailouts, highly secret deals with foreign central banks, and deluding the public (and themselves?) that they are providing a valuable service to the public, when in fact they are mainly protecting powerful banks, corporations, and politicians.

Therefore, we experience constant inflation, prolonged booms and busts, and illusions of prosperity, resulting in bad investments, minimal savings, and the transfer of wealth from the poor and middle classes to the wealthy. Ron Paul’s excellent book End the Fed [1] describes and documents these phenomena plainly and convincingly. As Paul points out, there is a growing movement to transition away from the Federal Reserve and their power to create money and control interest rates.

A degree of secrecy far more than found in any government agency prevails at the Fed, and no one breaks their barrier or forces any transparency. Congress has the authority to control the Fed, but up to now, little will to do so. There are several aspects which Ron Paul and others have noted about the disadvantages and dangers of the Fed, showing that their (the Fed's) work creates tremendous danger to the country. The Fed was the main factor in causing the Great Depression, which the Federal Government wasted no time in prolonging and deepening through bad, and often ridiculous, economic policies. The Fed is also the main culprit behind today’s economic crisis, which is being made far worse by the economic policies of the Obama Administration.

Austrian School economists predicted the housing bust and described the dangers of the Fed’s actions:

As adherents to Austrian economics know, the Federal Reserve-induced economic boom must turn to bust. People who have lived high, yet have truly earned nothing, will not fare well in the coming bust. Such cash-strapped and indebted families will head toward financial collapse and thus will turn to the state for welfare and credit relief. As to welfare, parent and child become virtual wards of the state….

The loan markets are profoundly distorted due to the nature of fiat money machinations. Because of this intervention, lending is now dramatically different. It is no longer necessary to know your borrowers. The bank – sustained by its cat-and-mouse scheme of fractional-reserve banking — has a huge incentive to fund the loan, and then sell the loan off to intermediaries who package the loans into mortgage-backed securities. In turn, this toxic junk is sold to mutual funds, insurance companies and other institutions starved for yield. The debt-o-rama grabs hold, and as for the borrowers, there is no longer a fear of debt….

Is it possible that the two-thousandaire is merely a precursor to the "new man" (a pliant, unthinking being) Mao and Lenin attempted to socially engineer via central planning? It would seem that the communists had it backwards thinking that banning money was integral to transforming mankind. For it certainly appears that easy money and credit do the trick in eroding the human spirit, morality, and basic decency, along with intellectual and financial independence. [2]

Constant Inflation

The monetarists argue that a top-down central bank guarantees monetary stability. Well, sure if your definition of stability is a grinding erosion of value through incessant inflation: today's dollar is worth $0.19 in 1971 dollars (the year the United States officially dropped any pretense of abiding by a gold standard) and worth only a nickel in 1913 dollars (the year the Federal Reserve was voted into existence). [3]

Moral Hazard
As has frequently been pointed out, numerous large bailouts have brought attention to moral hazard, that is, knowing that if a bank or company is considered “too big to fail,” it will be bailed out if it gets into trouble; therefore their management will likely be less cautious and willing to take more risks than would otherwise be the case. The other moral hazard, or more properly, moral failure, is that a monopoly on money, along with the unlimited power to create it at will, must lead to abuse and serious economic trouble and finally, collapse.

Political Connections
While the Fed is often thought of as non-political, it has usually tried to help the incumbent president politically. Ben Bernanke risked criticism by supporting (concocting?) President Barack Obama’s (and Treasury Secretary Timothy Geithner’s) politically unpopular auto bailouts and the Bush TARP bailouts which Obama also supported.

Tom Dilorenzo gives another example in this paragraph from a 2000 article:

As long as [President Bill] Clinton was fearful of impeachment, [Fed Chairman Alan] Greenspan kept the monetary spigots wide open, even while voicing "concern" about an "irrationally exuberant" economy. With Clinton out of the woods and the presidential race in full swing, Greenspan is attempting to reverse the irreversible economic forces that he set in motion over the past two and a half years. [4]

There is no easy answer to the current crisis. Even after something passes and everyone breathes a sigh of relief, we will still have this enormous debt and the longer-term problem unsolved. The conservative consensus, which I have supported, is that the Republicans must avoid caving to the Democrats in this situation, which, I think, could be politically damaging to the GOP. But if politics would allow it, Ron Paul offers, perhaps, the best approach, and that involves not paying the debt of the U.S. to the Fed (via Tulsa Change):



Over the years, the Fed has forestalled quick recoveries by preventing the corrections from taking place at times when the least amount of damage could have been sustained. Eliminating the Fed would put a lot of currency and economic troubles behind us, and ultimately lead to increased personal liberty and national prosperity.


