The Fed is Determined to Prove the QTM Right
The Fed is Determined to Prove the QTM Right by Tom Luongo for Gold Goats ‘n Guns
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Milton Friedman famously said, “Inflation was always and everywhere a monetary phenomenon.” But Friedman didn’t live through the QE years here in the U.S. and blatantly ignored the twenty plus years of Japanese deflation despite QE and insane levels of money printing during the latter years of his life.
Because Friedman, like a lot of modern economists, adhered strictly to the Quantity Theory of Money (QTM).
And as an Austrian economics kinda guy I somewhat agree with the QTM. I agree with Ludwig von Mises on this, as you would expect. So, how do we square the QTM with the evidence that QE in all of its guises has resulted in deflation, as expressed by the general price level, where ever it has been tried?
Martin Armstrong ask this question all the time and is openly hostile to the QTM. And his arguments have some merit, because, as he rightly points out the QTM only looks at the supply side of the money equation.
It cares not about the demand side. He’s right about that. What he’s wrong about is that the Austrians, like von Mises, haven’t considered this either.
Demand for money is just as important as the supply of it. And during a crisis, the demand side of the equation for any particular currency may, in fact, be more important.
This is what the Fed has struggled with for the past twelve years. The demand for the U.S. dollar has far outstripped the increase in supply, causing a far lower aggregate price rise than anticipated by the QTM.
But money, like all commodities, goes to where it is most demanded by thos that obtain it. And Bernanke’s QE post-2008 crisis didn’t go to the people, it went to the banks and the banks and the government who did what they thought was best with it.
In trying to prop up asset values the Fed, however, blew bubbles in no only equities but also home prices, cars, education, health care, government regulation etc.
Offsetting that has been the destruction of price in things like food and energy, which are now far cheaper in real terms (and as a percentage of disposable income) than they’ve been in decades.
And this dynamic couldn’t change in the post-Lehman years under Bernanke if the Fed, like the Bank of Japan before them and the other major central banks today, allowed the money printed to actually circulate.
The QTM seems to fail because the money never circulated.
Bernanke ‘sterilized’ the new money, paying banks not to lend but rather hold the money on reserve with the Fed paying a nominal interest rather than engaging in traditional lending.
Because if he had done that the QTM would have risen up to bite him in the ass.
Bernanke understood that he had a demand problem. There was too much demand for dollars to service non-performing debt. But if he had let those trillions circulate it would have touched off an inflationary spiral as most of the money wouldn’t have gone to debt service but to bid up the price of base commodities.
So he chose to slowly bleed out the excesses of the previous credit-induced boom through time and attrition, just like the Bank of Japan, and slowly build the unavoidable inflation through the expansion of the money supply while demand returned to normal.
While the QTM ignores the demand side of the money equation, when the definition of the money supply and, more importantly inflation itself, doesn’t accurately describe reality the QTM becomes a hindrance to understanding what’s going on.
This is summed up in the question, “If Bernanke printed all these trillions, why is there no inflation?” To which Gary North, writing for Lew Rockwell all those years ago answered, “IOER.”
IOER = Interest on Excess Reserves.
To Bernanke he beat the QTM by paying IOER. Previous to Bernanke, excess reserves hovered around zero. The market always paid a better return than the Fed’s 0.25%.
The Federal Reserve can re-ignite monetary inflation at any time by charging banks a fee to keep excess reserves with the FED.
Anyone who predicts an inevitable price deflation does not understand that the present scenario is the product of legitimately terrified bankers and the Federal Reserve’s Board of Governors. At any time, the FED can get all of the banks’ money lent. But the FED knows that this will double the money supply within weeks. This will create mass price inflation.
Bernanke paid the banks not to lend and therefore most of the money printed didn’t circulate. It wasn’t part of the supply and therefore couldn’t cause inflation.
Moreover, credit money was contracting at that time. The top of Exter’s Pyramid was collapsing and Bernanke was trying to widen the base of the Pyramid by printing trillions in base money.