Tuesday, November 12, 2013

Money Coming Through a Wormhole

It’s official. The U.S. jobs report for October shows that the government shutdown had virtually no impact on the economy—even though pundits and journalists everywhere were telling us that the economic effects of the shutdown would be severe and long-lasting.

As I said at the beginning of the shutdown, everything the media told us about the potential effects of the shutdown—at least in terms of historical precedent—was pretty much wrong. That’s a slight exaggeration, but not by much.

Yes, it did have temporary bad effects for federal workers, businesses dependent on federal spending and people who needed or wanted to use federal services and facilities. But, as far as the general long-term economy was concerned, it was a ripple, not a tsunami.

Democrats had a vested interest in the shutdown-will-ruin-the-economy storyline because that positioned them to blame Republicans for every problem in the economy for the next year or so. I’m not sure why so many journalists went along with it, though. I guess they are just gullible and too lazy to check to see what happened as a result of previous shutdowns.

Meanwhile, all the fuss over shutdown—as well as the less than glorious healthcare.gov launch—pretty much overshadowed the news event in October that could actually have more impact on the economy in the long run. That would be the president’s nomination of Janet Yellen to replace Ben Bernanke as chair of the Federal Reserve.

It’s hard to know in advance whether it will really matter that much if Yellen has the job as opposed to, say, Larry Summers, who was apparently the president’s first choice before the left wing of his party put up resistance. The fact is that Yellen is unquestionably fully qualified and, since the Fed works mainly by consensus, it’s not clear if Fed policy will be that much different as a result of the new chair. But the journalistic shorthand on her is that she is more inclined to easy money than Bernanke or Summers.

Is that true and will it make any difference? Well, Bernanke has been trying to tighten up the money supply for ages but, every time he implies in public that he might actually do that at some future point, the markets throw a hissy fit. So it’s not clear if it’s the Fed controlling the money supply or the markets controlling the Fed.

Why would the left-of-center wing of the Democratic Party be so keen on easy money or, as it’s otherwise known, “quantitative easing” or “bond buying.” Typical of the non-financial media’s attitude toward the growth of the money supply was National Public Radio’s report on the Fed meeting on October 30. In the course of his report, Jim Zarroli explained “bond buying” to listeners as being “aimed at keeping interest rates low and, you know, doing good things for the economy.”

Well, that’s one way to look at it. Quantitative easing seems to appeal to people who think that money and the economy is the same thing. The economy is the collective activity of everybody who lives and works in a society and how that activity contributes to everybody’s comfort and wellbeing. Money, as the old gag line goes, is just the way of keeping score.

A nation’s wealth consists of its population’s productivity, not of the amount of currency issued. The more currency issued in relation to productivity, the less the currency is worth. So why has the Fed been doing just that for years now? Because it takes a while for the real economy to catch up with the extra money printed by the Fed, so that extra money acts temporarily as a kind of stimulus. Think of it as a loan to help the country get through a rough patch. Of course, that rough patch has been going on now since before Barack Obama was elected president.

But if quantitative easing can be thought of as a loan, how does it get paid back? Ideally, it gets paid back by increased future productivity on the part of the population. In other words, it’s kind of like using a time machine to borrow money from your future self. What could better than that? Right? The problem comes, though, when the Fed “borrows” too much from the future and the economy doesn’t expand to absorb the extra money. Then you just have money that is worth less, i.e. inflation. People like me (and every German government) worry a fair amount about inflation. The reason we haven’t seen too much inflation so far, despite an awful lot of money printing, is that the economy has just stayed so darn weak.

So who actually gets the all the new money the Fed keeps printing? As I used to tell my daughter before she got too old and smart, it’s complicated. But in general it largely winds up in the stock market. The extra money comes from the government issuing bonds and then buying them back, which puts the money in the hands of investors. And investors invest. That is why, despite a weak economy, the stock market keeps reaching record highs. The economy has been so weak for so long and investors have gotten so used to easy money that we’re in the perverse situation where good economic news actually sends the markets sliding. That’s because investors are now more afraid of the money spigot being turned off than they are of unemployment or slow business expansion.

Has your irony detector gone off yet? That’s right. The very politicians most anxious to see easy Fed money continuing are the same ones who claim to be extremely concerned about “income inequality.” But the main beneficiaries of the Obama economy and the Fed’s resultant easy money policy are not the unemployed or the working poor. The main beneficiaries are investors and speculators—as long as they are savvy enough to get out of the market before the bubble eventually bursts.

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