Print, Baby, Print!
Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 12th August, 2010.
According to an article by Jonathan Laing in the 9th August edition of Barrons magazine:
Bernanke was correct back in 2002 when he pointed out that the Fed could always devalue the dollar by increasing its supply, but as far as we can tell that's the only important economics concept he has ever been correct about. The problem with the whole approach of mainlining "more liquidity into the financial system to counteract incipient deflation" is manifold. First, creating more money doesn't create more wealth or more real savings. Money, after all, is simply the medium of exchange. Second, when money is devalued by inflation (that is, by increasing its supply) the devaluation isn't uniform; rather, some prices rise more than others. In fact, in the early stages of an inflation-driven monetary devaluation some prices -- often the prices that the central bank and government are trying to support -- will not rise at all or will continue to fall. These distortions of relative prices lead to mal-investments, which, in turn, lead to the destruction of real wealth. In other words, not only does increasing the money supply fail to expand the size of the 'wealth pie', it eventually brings about a reduction in the size of the pie. Third, devaluing money by increasing its supply punishes savers and anyone on a fixed income. This is not just misguided from a pragmatic economics perspective; it is ethically wrong.
One of the main reasons for the on-going popularity of the money-printing 'solution' is the widespread belief that consumer spending -- what many economists refer to as "aggregate demand" -- drives economic growth. If you believe that economic strength is due to increasing aggregate demand and that economic weakness is due to falling, or inadequate, aggregate demand, then anything that gets consumers borrowing and spending will be seen as a plus. The reality, however, is that an increase in consumer spending is an effect, rather than a cause, of economic growth. The economic growth chain begins with saving/investing, moves along to increased production and ENDS with an increase in consumer spending. Is it really so hard to understand that for someone to consume more he must first produce more?
It's actually not quite that simple, because it isn't just a matter of producing more; it's a matter of producing more of what people want today and will want in the future. For example, due to the inflation-fueled boom of 2003-2007 the US economy and many other economies geared up to produce far more houses per year than would be required to meet genuine/sustainable demand for new houses. Consequently, it is now essential for some of the resources dedicated to the housing industry to be reallocated. Exactly how should these resources be reallocated? The answer is that neither we nor anyone else is qualified to say. Price signals will determine the correct allocation, which is why the central bank and the government must avoid taking actions that distort prices. But instead of getting out of the way and letting the market clear, the policy-making clique has been doing what it can to support house prices and boost the demand for new homes.
The fear is that if the market is left to its own devices the economy will experience deflation. This fear is expressed as follows in the second-last paragraph of the Laing article:
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