Start with the basics of money. Money is not wealth, it is the measurement of wealth. All money does is value the exchange of goods and services—the productive economy—similar to any other basic unit of measurement in the International System of Units. This requires money to have an unchanging value—also the same as any other basic unit of measurement. Otherwise, it throws the measurement of the exchange of the production of goods and services into chaos. Since money—in reality—is a neutral arbiter of the value of all goods and services, money can’t create wealth or expand economic growth. It can only value it.
The idea that money is wealth is one of the more destructive economic fallacies: enshrined by the Fed, taught in every university economics curriculum, acted on as policy by elected officials, and broadcast as conventional wisdom by the financial media. The natural result of money is wealth fallacy is that economic power accrues to the Fed. Without a monetary standard, the Fed can tinker endlessly with its power to create money out of thin air and distort the dollar’s value, capital allocation, and markets.
What about the Fed saving the global economy after the 2008 financial crisis? After all, Time magazine anointed Bernanke Person of the Year in 2009 for his heroic money printing. Bernanke remains feted as a national hero—at least by the MSM who increasingly substitute as organs of the state—but the glow is fading quickly. We are now a decade into Bernanke’s QE money printing experiment and what has it achieved? There is record global debt, the hypertrophy of finance has subsumed productive growth, negative interest rates became standard, income inequality increased, trade wars built on exchange rate instability are the norm, and markets are crumbling at the first baby step to reverse the global central bank liquidity flood.
The Mercantilist Fed
While money can’t create wealth, it can distort markets. The stagflation, oil turmoil, bracket creep, unemployment, and decline in living standards during the 1970s was the result of money creation as a substitute for productive economic growth. Nixon ended the monetary standard when he terminated the Bretton Woods international monetary system linked to gold. The discipline of Bretton Woods, when properly managed, prevented excess money creation. Bretton Woods termination ended the dollar as a reliable standard of measure. Without the monetary discipline of gold, the Fed and policymakers turned to money creation as a perceived means of growth and wealth. This is a mercantilist view, prevalent in Great Britain from 1580 to 1750, that Adam Smith destroyed with the publication in 1776 of The Wealth of Nations. The history of economics is that bad economic ideas never die. They just wait their turn to recycle back into favor. Money as wealth is a bad idea that seduces by its simplicity. Money buys stuff, so more money will buy more stuff. The more stuff one has, the wealthier. Throughout history, nations, states, and empires continuously self-destruct by instituting the economic fallacy that money is wealth.
Bernanke’s QE money creation fine-tuned the 1970s monetary disaster. Congress passed the Emergency Economic Stabilization Act of 2008 that allowed the Fed to pay interest on reserves starting in 2009. The Fed could buy unlimited interest rate sensitive assets and drive the price of interest to the zero bound because a portion of the new money creation was held as excess reserves. Depository institutions, primarily big domestic and foreign banks, earned interest on their excess reserves account held with the Fed. This is free money for banks. If only we could all receive free money from the Fed. In essence, the Fed created money out of thin air then removed part of that money from the economy by paying interest on it. About half of the Fed’s money creation since 2008 has been held as excess reserves. Banks get free money, the Fed drives interest rates toward zero while expanding its interest-earning assets, i.e. balance sheet, and inflation is held in check. Zero interest rate credit incentivized corporations to buy back their stock and merge with their competitors rather than invest in the future. This results in rising share prices and diverts resources to stock-based compensation. Income inequality increases. Rather than allocate capital to the productive economy, banks find it more profitable to churn the monetary chaos through derivatives, interest rate, and foreign exchange trading. Missing is growth incentives for the productive economy. The productive fall behind with their zero interest rate savings accounts and lack of access to free capital.
Keynesian demand-side theory posits that artificially low interest rates will stimulate aggregate demand. Find a way to get more money into the pocket of consumers–filtering it through D.C. and redistributing it to constituents is the preferred Congressional method–and they will spend the economy into economic nirvana. At least, that’s the theory. For some reason, real growth always get waylaid on the way to Keynesian nirvana. Despite the monolithic control of demand-side economics, we all secretly know that it is producers who create growth and wealth. Spending other people’s money justifies perpetual government growth. Demand-side economics is the gift that keeps on giving to rapacious government.
We are approaching the 48-year mark of the Fed playing with its fiat dollar. Powell inherited the mess. Powell is just another functionary in the Bernanke, Yellen ivory-tower-divorced-from-productive-entrepreneurial-reality mode. He operates in the same cloistered, demand-side, errant econometric monetary model. Yet, like any Fed Chair, Powell creates monetary policy at the discretion of the President and his Treasury who have ultimate power over the Fed. Trump could sign an executive order today linking the dollar to gold at its current price, stabilizing the value of the dollar, and ending 47 years of dollar chaos. The funds rate hike imbroglio would become moot because the market would set the funds rate along with all other interest rates.
This is not as easy as it sounds because the Fed would have to unwind excess reserves completely and this would result in all sorts of market turmoil. The gold-dollar link would take the blame and probably could not withstand the political backlash. Returning to gold in the current global monetary environment would require real finesse. Needed with monetary reform is pro-growth fiscal policy to offset the deleterious effects of the global QE monetary expansion. This would include tax cuts on capital and income, reduced regulation, foreign policy reform of perpetual war, and a return to limited government.
As long as our current mercantilist, Keynesian, demand-side path continues, Bernanke’s QE monetary experiment is going to boomerang on markets. Funds rate hikes are not doing any good and the Fed should halt them, but they are not the structural problem inhibiting growth. They are a symptom of the errant economic model in which the Fed operates. Real monetary reform is beyond demand-side theory–that rose to prominence with misinterpretation of the cause of the Great Depression.
The economic structural problem begins with the ongoing manipulation of the value of the dollar in an errant attempt to create wealth. The longer this continues, the greater the structural problems, and the more difficult the solution. Economic history is a continuous cycle of attempts to create wealth through money expansion. The result is always the same. It ends in failure.