I must admit to some anxiety writing an opinion piece on the Federal Reserve System’s (Fed’s) monetary policy. No doubt for many the topic seems uninteresting. Yet if we are to restore our nation’s freedom and prosperity, we must take the interest and effort to critically examine our government’s interventions. My intent is to make plain that the Fed’s Quantitative Easing (QE 1-3) manipulation of financial markets is yet another illustration that government intrusion into markets not only infringes on our economic freedom but inevitably is the problem, not the solution.
So what is QE? In the aftermath of the 2008 financial crash – arguably caused by misguided federal intrusion into the housing market – beginning in December of 2008 through 2014, the Fed went on an unprecedented $3.5 trillion shopping spree, buying up bank held long-term US Treasury Bonds and government (i.e. taxpayer) guaranteed mortgage securities. Over that 6-year period, the Fed expanded assets on its balance sheet from $890 billion to more than $4.4 trillion, “creating” $3.5 trillion out of thin air.
The Fed “pays” the banks for financial assets with credits in the Federal Reserve System. So for example, if the Fed buys $100 million of Treasuries from a bank, the Fed then credits the bank with $100 million in the Federal Reserve System. The Fed now has the $100 million of Treasuries on its balance sheet and the bank now has $100 million in its accounts. The only problem is that there are no assets behind the Fed credits. If an individual or bank would issue a check without any underlying assets, we would call this writing a bad check or bank fraud. When the Fed does this, it is called “Fed open-market operations”.
The immediate outcome of this quantitative easing was $trillions of increased cash reserves in big banks. The second consequence of QE was manipulation of the bond market – the Fed held as much as 25% of all long-term Treasuries – to lower interest rates. How do Fed open-market operations affect interest rates? Market interest rates correlate strongly to long-term Treasury bond rates. The Fed’s buying up of Treasuries lowers the supply of these securities in financial markets. As a result the remaining long-term Treasuries have a higher market value. Like all bonds, when the value of Treasuries increases, the interest they pay out decreases. This may seem counterintuitive, but basically the financial logic is if the bond is more valued, it takes a lower interest payout to encourage purchase; if the bond is less valued, it requires a higher rate to encourage purchase.
Step 1 of the (central) planning accomplished: QE recapitalized banks and forced down interest rates. Now step 2: Banks flush with Fed cash would lend it out at low rates and grow the economy. As it turns out step 2 never materialized. QE did work out great for the federal government, big corporations and banks, and wealthy individuals. Lower interest rates allow government to finance its profligate spending at lower costs, thus encouraging more irresponsible spending. Big corporations recognizing the risk of investment in an economy already hampered by over-regulation, high taxes, and uncertainty rather than expanding operations have been using cheap money to buy back and increase the value of their stock. Big banks flush with cash reserves rather than lending low interest money in an unhealthy economic and difficult regulatory environment have instead mostly elected to leave their unprecedented financial reserves to collect low but risk-free interest from the Fed. Finally, the wealthy have benefitted from a surging stock market as cash looking for higher returns flowed into the stock market artificially increasing its value.
The economy, those struggling to make a living, and savers have not been so fortunate. Since the recession officially ended in June 2009, the economy has grown at a sluggish annualized 2.1%. If the economy had instead grown at the average economic expansion rate experienced since 1960, our country would be $1.89 trillion wealthier today.
Supporters boast the Fed’s quantitative easing and this administration’s economic policies have resulted in the 5.1% unemployment rate; yet, the official unemployment measure belies the economic and employment realities. Since 2008, wages have been flat or falling. The underemployment rate which includes those workers that are highly skilled but working in low paying jobs, workers that are highly skilled but work in low skill jobs, and part-time workers that would prefer to be full-time is 10%. The differential between the unemployment rate and the underemployment rate is the highest on record. The employment rate of the working-age population is 59.2%, close to 35-year lows. Hurt most of all are the retirees on fixed incomes who played by the rules and put aside for their retirements. While Fed manipulation of the financial markets funds irresponsible government spending and enriches the wealthy and big banks and corporations, those retirees struggle on the pittance produced on their savings.
Perhaps the most essential harm from the Fed’s machinations to literally paper over a bad economy is that these monetary interventions impede the real solution to our economic woes – economic and fiscal reforms that promote GDP growth. The supporters of the big government status quo claim that the new normal is 2-2.5% annual economic growth. It is the cost of the welfare state. Yet the best way to promote the social and economic welfare of individuals is economic growth.
Seemingly small changes in economic growth have huge ramifications in the long run. From 1790 to 2014, our economy grew at an annualized 3.73%. Had growth instead been at this recovery’s rate of 2.3%, our GDP would be $780 billion instead $17 trillion and our GDP per capita today would be less than that of Somalia.
Much hand-wringing goes on among politicians and the liberal press searching for the solution to our economic weakness; yet the answer is no mystery. The Economic Freedom of the World report published annually for the last 20 years, each year has gathered and analyzed economic data from 157 countries (with data from 100 countries extending back to 1980), and the conclusion is invariably the same – individuals living in freer economies are wealthier, healthier, and live longer than those in less free economies.
The solution is not more government. The solution is more freedom. Please join the campaign for liberty. Our future freedom and prosperity depend on it.