[1] Ron Paul, End the Fed, New York: Grand Central Publishing, 2009. This is important reading for anyone interested in the U.S. economy and the Federal Reserve. I highly recommend it.

[2] Karen De Coster and Eric Englund, “Will the Federal Reserve Create the New Socialist Man?” 06/26/2006, Mises.org.


[3] Stephen Mauzy, “Don’t Blame the Federal Reserve,” 12/15/2009, Mises.org.


[4] Tom Dilorenzo, “The Federal Reserve and Political Corruption,” May 2000, Mises.org.

Related articles

• The Morality of Gold (lewrockwell.com)
• Debt Ceiling Debate Bolsters Ron Paul and the Gold Standard (usnews.com)
• Ron Paul: Default Now, Or Suffer A More Expensive Crisis Later. Start by canceling out the debt held by the Federal Reserve. (politicalmetals.com)

QE2: Bubble, Bubble, Toil and Trouble

Image via WikipediaWhat is QE2 and what is the Federal Reserve trying to accomplish?
The Fed decided to embark on a $600 billion plan to buy Treasury securities in order to balance out economic components to better fulfill their mandate for price stability and full employment.
Ben Bernanke’s statement:

“Measures of underlying inflation are currently at levels somewhat below those the [Federal Open Market] Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate …
“The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.” [1]

What happened with QE1?
Mike Larson at FXStreet.com writes,

[In the housing and mortgage arena], [t]he Fed bought $175 billion in debt sold by Fannie Mae and Freddie Mac. It also bought $300 billion in U.S. Treasuries, and $1.25 TRILLION in mortgage backed securities — bonds made up of bundles of home loans. [2]

Larson notes that key housing indicators such as housing starts, sales of existing homes, etc. demonstrate the failure of the QE1 effort to help the economy. [3]
Another writer sees the effort as likely to fail:

Mr. Bernanke is making the same blunder that we made with the past bubbles busts – if we can create paper profits and convince consumers that they should spend those paper profits then we’ll be on our way to economic prosperity. The problems arise when asset prices readjust lower to meet their true fundamentals. It’s ponzi finance and nothing more.
As I have previously explained, the goal of QE is to increase aggregate demand by creating a fictitious wealth effect and by increasing bank loans. [4]

Fed Independence in Danger? Or Fed Independence Is a Danger?
The Federal Reserve’s massive involvement in the TARP bailouts and QE1 have led to criticism of the Fed for getting involved in fiscal (in addition to monetary) policy. Thus the Fed has been subjected to more than usual political criticism and calls for its abolishment, and a return to the gold standard.
When the Fed is arbitrarily inflating the money supply by trillions, there will eventually be much more inflation than they claim to want. Bernanke says QE2 is supposed to ramp up inflation a bit so as to balance out with increased employment, thus getting both the Fed’s mandates into line.

It is certain that the Fed has not succeeded in its full-employment mandate. There hasn’t been a great amount of inflation because much of the newly-created money has sat in banks’ Federal Reserve accounts drawing minimal interest because banks don’t see much demand for loans due to the Obama Administration’s promotion of threatening conditions, i.e. higher taxes, Obamacare, and general hostility toward business large and small.

Do We Know the Real Reason for This Project?
J. D. Foster at National Review Online thinks Bernanke is not forthcoming about his actual reasons for wanting this “stimulus,” because of possible political consequences, but apparently it is not wanted simply to stave off deflation:

… If the economy is expected to muddle through, let alone accelerate, then there is no reason to embark on a highly risky, highly controversial new round of quantitative easing [to prevent deflation].

Why won’t Bernanke be transparent in this? Because he also worries about the Fed’s independence. Imagine President Obama’s reaction if the chairman of the Federal Reserve were to point out the obvious truth that the economy dare not sustain a massive tax hike at this time. Or if he were to say that the prospect of such a tax hike is what forced the Fed’s hand on QE, despite the risks. Whatever Bernanke’s intentions, this would be interpreted as a blatantly partisan act by the non-partisan Fed. [5]

Turn Off the Bubble Machine!
According to some of the Fed’s critics, especially of the Austrian school, the central bank’s manipulation of the currency is what brings on the bubbles, booms, busts, and accumulating inflation that our economy experiences. They point out that the Fed was slow to recognize (publicly, anyway) the housing bubble, leading to a deep recession which Peter Schiff was ridiculed for correctly predicting.

