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by Shawn Ritenour

Defenders of the Federal Reserve have been out in force recently declaring the triumph of Money Printing 2, James Grant’s suggested more truthful term for “quantitative easing.” Some pundits point to an 18-percent increase in the S&P 500 since last August, when the Fed’s policy was announced. They also laud a significant increase in inflation expectations. Nominal GDP is on the rise again and official unemployment is lower. All of these are seen as positive economic signs, indicating that Fed policy is working. Don’t believe it.


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Behind the talk is the notion that monetary spending makes the economic world go round. It does not. Increasing money supply does not magically increase the quantity of land, labor, or capital goods available for production. Creating money out of thin air does not produce more consumer goods, and there is the rub. We cannot eat money. We cannot wear money. We cannot live in money. Even the Beatles knew that money can’t buy you love.

Increasing the money stock can, however, result in higher overall prices for goods, including shares of equity stock. It should not surprise us that when the Fed increases money supply, stock prices rapidly increase. As it drives interest rates down, the Fed encourages investors to put their money anywhere they can get a better than average return. If this be in stock investments, so be it.

The trouble is that such inflation-fueled spending does not result in true economic prosperity in the form of more goods to satisfy our ends. It might encourage more spending, but not investment that reflects the wishes of society. Investors are encouraged to invest in industries that are too capital intensive relative to the wishes of savers in society. Such malinvestment fuels investment bubbles. The Federal Reserve inflated the M2 money supply by 48 percent from February 2001 through September 2008, and what does it have to show for itself? The worst economic debacle since the Great Depression. Monetary inflation via credit expansion generated malinvestment in the housing market as well as in the financial derivatives market. Distortions in investment and consumption took place until, due to shrinking capital stock being stretched in too many directions, the commercial paper market found itself “in difficulty;” interest rates began to increase and entrepreneurs were forced to begin liquidating investments that seemed good during easy credit, but were revealed to be unprofitable by real economic conditions.

Regarding current macroeconomic statistics, no one is disputing the facts, but the happy interpretation leaves much to be desired. In the first place, while official unemployment has fallen a little over 1 percent from its height of 10.1 percent during the Great Recession, if the Fed’s expansive monetary policy is really that wise, one might think the unemployment rate should be much lower. In fact, much of the drop in the unemployment rate is related to a drop in the civilian labor force relative to its December 2007 level. A low official unemployment rate is not per se an indication of a flourishing economy. In May 2007, the unemployment rate was 4.4 percent. Was the economy strong? No.

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