Quantitive Pain

Ben Bernanke out, Janet Yellen in. But, don’t worry, the same failed fiscal policy will continue chugging along.

For those playing catchup, since 2008 the Fed has been using a practice called “Quantitative Easing” or QE. Since the interest rates have already been at or near 0%, it’s the Fed’s way of inflating the money supply. The theory goes that by buying financial assets, businesses will have access to easy credit and easy cash, then they’ll open factories, hire employees, and that will get the economy going again.

As it happens, there are two big problems with this plan: the capital is straight out of Wonderland, and everyone knows it.

When the Federal Reserve prints cash to buy assets, business hasn’t improved, there’s no extra demand needing to fill, and there’s no reliable projection to indicate it’s going to get better anytime soon. No decent businessperson is going to expand operations today, knowing they won’t have the magic money tomorrow. In other words, no one is going to take on additional liabilities without confidence they’ll have the revenue to cover them tomorrow.

Much to the contrary, it’s a very dangerous fiscal policy to follow, and one we’re all to familiar with.

When we throw good money after bad, we create an artificially large market: or, a bubble.The problem with bubbles is that they cannot be sustained forever. Already the Fed owns over $2 trillion worth of bonds and other financial assets under QE, but the Fed cannot continue to buy tens of billions of dollars worth of assets every month. The money runs out, and the bubble bursts.

Instead of the markets returning to their natural levels, investors will attempt to avoid losses and pull their cash out as well. The market contracts below its natural growth and the economy contracts. In other words, we go into recession.

This isn’t some big secret. Investors have been paying close attention to the Fed in the hopes of pulling out their cash before the QE fountain runs dry. Companies know it as well, and have been reluctant to grow, knowing the contraction which will eventually follow.

Instead of growing the economy, the Fed’s policy creates a bubble in financial markets which is not reflected in economic growth. Instead of investors being able to judge profits and growth based on customer demand, they play a game of beat-the-Fed, and businesses grow slower than they otherwise would.

Contrary to growing the economy, Quantitative Easing only slows recovery.

If you doubt it, just ask yourself why the Stock Market has hit record highs in 2013, yet unemployment remains at 7.3% and labor participation remains at a 35 year low.

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