Fred: I see you collect coins.
Mike: They are more valuable when more rare.
Fred: What if the government produced some more of the rare ones, so you couldn't tell the difference?
Mike: They would be devaluing the coin market. I would lose money.
Fred: You can relax. The government is only creating more dollars.
Mike: Bummer! I collect dollars too.
Quantitative Easing is a $600 Billion Tax Increase
11/13/10 - Chicago Boyz by Shannon Love
[edited excerpt]: The Fed (Federal Reserve Bank) is taking (stealing) $600 billion dollars of real value from your pocket and using that value to buy US Treasury bonds. This funds the Federal government without saying the word "tax".
The transfer of real value goes from You, to the Fed, to the Government. It’s a damn tax increase craftily carried out using the finance system.
Instead of taxing just American citizens or those doing business in America, it taxes everyone who holds either dollar bills or bank accounts denominated in dollars.
Worst of all, it’s stupid. You can’t fix the economy by tricking people into taking economic action against their own self-interest
Money is a Bit Mysterious
Money is hard to understand because it does not really represent a specific, real value. You can exchange it for many things, but you don't have a guarantee about what it will buy. For example, you can use money to buy a coffeemaker. You will have a choice of many prices and styles in a free market, but you have no guarantee that you can buy what you want at the price you expect.
Money can keep a constant value if it is treated with respect and honor by the government and banks which create the money.
The exchange of money and goods in a free market is a bit mysterious. This exchange is the result of the productivity and preferences of millions of people. Pure reason does not tell us what prices should be. But, we observe that money and goods settle into a balance (an equilibrium) where prices and preferences are fairly stable.
Pizza, Prices, and New Money
For example, compare a pizza for $10.00 to a hamburger for $3.00. This ratio of 10 to 3 is probably stable, even if the price level is not. If the pizza rises to $12.00, we would expect the hamburger to rise to $3.60. The ratio 10 to 3 comes from the average preferences of people. The particular prices depend on the amount of money available compared to the supply of hamburger, buns, dough, and cheese, and the work of preparation.
The Federal Reserve Bank is creating $600 billion and using it to buy US Treasury bonds. Yes, it really is just creating the money. Poof! There is the money. This is almost as easy as typing $600,000,000,000 into its computers, and it shows up as money in its account.
The Fed buys Treasury bonds. Those Treasury bonds are a promise by the US Treasury to pay back that $600 billion. The government has $600 billion more cash to spend on whatever it wants.
The government becomes the "first spender" of that new money. That is a nice privilege if you can get it. Government workers take their new dollars and buy hamburgers for $3.00 each. The hamburger stand happily sells more hamburgers. Soon, their suppliers see they are running out of beef and buns, and they raise their prices to balance their supplies against the new demand from that fresh money.
As hamburgers rise in price, people express their preferences for pizza compared to hamburgers, and are willing to pay more for pizza. Eventually, the prices of pizza and hamburgers come to the same ratio of 10 to 3, but at a higher general price level of $12 to $3.60.
The Federal Reserve created the $600 billion in new money out of nothing. But, it can't produce the meat and buns for hamburgers and other goods out of nothing. More dollars are used to buy the same amounts of real goods, so prices go up until the new amount of money balances the goods available.
Bad Economic Theory vs Reality
The Fed is following Keynesian economic theory. It would argue that this extra money causes people to work harder and produce more, encouraging "the economy" to produce more goods. The government considers the spending of this new money to be an increase in GDP (Gross Domestic Product). So, there would be no inflation, and prices would stay nearly the same.
In reality, "the economy" refers to people. People work to produce and exchange real things, not just pieces of paper called money. People work to support and enjoy their lives, not to increase an accounting measure called GDP. The government can pay people with that new money, but there are no additional real goods available for those people to buy as their payment in real things.
The first spenders and receivers get full value for the new money. People farther along the network of exchange get less value as prices go up. People who have long-term savings in dollars are last in line. They get the fully diluted, reduced value for their dollars when they eventually buy real goods at higher prices.
Useless vs Useful GDP
Here is a subtle point. These monetary manipulations by the government may actually increase the production of real things, for a while. Government economists congratulate themselves. Yet, we citizens should be unhappy.
