The Monetary Policy Dilemma


There are times you just scratch your head at the sort of idiocy displayed in both the media and so-called “economists” who claim to be both formally trained and have reasonable intellect in their field.

This is one of them.

Federal Reserve Chair Janet Yellen and her colleagues have lowered their sights on how fast the economy needs to expand to meet their goal of cutting unemployment.

No longer are they saying growth must accelerate from the 2 percent to 2.5 percent pace it has generally averaged since the recession ended. Instead, they are stressing the importance of preventing the expansion from faltering.

The Fed caused the cessation of real growth in the economy through its QE policy.

Let me explain.

The basic economic equality is MV = PQ; that is, “Money”(ness) X Velocity (times each unit of “moneyness” is spent in a given amount of time) = Price (of each item or service produced) X Quantity (number of goods and/or services sold.)

This is a fact and nothing can change it.

Now here’s the problem — we state “PQ” (otherwise known as GDP) in units of “M”.

If you don’t understand the problem that QE presents (indeed, that any borrowing presents) with this you’re not very bright.

Short-term borrowing — that is, a loan that is quickly extinguished — doesn’t change “M”.  It time shifts a transaction but economically is otherwise a non-event from a monetary perspective.  If I borrow $100 from you to buy a night at the bar, get paid on Friday and give you back your $100 (with or without interest) I have simply changed the night at the bar’s economic event from Friday to Tuesday; further, the event Tuesday now cannot happen on Friday (as well) because the $100 has already been spent.

I have not changed whether it happens at all.

QE, however, is a permanent change in “M”.  It is intended to “make up” for private borrowing for which there is either no demand or no supply.  That is, in the market today there is insufficient incentive for private capital to be loaned either because the interest rate that can be earned doing so is unattractive for the risk inherent in the loan or there is nobody willing and able to borrow at the offered rate.

But since “QE” is not “paid back” and withdrawn it permanently changes the amount of “M” in the system.  Since GDP is stated in “M” to get an accurate account of GDP you must subtract back off any permanent change in “M” from GDP.

QE, on a rolling 12 month basis, is about $1 trillion.  The US Economy is about $17 trillion.  Therefore you must subtract the amount of QE added back out, which is about 5.9% of the total economy!

In other words with the current GDP “growth” of effectively zero (0.1%) the economy is in fact in deep recession as the actual “growth rate” is currently -5.8%.

This is caused by QE.

Now here’s the bad news.  By suppressing bond yields The Fed has taken a means of faking growth and embedded the cost of that into every portfolio that includes long-dated loans such as mortgages and Treasuries.  This cost will remain until those debt instruments mature or are prepaid, and there won’t be as many prepayments (in the private sector) as usual since the instruments were issued during a time of intentionally-suppressed rates.

That cost accrues because the discounted price of the instrument is higher than it would otherwise be, and the yield lower.  Whether that cost shows up in the form of capital depreciation or lower coupon doesn’t matter; it cannot be evaded.

In effect what The Fed has done is provide a temporary “goose” to economic activity totaling several trillion dollars over the last four yearsbut the price of that “goosing” has been distributed to, and embedded in, the portfolios of those who hold these instruments including the bonds held by Social Security and Medicare along with private pension concerns.

You didn’t hear “QE” described this way, probably because there would have been an immediate call to indict, prosecute and imprison the entire FOMC for fraudulently manipulating economic reports and statistics were it to have been accurately described but mathematically it is this way.

I’ve been pointing this out since the beginning of “QE” — but the fact is that nobody wants to talk about it in detail because as soon as you do you’re forced by nothing more-complicated than basic Algebra to admit that all of these machinations are nothing other than a scam intended tomislead both business people and the general public, willfully and intentionally engaged in by Congress, The President and The Fed all acting together.

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