I hate writing this post, because Laurence Kotlikoff is a highly respected economist who has done important work on the long run fiscal liabilities of the government. And after reading this, those of you who don’t know him will (wrongly) think he’s a crackpot. But he wrote this for Forbes, and it calls for a reply:
In his parting act, Federal Reserve Chairman Ben Bernanke has decided to continue printing some $85 billion per month (6 percent of GDP per year) and spend those dollars on government bonds and, in the process, keep interest rates low, stimulate investment, and reduce unemployment.
Trouble is, interest rates have generally been rising, investment remains very low, and unemployment remains very high.
Bernanke’s dangerous policy hasn’t worked and should be ended. Since 2007 the Fed has increased the economy’s basic supply of money (the monetary base) by a factor of four! That’s enough to sustain, over a relatively short period of time, a four-fold increase in prices. Having prices rise that much over even three years would spell hyperinflation.
And while Bernanke says this is all to keep down interest rates, there is a darker subtext here. When the Treasury prints bonds and sells them to the public for cash and the Fed prints cash and uses it to buy the newly printed bonds back from the public, the Treasury ends up with the extra cash, the public ends up with the same cash it had initially, and the Fed ends up with the new bonds.
Yes, the Treasury pays interest and principal to the Fed on the bonds, but the Fed hands that interest and principal back to the Treasury as profits earned by a government corporation, namely the Fed. So, the outcome of this shell game is no different from having the Treasury simply print money and spend it as it likes.
The fact that the Fed and Treasury dance this financial pas de deux shows how much they want to keep the public in the dark about what they are doing. And what they are doing, these days, is printing, out of thin air, 29 cents of every $1 being spent by the federal government.
The “interest rates have generally been rising” comment is a bit misleading, as the 10 year bond yield is still very low, and part of the increase was expectations that the QE policy would be discontinued.
Much more importantly, he’s flat out wrong when he said that the Fed is printing money to finance the budget deficit. That is simply not true. He is implicitly assuming that the monetary base is “high-powered money.” That was true before 2008, but is no longer true. The Fed is merely exchanging interest-bearing reserves, which are liability of the federal government, for Treasury securities, which are different liability of the federal government. The Fed is not monetizing the debt.
I have heard one financial guru after another discuss Quantitative Easing and its impact on interest rates and the stock market, but I’ve heard no one make clear that close to 30 percent of federal spending is now being financed via the printing press.
That’s an unsustainable practice. It will come to an end once Wall Street starts to understand exactly how much money is being printed and that it’s not being printed simply to stimulate the economy, but rather to pay for the spending of a government that is completely broke “” with long-term expenditures obligations that exceed its long-term tax revenues by $205 trillion!
This is an outrageous claim, the sort of thing you’d normally see at crackpot websites on the internet. The idea that Ben Bernanke (a moderate Republican) is printing money to bail out the federal government is insulting and absurd.
When Wall Street wises up to our true fiscal condition (and, some, like Bill Gross already have), it will dump long-term bonds like hot potatoes. This will lead interest rates to jump and make people and banks very reluctant to hold money earning no return. In trying to swap their money for goods and services, the public will drive up prices.
As I often say, when the markets tell you that your theory is wrong, believe the markets, don’t believe your theory.
His post is entitled “Is hyperinflation just around the corner?” The answer is no. Two percent inflation is just around the corner, and the corner after that, and the corner after that …
That’s if were lucky, if were unlucky we’ll get 1% inflation.
HT: Macus Nunes