Fed Bankrupting Consumers While Enriching Wall Street as a Matter of Policy?

Majority of Wall Street dealers still expect Fed QE3 … Despite improved hiring last month, most Wall Street economists still expect the Federal Reserve to do more to stimulate growth this year, with the majority looking for action as soon as September. The median of forecasts from a Reuters poll of 17 primary dealers – the large financial institutions that do business directly with the Fed – showed a 63 percent chance the central bank will for the third time expand its balance sheet via large-scale bond purchases. If the Fed does act, 13 said they thought it would do so at its next policy meeting in September, up from eight in a July 6 Reuters poll of 16 dealers. There are 21 primary dealers. Friday’s poll was conducted after a government report showed employers added 163,000 new jobs. − Reuters

Dominant Social Theme: We are doing all we can to benefit the average consumer and job-holder.

Free-Market Analysis: Here is a question that needs answering: Why is the Fed giving away money freely to big professional investors that hold massive amounts of government bonds (“quantitative easing”) while starving small businesspeople and investors of loans?

In this article, we’ll try to provide an answer. Let’s re-examine the business cycle in order to set the stage for our analysis.

It is government that creates recessions and depressions to begin with via the overprinting of money. Over time, the booms grow stronger as more and more money is pumped into the economy. The busts likewise grow deeper. The current bust is among the deepest in recent memory.

Many paper-money pundits have advocated reinflation via Fed money printing. In fact, the New York TimesPaul Krugman wrote the following in 2002:

The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Read this statement carefully. Is there anything about it that strikes you as playful? Krugman quotes a top official with one of the largest bond complexes in the world to back up his statements. He doesn’t seem the least bit facetious to us. But nonetheless in 2009, Krugman felt compelled to offer the following explanation:

And I was on the grassy knoll, too … One of the funny aspects of being a somewhat, um, forceful writer is that I’m regularly accused of all sorts of villainy … The latest seems to be that I called for the creation of a housing bubble — in fact, the bubble is my fault!

Guys, read [the article] again. It wasn’t a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that’s just what happened.

Krugman is being evasive here, in our view. He is very obviously a reflationist, someone who believes that government monopoly money printing can provide the boost an economy needs to regain prosperity.

For this reason, the Fed’s Ben Bernanke (also an avid reflationist) has printed lots of money for purposes of “quantitative easing” 1&2. The easing has not done much to stimulate the larger economy, however, which is why there is speculation that Bernanke will shortly embark on a QE3.

This brings us to our second point. Incredibly enough, the Fed itself is paying big banks interest on money it has printed and deposited in its money center banks. The Fed is essentially paying banks .25 percent NOT to lend. In an article in the New York Times, economic commentator Bruce Bartlett noted the following:

The Fed can penalize banks for holding excess reserves by charging them interest rather than paying them interest. This has been done in other countries.” … On July 5 the central bank of Denmark announced that it would begin charging an interest rate of 0.2 percent on reserves.

Bartlett also noted it was “puzzling” as to why the Fed continued to basically discourage banks from making loans.

So here is a question that needs answering: Can the Fed reflate the larger dollar economy by encouraging its biggest banks to lend? Could it have done so directly after the bust of 2008?

Remember, at the time the Fed rushed tens of trillions around the world in supposed short term loans. This money, it is said, effectively unfroze locked-up liquidity and allowed the current money structure to survive.

But the larger economy STILL hasn’t recovered. Likely, it is simply not feasible to reflate right away after a large bust. One can perhaps provide stability via liquidity, but this is a bit like putting a corpse on ice. It doesn’t stink … but it’s not alive, either.

It was the opinion of no less an acute observer of the markets than Murray Rothbard that when a big bust occurred, such as took place in 1929, reflation was not particularly possible, immediately anyway.

It was Rothbard’s contention that “deflation” would have to take place within the larger economy before a recovery. Rothbard granted that deflation – a contraction of the money supply – would inevitably have the effect of lowering prices.

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