The Clever Fellows of Jackson Hole

The cony-catchers assembling in Jackson Hole, Wyoming, believe the darnedest things.  They think they can decide the price of the economy’s most important component – its money – better than the market can.  Moreover, by low-balling the price of money they think they can get consumers to spend money they don’t have to buy goods and services they don’t need.

This may sound absurd, we know, but it really is the principal objective of monetary policy these days.  Still, this isn’t the half of it…

For when commercial bankers choose not to transmit all the cheap credit into the economy via personal and business loans, central banker plans to goose the economy break down.  That’s when fiscal policy is called upon to pick up the slack.  To this end, government economists believe they can stimulate the economy by spending gobs of money the government doesn’t have – a minor detail, of course – on programs the world doesn’t need.

So to get the money that it doesn’t have to stimulate the economy with spending programs, the government borrows it from the central bank.  Yet the central bank doesn’t really have any money either.  Thus, it creates the money through a simple ledger notation, loans it to the government, and chalks it up as an asset on its books.

Quite frankly, we don’t know how this can possibly go on.  But it does go on…and it has been going on for much longer than anyone with an honest sense about them could fathom…

Putting Mad Monetary Policies to the Acid Test

For a time, during the 1980s and 1990s, nothing bad happened.  Many academics thought the money problem had been solved.  In hindsight, it’s clear that financial problems had just been papered over with ever expanding debt…debt that the economy can no longer support.

Federal Reserve Chairman Ben Bernanke’s spent his whole life studying the Great Depression.  For years he devised theories and wrote papers contemplating the best policy response to counteract a debt deflation and a drop in aggregate demand.  His master achievement, before becoming Fed Chairman, was contriving the academic foundation for quantitative easing.  It’s likely he thought he’d never have to put such lunacy to practice…

Yet when credit markets blew up 2008, the moment came for Bernanke to put his mad monetary policies to the acid test.  Several trillion was added to the Federal Reserve’s balance sheet and $7 trillion more was added to the public debt.  Yet, despite these efforts, and the vast expectations for a renewed prosperity, the economy’s lurched along with no real recovery to speak of.

What happened?

The transmission mechanism for the Fed’s cheap credit – commercial banks – didn’t funnel the funny money into the economy.  On top of that, besides what Paul Krugman had promised, all the government spending made possible by the Fed didn’t do a lick of good either.

No doubt, this isn’t how Bernanke penciled things out.  In addition, he’s set in motion a much larger problem for the economy…

The Clever Fellows of Jackson Hole

At some point the banks will begin lending out more and more of the reserves that have been created by the Fed.  Once the money starts flowing it won’t take long for inflation to pick up.  Plus, when all the dormant money that’s been created since 2008 comes to life within the economy, price inflation could very quickly get out of control.

In the meantime, quantitative easing’s had another peculiar effect.  It has puffed up the stock market like a balloon.  What’s more, Wall Street’s grown to expect it and stock prices have rallied all summer based on the expectation of QE3.

Here it is, the last day of August, and the world is intently waiting for Bernanke to speak.  Later today, from the solitude of Jackson Hole he will impart some words on the world and may even tell of his latest musings on quantitative easing.

Will more quantitative easing really help the economy?  If so, how much…should it be open ended, and unlimited?  How will inflation be controlled when the excess money that has been created makes its way into the economy?

What will more QE do to stocks?  Will it create a massive bubble?  What about Treasuries?  How long can rates be suppressed before they explode?  What side effects and distortions will it have?

Obviously, Bernanke and all the other clever and crafty fellows in Jackson Hole know exactly what they are doing.  They always do.  You can count on it…even if it kills you.

Sincerely,

MN Gordon
for Economic Prism

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