Sunday, 27 January 2013

How Fed Policy Destroys Wealth Creation

In a recent article by Dr. Frank Shostak titled "Fed’s policies expose mainstream fallacies" the author sums up eloquently some of the real and damaging effects of Fed policy and money printing,
So why has the massive monetary pumping by the Fed and the near zero federal funds rate failed to strongly revive economic activity and exert visible upward pressure on the prices of goods and services?
Is the comment by Benjamin Friedman that money is not relevant now valid? We would suggest that the fact that massive pumping by the Fed has failed to produce results along the line of mainstream models doesn’t indicate that money supply is not important any longer in understanding what is going on.
The fact that economic activity is currently not responding to massive monetary pumping as in the past is indicative that prolonged reckless monetary policies have severely damaged the economy’s ability to generate real wealth. Contrary to Friedman, we maintain that money very much matters. Contrary to mainstream thinking, an increase in money supply doesn’t grow but rather destroys the economy.
The ongoing monetary pumping coupled with an ongoing falsification of the interest rate structure has caused a severe misallocation of scarce real capital. On account of reckless monetary policies, a non-wealth generating structure of production was created – obviously then, on account of the diminishing ability to generate real wealth, it is not possible to support (i.e. fund) strong economic activity.
Remember that monetary pumping is always bad news for the economy since it diverts real funding from wealth generating activities to wealth consuming activities. It sets in motion an exchange of nothing for something.
As long as the economy’s ability to generate wealth is still there the reckless monetary policies of the central bank can be absorbed. Loose monetary policies can create the false impression that they are the key drivers of economic growth.
However, once wealth generating activities as a percentage of total activities falls below the 50 percent line the reality takes over and general economic activity has to fall.
In response to the weakening in the wealth generating process various non-wealth generating activities that were supported by wealth generators are coming under pressure. To stave off bankruptcy they are forced to lower the prices of goods and services that they produce (the goods they produce are very low on consumers’ preference scales).
We know now that such central bank "policies" do not work, rather to the contrary, it makes it worse. Look no further than to the U.S. and euro area. But this is nothing new and mainstream 101 economic books wrote about the quantity theory of money and how increases in money supply is no substitute for the real economy and how money printing itself do not create wealth pre the "financial crisis" of 2008. And moral hazard is certainly nothing new in the economics sphere.

Maybe they do really believe at the Fed that their "unconventional monetary policies" can actually help the real economy. Another plausible reason is that they are simply bailing out their banks (remember the Federal Reserve System is a banking cartel - protecting their banks must therefore be priority 1, the economy comes 2nd), backed by the U.S. tax payers and that their actions have actually nothing with "policy" at all. If you believe central bankers are really unintelligent and that the "lost decades" in Japan have gone unnoticed in the grand halls at the Fed, you should probably pick the former as the correct answer.

One thing is for sure though, many main stream economists have not done their homework and should be permanently banned from teaching at universities. Professor Ronald Coase was definetely on to something in his "Saving Economics from the Economists" article in the HBR.

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