On October 8, Americans awoke to government reports that the domestic economy had shed another 95,000 jobs in September. Despite the billions of dollars mailed to select citizens in the form of stimulus checks and the politicized bailouts of protected industries, U.S. policymakers have failed to resuscitate the moribund economy or coax unemployment down from its ten-percent perch. But Washington’s latest strategy for jump-starting business activity—“quantitative easing”—should horrify taxpayers because of its eerie resemblance to the efforts of Dr. Frankenstein.
Compared with this new stimulus effort, Mary Shelley’s chilling tale has a relatively happy ending. Dr. Frankenstein’s flat-headed ogre murdered only three innocents before fleeing into the arctic snows. By contrast, the viral effects of quantitative easing pose existential risks to the American economy, the U.S. dollar’s reserve-currency status, and the global financial system. If you liked the currency policies of Weimar Germany’s Reichsbank or Robert Mugabe’s monetary skullduggery in Zimbabwe, then you’ll love the Federal Reserve Bank’s current flirtation with disaster.
The federal government spends more money doing things most Americans don’t want done—drone attacks on Afghani weddings, maintaining the domestic sugar price at twice the international market price—than it is able to pay for by extracting tax dollars from those same Americans. As a result, the government must issue Treasury bonds to finance its deficit.
Few investors see any attraction in ten-year U.S. government bonds, which are currently yielding less than 2.5 percent, especially after factoring in the possibility of default. So instead of offering a higher rate to entice the Chinese or other high-savings nations to buy our dicey debt, the government has decided to buy its own bonds.
How can the federal government afford to purchase bonds, when it is already out of cash?
That is where quantitative easing comes in. The mechanics of the process are simple. First, the Federal Reserve creates money ex nihilo and credits the new matter to its own account. Then, with its make-believe bankroll, the Federal Reserve uses its electronic funds to purchase U.S. government bonds. (The policy’s proponents scoff at those who equate such financial legerdemain with “printing money”: Nowadays, money creation happens electronically. Memories of overheated Weimar printing presses only frighten those who are fixated on our benighted financial past.)
The central bank’s technocracy believes that by taking money—or, in this case, computer bytes—from the government’s left pocket and putting them into its right pocket, economic recovery will ensue. If only it were so simple, or at least not so risky.
Former Fed Chairman Alan Greenspan, whose two-decades-long easy-money regime was responsible for the last real-estate bubble as well as the late-90’s stock-market orgy, warned attendees at a foreign-exchange conference about the bogeyman ready to spring from the Fed’s computers. Bloomberg News quoted Greenspan as telling the assembled financiers that “We’re increasing the debt held by the public at a pace that is closing [the gap between our debt and] any measure of borrowing capacity.”
In laymen’s terms, Greenspan’s warning reflects the law that a borrower can only carry so much debt before lenders declare him bankrupt. Thus, the judgment of one former central-bank demigod not previously known for monetary responsibility: The United States is running headlong into the brick wall known as borrowing capacity.
It will be bad enough when international bond buyers stop purchasing U.S. government debt. But Armageddon will come when those bondholders decide to dump the paper they already own, driving up U.S. interest rates. Imagine how much worse the U.S. economy will perform when adjustable-rate mortgages rise from 8 percent to 14 percent, and credit cards jack up their 1-percent teaser rates to 19.9 percent, overnight. The national funeral for the domestic consumer will have to be canceled, as the only Americans liquid enough to attend will prefer the comfort of their Swiss chalets to lining Connecticut Avenue in the rain.
What will happen in the near future when the Fed unleashes its second round of quantitative easing—inflation—on the global economy?
Capital goes where capital is treated best. And today, the developing world treats capital better than the stagnant developed nations of the north do. The recent inflationary policies of the United States and the European Union have flooded the economies of Brazil and Indonesia with capital looking to exploit the higher interest rates and growth prospects common in developing regions. But this capital has no national loyalty or moral code; it will flee these regional upstarts at the first sign of economic weakness or political instability. Leaders of the developing world have learned through experience that foreign capital drives up the value of local currencies, which then impedes their ability to export.
In their pursuit of higher returns, global financiers arbitrage away the developing country’s lower labor and raw-material cost advantages. This process devastates the host country when the parasitical capital reverses course by dumping the local bonds and currency. In the wake of this violent process lie unemployed workers, shuttered factories, and, in some cases, smoldering political unrest. As tempers flare and barricades go up in front of the national palaces straddling the equator, fund managers in New York and London will report successful quarterly results to their deep-pocketed investors, whose loyalty to the fund manager is as illusory as the fund manager’s loyalty to the economies in which he invests.
The leaders of developing countries will want to rethink just how well they treat foreign capital, which remains forever free of national, ethnic, or moral attachments. Thailand’s Finance Minister Korn Chatikavanji has done just that. On October 11, he proposed a 15-percent withholding tax on interest payments and a capital-gains tax on Thai bonds, all in an effort to temper the recent rise in Thailand’s currency, the baht. Other leaders will likely follow.
In October, economist David Carbon of DBS in Singapore told the Wall Street Journal that every day another two billion dollars flows from developed countries to East Asian upstarts. Carbon fears that trillions of dollars from the Fed’s first quantitative easing—“QE1”—have yet to be spent, even as the Fed has started to test the market’s appetite for “QE2.” The financial press could do us all a great service by eschewing the monikers proposed by the Fed and naming this ill-fated inflationary vessel Titanic.