What Goes Straight Up?
Graphs of economic statistics usually meander across the page like a walk through the forest; others will wiggle up and down with the business cycle like an EKG machine. Only recently have we been confronted with statistics that shoot up vertically, like a lie on a polygraph test.
Statistics such as the monetary base and the money supply have gone vertical due to the Federal Reserve’s trillion dollar bailouts of big financial institutions. Essentially they have taken possession of some of the banks’ assets in exchange for adding reserves to the banks’ accounts at the Federal Reserve. This is the easy part. All they have to do is to make a bookkeeping entry in the account of the banks and money is created out of thin air.
Monetary inflation is the source of most of our economic problems, but the one people are most familiar with is price inflation. What happens when all that new money makes its way from bank reserves to new loans as intended? Eventually that loaned money makes it into paychecks and then into the markets for gasoline and milk, and this means higher prices for all.
The Federal Reserve has said that it understands the importance of reversing policy and withdrawing excess liquidity to prevent price inflation. In Congressional testimony Federal Reserve Chairman Ben Bernanke said that “We understand the necessity of winding this down at the proper moment so we will not have an inflation problem at the other side.”
Easier Said Than Done
Anyone can push the monetary inflation button and interest rates will fall and the politicians will jump for joy. The hard part is reversing this policy. It will involve the Federal Reserve selling assets like government bonds and asset-backed securities back into the financial markets. This would soak up liquidity, but it would also reduce bank reserves, reduce credit availability and loans, and increase interest rates.
If they start the reversal before the economy recovers, they may be able to beat down price inflation in the economy, but what will the politicians and pundits say to higher interest rates and restricted credit while unemployment is still rising? If they wait until the economy has recovered, most experts think it will be too late to prevent the emergence of higher price inflation in the future.
Of course a better question might be–how often does the Federal Reserve, or any central bank, reduce the money supply? Long term statistics of the money supply show that central banks are clearly in the business of inflating the money supply and debasing or devaluing our money. This way they make money, banks make money, and politicians get to pay the $11+ trillion national debt with depreciating paper money.
This is why economists from the Austrian school have always emphasized the importance of the gold standard where gold and silver serve as money. When money is a tangible thing like a silver dollar and banks are required to hold checkable deposits on reserve, a central bank could not have caused the housing bubble that led to the multi-trillion dollar bailout/stimulus policy. Gold secures the value of money and prevents reckless government spending.