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Guest Post: The Adverse Effects Of Monetary Stimulation
Submitted by Alasdair Macleod via GoldMoney.com,
A number of people have asked me to expand on how the rapid expansion of money supply leads to an effect the opposite of that intended: a fall in economic activity. This effect starts early in the recovery phase of the credit cycle, and is particularly marked today because of the aggressive rate of monetary inflation. This article takes the reader through the events that lead to this inevitable outcome.
There are two indisputable economic facts to bear in mind. The first is that GDP is simply a money-total of economic transactions, and a central bank fosters an increase in GDP by making available more money and therefore bank credit to inflate this number. This is not the same as genuine economic progress, which is what consumers desire and entrepreneurs provide in an unfettered market with reliable money. The second fact is that newly issued money is not absorbed into an economy evenly: it has to be handed to someone first, like a bank or government department, who in turn passes it on to someone else through their dealings and so on, step by step until it is finally dispersed.
As new money enters the economy, it naturally drives up the prices of goods bought with it. This means that someone seeking to buy a similar product without the benefit of new money finds it is more expensive, or put more correctly the purchasing power of his wages and savings has fallen relative to that product. Therefore, the new money benefits those that first obtain it at the expense of everyone else. Obviously, if large amounts of new money are being mobilised by a central bank, as is the case today, the transfer of wealth from those who receive the money later to those who get it early will be correspondingly greater.
Now let’s look at today’s monetary environment in the United States. The wealth-transfer effect is not being adequately recorded, because official inflation statistics do not capture the real increase in consumer prices. The difference between official figures and a truer estimate of US inflation is illustrated by John Williams of Shadowstats.com, who estimates it to be 7% higher than the official rate at roughly 9%, using the government’s computation methodology prior to 1980. Simplistically and assuming no wage inflation, this approximates to the current rate of wealth transfer from the majority of people to those that first receive the new money from the central bank.
The Fed is busy financing most of the Government’s borrowing. The newly-issued money in Government’s hands is distributed widely, and maintains prices of most basic goods and services at a higher level than they would otherwise be. However, in providing this funding, the Fed creates excess reserves on its own balance sheet, and it is this money we are considering.
The reserves on the Fed’s balance sheet are actually deposits, the assets of commercial banks and other domestic and foreign depository institutions that use the Fed as a bank, in the same way the rest of us have bank deposits at a commercial bank. So even though these deposits are on the Fed’s balance sheet, they are the property of individual banks.
These banks are free to draw down on their deposits at the Fed, just as you and I can draw down our deposits. However, because US banks have been risk-averse and under regulatory pressure to improve their own financial position, they have tended to leave money on deposit at the Fed, rather than employ it for financial activities. There are signs this is changing.
Rather than earn a quarter of one per cent, some of this deposit money has been employed in financial speculation in derivative markets, or found its way into the stock market, gone into residential property, and some is now going into consumer loans for credit-worthy borrowers.
In addition to the government’s deficit spending, these channels represent ways in which money is entering the economy. Furthermore, anyone working in the main finance centres is being paid well, so prices in New York and London are driven higher than in other cities and in the country as a whole. They spend their bonuses on flashy cars and country houses, benefiting salesmen and property values in fashionable locations. And with stock prices close to their all-time highs, investors with portfolios everywhere feel financially better off, so they can increase their spending as well.
All the extra spending boosts GDP, and to some extent it has a snowball effect. Banks loosen their purse strings a little more, and spending increases further. But the number of people benefiting is only a small minority of the population. The rest, low-paid workers on fixed incomes, pensioners, people living on modest savings in cash at the bank, and part time employed as well as the unemployed find their cost of living has gone up. They all think prices have risen, and don’t understand that their earnings, pensions and savings have been reduced by monetary inflation: they are the ultimate victims of wealth transfer.
While luxury goods are in strong demand in London and New York, general merchants in the country find trading conditions tough. Higher prices are forcing most people to spend less, or to seek cheaper alternatives. Manufacturers of everyday goods have to find ways to reduce costs, including firing staff. After all if you transfer wealth from ordinary folk they will simply spend less and businesses will suffer.
So we have a paradox: growth in GDP remains positive; indeed artificially strong because of the under-recording of inflation, while in truth the economy is in a slump. The increase in GDP, which reflects the money being spent by the fortunate few before it is absorbed into general circulation, conceals a worse economic situation than before. The effect of an expansion of new money into an economy does not make the majority of people better off; instead it makes them worse off because of the wealth transfer effect. No wonder unemployment remains stubbornly high.
It is the commonest fallacy in economics today that monetary inflation stimulates activity. Instead, it benefits the few at the expense of the majority. The experience of all currency inflations is just that, and the worse the inflation the more the majority of the population is impoverished.
The problem for central banks is that the alternative to maintaining an increasing pace of monetary growth is to risk triggering a widespread debt crisis involving both over-indebted governments and also over-extended businesses and home-owners. This was why the concept of tapering, or putting a brake on the rate of money creation, destabilised worldwide markets and was rapidly abandoned. With undercapitalised banks already squeezed between bad debts and depositor liabilities, there is the potential for a cascade of financial failures. And while many central bankers could profit by reading and understanding this article, the truth is they are not appointed to face up to the reality that monetary inflation is economically destructive, and that escalating currency expansion taken to its logical conclusion means the currency itself will eventually become worthless.
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Just another article from a malcontent who hates Merica, and the troops, by trying to start class warfare by claiming wealth is being unfairly distributed to the job creators.
sarc?
