The World’s Greatest Economic Experiment?
Or More of the Same?

Some people call the U.S. Fed’s monetary policies in recent years “the world’s greatest economic experiment.” But an experiment is usually a course of action the results of which are not known in advance. This is not the case with the Fed’s maneuvers. The Fed has 1) printed more money (QE), 2) purchased financial instruments from the federal government, and 3) lowered interest rates, to name but a few familiar moves in recent times.

We have seen all of these policies in the past and can state with certainty what their outcomes will be. The only thing we don’t know is when the outcomes will occur. 

  1. QE is another way of saying inflation of the money supply, which ultimately leads to price inflation. The only thing delaying this from being more noticeable is the fact that the world is using the U.S. dollar as a reserve currency and for the purchase of goods…primarily oil. Thus, the demand for U.S. dollars is far greater than it is for any other currency. It is also difficult to estimate how far the Fed can go with its QE before the world has enough dollars and says, “No more.” Cracks in that dam are already showing, however, with Russia and China looking for ways around using the U.S. dollar when selling or buying goods to/from other countries. If/when they are successful at weaning the world off U.S. dollars, the demand for dollars will drop, and so will the dollar’s purchasing power. Imagine what it would be like if the U.S. were on parity with the rest of the world!
  2. Purchasing government debt encourages the federal government to borrow and spend more money. As far as I can tell, the only U.S. Senator with enough gumption to criticize the expansion of government debt and allow the government to shut down for a few hours is Rand Paul. Nevertheless, the budget bill was passed and is projected to add hundreds of billions of dollars to the budget deficit. While this amount may not seem like much, one never knows where the tipping point is and which dollar will start the avalanche that leads to the destruction of the dollar.
  3. Low interest rates, of course, punish savers, thus reducing savings and capital investment. Without capital investment, standards of living decline and people must borrow money or speculate in an attempt to maintain their standards of living. In short, without a market rate of return on their savings, they turn to riskier, more speculative investments. More often than not, this leads to a misallocation of resources and, in the long run, a loss of capital. Nothing experimental there.

Currently, the Fed is on a mission to raise interest rates. As rates rise, the upward pressure on prices may decline as the cost of borrowing rises. If a recession follows, the Fed will have either raised rates too quickly (too quickly for people who didn’t anticipate the rise) or too far (as it has done in the past). No experiment there.

As the incipient recession becomes obvious to all (including the Fed), the Fed will reverse its policies and print more money, purchase more government debt (and private debt, as other central banks do), and lower interest rates once again in an attempt to buoy the stock market and raise prices. Sound familiar?

No, this is not an experiment. This is the same old routine that the Fed and other central banks have been pursuing for years. The remaining question, which I have been hearing all my life, is: Will the Fed lose control on the upside (inflation) or the downside (deflation)? The level of debt suggests that it could be lost to the downside in the short run, and then, when the Fed reacts to the deflation, to the upside thereafter. We’ll see.

Robert F. Sennholz

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