Ben and I are stranded on an island, Robinson Crusoe-like and I, on my east side of the island, have been planting yams, collecting coconuts, and doing a little fishing. Ben decides to hunt on his west side and offers to trade a boar hindquarter for some yams. We negotiate and make a deal: 20 yams for one ham. That goes on for a while and then Ben tells me that he needs the yams but haven’t caught any boar lately and he gives me an IOU for the 20 yams. Good old Ben has been reliably providing me with ham. It works OK for a while until Ben realizes that all he has to do is give me IOUs to get my yams. He decides to stop hunting because … well, IOUs are easier. Soon, I’ve got a lot of IOUs (I’m a gullible fellow) but no ham. My yam supply is now dangerously low. I wake up one night and it occurs to me that these IOUs are just pieces of paper that are false promises for future hams and they are worthless because Ben isn’t going to hunt. I’ve got a claim on nothing. I feel like picking up a sharp pointed stick and …
This is called quantitative easing when you take it to a modern extreme.
Of course the creation of money today is a bit more complex than our Crusoe fantasy, but the principle is the same. More currency will not do anything positive, although it may seem so for a short period. Which is exactly what has happened in the U.S. with quantitative easing v1.0 and 2.0. At each attempt to stimulate the economy we see a brief rise and then the economy slips backwards and continues to stagnate. The stimulus effect has become weaker at each wave. It’s easy to see why $2.2 trillion of new money pumped into the economy would cause GDP to increase because GDP measures spending in dollar terms. It doesn’t necessarily mean it causes real economic growth, and, as history has shown us, it hasn’t worked here or anywhere for that matter. It actually contributes to slower growth or recession because it destroys capital.
In the mythology of the economic beliefs of central bankers, new money hits the economy at some uniform rate so that everyone benefits. They think everyone will spend more and thus revive production. It doesn’t work that way. When QE1 and 2 were implemented the new money went to bankers who sold Treasury bonds to the Fed. They then invested it through loans to their favorite customers and those chaps would be the financial community who borrowed cheap dollars to invest in stocks and other financial products. As well, the banks themselves did the same thing. As a result our financial markets spurted. Lending to large and small businesses was subdued. So who benefited? Could it be Wall Street?
There are other reasons for our economic morass as well: ZIRP ( a sub-branch of monetary easing), government spending (federal, state, and local) equal to 43% of GDP; high taxes, uncertain regulatory climate (regime uncertainty), regulatory controls, looming cost of Obamacare, government programs to thwart real estate deleveraging, and other things. But the prime driver behind economic stagnation and, now, declining economic growth, is the Fed.
From the U.S. to the Eurozone to China, central bankers believe that “printing” money will revive their sagging economies. It won’t.