Marvin Hutchinson of Money Morning sees the Fed’s move as creating a commodities bubble that must burst:

By encouraging higher inflation - a stance that was clear in the recent statement of the policymaking Federal Open Market Committee (FOMC) - Bernanke is creating a commodities bubble that is already showing signs of distorting the global market. By keeping interest rates below inflation for years at a time, he is discouraging U.S. saving and encouraging leverage.

That leads to the creation of massive bubbles - such as are currently appearing in the junk bond market, and occurred in dot-com bubble of 1997-2000 and the housing bubble of 2003-06.

In the long run, the losses from those bubbles bursting - combined with the low savings rates - will destroy the U.S. capital base. Once the United States no longer has more available capital than its competitors, it will have less and less ability to create good-paying jobs and preserve U.S. living standards. Thus, unemployment will increase and real wages will decline. [6]

A satirical article at The Onion was headlined, “Recession-Plagued Nation Demands New Bubble To Invest In.”
But we’ve had enough of the bubble-and-burst cycles.
World financial leaders oppose it.
Reuters reports:

Resentment abroad stems from worry that Fed pump-priming will hasten the U.S. dollar's slide and cause their currencies to shoot up in value, setting the stage for asset bubbles and making a future burst of inflation more likely.

“With all due respect, U.S. policy is clueless,” German Finance Minister Wolfgang Schaeuble told a conference.

“(The problem) is not a shortage of liquidity. It's not that the Americans haven't pumped enough liquidity into the market, and now to say let's pump more into the market is not going to solve their problems.” [7]

 Ambrose Evans-Pritchard at The Telegraph reports that the world views the Fed action as a move to devalue the dollar:

China's commerce ministry fired an irate broadside against Washington on Monday. "The continued and drastic US dollar depreciation recently has led countries including Japan, South Korea, and Thailand to intervene in the currency market, intensifying a 'currency war'. In the mid-term, the US dollar will continue to weaken and gaming between major currencies will escalate," it said. [8]

Further, Evans-Pritchard writes,

As this anti-dollar revolt gathers momentum worldwide, the US risks losing its "exorbitant privilege" of currency hegemony – to use the term of Charles de Gaulle. [9]

Evans-Pritchard expects the Fed’s policy to bring more food inflation to countries that can least afford it:

The innocent bystanders caught in the crossfire of Fed policy are poor countries such as India, where primary goods make up 60pc of the price index and food inflation is now running at 14pc. It is hard to gauge the impact of a falling dollar on commodities, but the pattern in mid-2008 was that it led to oil, metal, and grain price rises with multiple leverage. The core victims were the poorest food-importing countries in Africa and South Asia. Tell them that QE2 brings good news. [10]

Conclusion
The Fed’s decision to implement QE2 will lead to inflation, reducing the value of the dollar, and aggravate currency relationships with other countries. This will contribute to weakened purchasing power for Americans, who already are cheated of the ability to gain from saving, and will contribute little to nothing to economic recovery. It will do nothing to increase demand in America or elsewhere.

Loosening money and credit even more won’t help when interest rates are near zero already, and banks are lacking customers who want to borrow. QE2 exacerbates the problem by introducing more risk and uncertainly into the markets. It’s been correctly characterized as a back-door tax increase.

Also, the Fed subjects itself to even more scrutiny and criticism, and risks the independence it so wants to protect. Both the dollar and the economy would benefit greatly from less manipulation and “help” from the government and the Fed.

[1] Mike Larson, “Fed confirms: QE2 on tap … despite dismal failure of QE1! Have these guys gone nuts??” 09/24/2010, FXStreet.com.

[2] and [3] Ibid.

[4] Pragmatic Capitalism, “Northern Trust: QE1 Failed, Why Will QE2 Work?” 10/10/2010.

[5] J.D. Foster, “Why Bernanke’s QE Justifications Don’t Wash,” 11/15/2010, The Corner, National Review Online.

[6] Marvin Hutchinson, “As QE2 Looms, Is the Fed Focusing on the Wrong Things?” 10/08/2010, Money Morning. (Emphasis added)

[7] Glenn Somerville and Zhou Xin, “Global anger swells at Fed Actions.” 11/05/2010, Reuters, via Yahoo! News.

[8] Ambrose Evans-Pritchard, “QE2 risks currency wars and the end of dollar hegemony,” 11/18/2010, The Telegraph (U.K.).

[9] and [10] Ibid.

Photo: Portrait of Federal Reserve Chairman Ben Bernanke. Public domain.

Related articles

• "QE2: Last Rites for the World's "Reserve Currency"" and related posts (zerohedge.com)
• Republicans to Bernanke: QE2 is a Bad Idea (dailyfinance.com)
• House And Senate Republicans Attack Fed Over QE2 In Letter (businessinsider.com)