Say that you work for the government or provide it with goods and services, and suppose that the government has no real goods to pay to you. That is, it has spent its tax revenue and has borrowed all that it dares.
It might command you to "volunteer" a few days of your time for no pay, to work on government projects. You would add to GDP by producing real goods and services, without being paid. People would be alarmed at this system of forced work, even if they had no other job at the time.
Instead, the government can do much the same thing by creating new money through the Fed. They pay you instead of making you work for free. You might add to the real goods and services of the society, if what you do for the government is actually useful. Useful or not, government accountants add your pay to GDP, and GDP goes up in the official accounts.
The problem is that the government is consuming your production for its purposes, and your production is not available to pay you real things. You will get your real things from the production of others when you spend the new money. There are now more dollars available to buy the same goods as before. Prices go up for the goods that you receive as your real pay.
Instead of forcing you to work for the government, the government has fooled everyone into working for less real payment than they think they are getting. That is a tax.
Inevitably, the government extracts $600 billion dollars of value from the society, and the people pay that bill as a hidden tax on the real value of their bank accounts. Or, they see prices go up before they get their next raise, giving them a bit less for their work. People who save dollars feel inflation the most. The government is taxing them after the fact, on top of whatever taxes they originally paid on their income.
The government says: "We have not raised your taxes. A small amount of inflation is good for the economy, producing increased salaries". This is a fraud on people who produce. Yes, their salaries go up, somewhat behind increasing prices.
Money loses value when it is treated as a tool of the government, to take value from the people while pretending that government actions have not caused inflation. Or, amazingly, Fed Chairman Bernanke has announced that he wants to cause higher inflation (for the good of us all). Money creation as the Fed is doing it causes inflation, and this is a fraud on the public trust.
Sarah Palin (don't laugh) sums up the situation nicely. Newt Gingrich and German Finance Minister Wolfgang Schaeuble agree. See also an Xtranormal video where two dogs discuss the true meaning of quantitative easing (creating money).
Cubachi [edited]: Fed Chairman Bernanke wants quantitative easing to raise inflation to 2% annually. The problem is that we already have inflation. This will make prices for goods soar even higher. Interest rates have gone up since Bernanke’s announcement; not what he expected.
Secret Walmart Survey Shows Inflation Now
11/11/10 - CNBC reports on current inflation:
[edited] Walmart is the world’s largest retailer. Their new survey showed a 0.6% price increase in the last two months, according to MKM Partners. At that rate, prices would be 3.6% higher a year from now, 80% higher than what the Fed has proposed.
Jim Iuorio of TJM Institutional Services:
“I suspect that when Bernanke thinks about reflation he has a difficult time looking beyond real estate. The Fed thinks that inflation is somehow unimportant when it is not driven by higher wages. It is quite important to people who see their homes going down in value and the food and energy they need going up in price.”
The Goals of Quantitative Easing
11/15/10 - Cafe Hayek by economist Don Boudreaux
[edited] The LA Times reports that interest rates went up last week on Treasury, corporate, and municipal bonds.
This is a direct and predictable consequence of the Fed’s diarrhea of dollar creation. The Fed's goal might well be “to keep longer-term interest rates depressed”, but economies reflect realities and not mere intentions.
Market participants understand that this huge increase in the supply of dollars will spark higher inflation. Lenders thus insist on higher long-term interest rates to compensate them for the falling value of the dollar.
Let's Counterfeit Our Way to Wealth
Feb 2009 - Easy Opinions
The thinking of economist John M. Keynes in 1935 has an outsized influence on the policies of our government. He said that increased spending was good for a recession. As you might expect, governments heartily agree because they use any difficulty as an excuse to raise taxes and spend money on their friends.
Unfortunately, Keynes was a crackpot. He said that government spending gives a multiplied return to the society. Unfortunately, that comes from a mistake counting transactions as if the entire value of each transaction creates wealth, instead of merely valuing or identifying wealth.
Obama's economic team claims that there is a 1.5 wealth multiplier on government spending. They say that the government can spend our way to prosperity. If that were true, we could all profit from encouraging people to counterfeit money.
That is what the Fed is doing as the master counterfeiter for the economy. Bernanke thinks that creating money and spending it through government is going to multiply our wealth. Somehow. In a way that has not been demonstrated.