When comments like this require a sarc tag, it means a given society is lost.
I'm assuming this was a sarc comment, but it is unbelievable just how many people in the US today would agree with that.
"Stimulus"
Boris is not think that word is mean what AmeriKan think it is mean.
I assume this is sarcasm, right?
JSTFU and get your Barrycare........... We're waiting.
GDP is strong due to big government deficit spending and there are many little governments doing likewise. Under recording inflation is a solid #2 tho.
Some of the most important people in any Ponzi scheme are the liars; the knowing liars and the unknowing liars (the delusional).
The FED, the Treasury, and the U.S. Government itself have become Herbalife writ large.
A pyramid Ponzi scheme of knowing liars and delusional sellers and buyers.
Lets check: Its only a Ponzi scheme if the economy is growing at a lower percentage than median interest rate of ALL debt.
What are mediean interest rates? 0-2%?
Whats GDP growth? 2%?
Are GDP numbers faked? Yes.
What are the REAL GDP numbers? Umm, negative?
Is it a Ponzi? Yes, it is a Ponzi
it's an 'Extreme Ponzi Makeover Show" sponsored by Oligarch's R Us, can't wait until they roll out the NASCAR for it
WRONG. Rates-of-change in money flows (our means-of-payment money times its transactions rate-of-turnover), has to exceed real-output by 2-3 percentage points in order that output can be sold, production won't decline, & jobs won't be cut back.
The FED CANNOT create money. It can only manipulate the value of money.
Monetary stimulation? Is that when Ben Bernanke sucks Uncle Sam's 'T-bills'?
I get a real kick out of you Doomer Douchez and your twisted explanations of how things work. What is hilarious is your arrogance -- which is the spoiled brat Boomer in you. I like how there are pages of posters calling a Nobel winner an idiot and saying his explanation of QE is flawed...
Ahem, you people on here are the morons!
What is happening to US is that WE are being crowded out and taken over by SOCIALISM! FASCISM! STATISM! Call it whatever you want ISM, it sure ain't capitalism and it sure ain't freedom!
The Government is taking over! This is called crowding out. Combine this with monopolies and oligopolies and you have a Fascist movement. The anti-trust laws and the constitution were put there for a reason.
WE have let the ultra wealthy divide and conquer us. Special interest groups have now served their purpose and will be fed back in with the masses.
The Nigel Farage speech is important -- we don't want to be collectivized into the hive!
There is no inflation because the money supply has yet to be unleashed! Velocity has been falling. The Fed is allowing for a 'carry trade' by paying interest on reserves. The dismantling of the pillars and/ or rules of the financial industry are allowing for the GIGANTIC derivatives trade (as funded by the 'carry trade').
Yes, it is criminal! By the way, welcome to hell!
WE need to CHANGE the system.
So stting around bitching doom doesn't get us anywhere. Go out and make some money and be ready to spend it against THEM!
Look at the House of Saud -- why the fuck do we support them? They oppress their people. They are now controlloing us!!! Obama is such a moron that he fucked up their next war on an enemy.
WE need to stop these wars!
The House of Rothschild run the 'money scheme'. F them! F Isreal (and no isreal isn't Jews). Isreal is the Rothschilds private company, it does their bidding, their expansion, "zionism".
Russia was our enemy for good reason and now they look like the good guy!!!
Same with China.
I pray that OUR military isn't going to be used against us. As crazy as this seemed even 3 years ago I am now wondering...
Fuck you McCain you traitor!
Fuck you Obama you're not even an American!
Fuck you federal Reserve you are a parasite on our nation.
Fuck you doomer boomers as you are so self centered and egotistical and dumb that you still don't get it!!!
Love to see you bust through the door to take the lead !!
unfortunately the handicap autoswing is broken
...speaking of swings, too bad your fuckswing is broken Haka... the wife must be bored not being able to strap it on and pound your little bitch ass!
No Tedddy we get it,and you will get it when I bend you over and make you my bitch.Where do you live ?
hahaha, hey Big Talker. Go find a new bitch, I own haka now :)
LOL, you're a light snack before bed
The government proctologist in the chainmail gloves will see you now.
That wanker Jim Sinclair sure has been quiet lately. Not even the gold pumpers at King World News has had him on lately. Perhaps he is still looking for that $1600 which the wanker said would not be broken after the Cyprus theft.
YOU FUCKING IDIOTS DON'T GET IT!!!
SELL YOUR OVERPRICED BONDS AND BUY PHYSICAL GOLD!!!!!
Listen to what Nobel Prize winner said, "the effects are greatly exaggerated". Interest rates are going up! they can only manipulate the shape of the curve.
Stop buying bonds to stop the corrupt Governement from having money to spend!
Your doom and gloom keeps feeding the low return psycology. Marc Faber got long bonds again when rates spiked! All you doomer boomers keep doing the same trade!
Gold is the enemy of Fascism!
Vacate the US Treasury Market -- starve the corrupt governement!
Reintstate the pillars and end the Fed carry/ derivative trade.
Sell GOOG -- buy Gold!
Sell FB -- buy gold
Sell U.S. Treasuries -- buy gold.
The Tea Party has it right -- shut down the corrupt governement.
Ok, got it, but what are you going to do with all the gold?
Well, either interest rates will have gone up enough to reflect a better risk/reward and/ or the currency will have been devalued in the wake of a re-set (mass default and/ or hyper-inflation).
...and trade back in.