The Federal Reserve today voted in favor of capitalism by refusing to engage in a new round of “Quantitative Easing”; better known as trying to inflate the economy by printing paper money. This weekend, former Chairman Paul Volker wrote an Op Ed in the New York Times titled a “Little Inflation Can Be a Dangerous Thing” to telegraph around the world that the United States will now be pursuing monetary policy “in a context of price stability.” For capitalists; those six words mean that adults are back in charge of America’s financial future. For social welfarists; those six words mean it is time to panic!
Over the last three years the Federal Reserve has been called upon to facilitate massive efforts to re-inflate the U.S. economy to save the banks and bring back the credit driven consumption boom that died in the 2008 Credit Crisis. Through stimulus programs and money printing; the Obama Administration, Congress, and the Fed went all-out to somehow bring back the days of McMansions, conspicuous consumption, and full employment. After $5 trillion of government spending and $2 trillion of money printing; real estate prices are falling, consumer demand is stagnant, and 9% unemployment has become the “new normal”.
America’s social welfarists cheer-leader, Nobel Prize winner Paul Krugman, responded by ridiculing Volker in the Times as naïve with an attack Op Ed: “When Inflation Was Good”. Krugman blamed Volker for not understanding how the 78% inflation of WWII rescued America from the Great Depression. Krugman regularly dismisses the failure of massive government intervention to lower unemployment as due solely to cowardice on the part of politicians to make the program even larger.
Volker scoffs at Krugman’s call for “just a little inflation” to solve America’s problems. He understands the chorus for inflation starts out low and just ratchets up until the nation is in crisis:
The siren song is both alluring and predictable. Economic circumstances and the limitations on orthodox policies are indeed frustrating. After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations — as the Fed and most central banks believe — why not 3 or 4 or even more? Let’s try to get business to jump the gun and invest now in the expectation of higher prices later, and raise housing prices (presumably commodities and gold, too) and maybe wages will follow. If the dollar is weakened, that’s a good thing; it might even help close the trade deficit. And of course, as soon as the economy expands sufficiently, we will promptly return to price stability.
Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth.
After the Fed’s announcement that they will no longer offering up endless creative interventions to prop up the economy; the Dow Jones stock index fell 300 points. Until today; a whole generation of Wall Street traders believed they are entitled to the maximum benefits of American capitalist system; but would be bailed-out when they fail. As a warning of what was coming from the Fed; this morning Moody’s Investor Services cut their credit rating on Citicorp, Bank of America, and Wells Fargo. The firm gave as a basis for the cuts:
“During the crisis, the risk of contagion to the US and global financial system from a major bank failure was viewed as too great to allow such a failure to occur — a view borne out in the aftermath of the Lehman failure. This led the government to extend an unusual level of support to weakened financial institutions and Moody’s to incorporate the expectations of such support in its ratings. Now, having moved beyond the depths of the crisis, Moody’s believes there is an increased possibility that the government might allow a large financial institution to fail, taking the view that contagion could be limited.”
America’s financial engineering skills have been proliferated to the far corners of the earth. Banks worldwide have run up an incredible $700 trillion in derivatives market; ten times more than all the economies of the globe combined. When the 20008 Credit Crisis hit the Wall Street Banks told Congress if they were not bailed out the world would end. After the bailouts, those same banks made record profits and paid record bonuses.
By the Fed adopting a policy of “price stability”; when banks make really bad business decisions their shareholders will be wiped-out and their creditors may have to take haircuts. Welcome back to the wonderful world of capitalism; where winners are rewarded and losers pay a price.