By Rodney Johnson, special to the Times
In Print: Sunday, October 17, 2010
The most damaging program you have never heard of is getting worse. The Federal Reserve has just released the minutes of its last regular meeting. This board of bankers, which controls the money in the United States, has determined that the economy is not recovering at the speed it should.
In response, the Fed stated that it stands ready to unleash another round of "quantitative easing," a technical-sounding term that actually means printing a large quantity of dollars to make credit easier to obtain. Most Americans are only vaguely aware of this program, and few can describe its outcomes, intended or otherwise.
This program is never voted on and is beholden to no one. While the goal is worthy — reduced unemployment — the side effects are deadly: stealing wealth from all Americans, further impoverishing the poor, and funneling billions more in profit and bonuses to Wall Street.
In the spring of 2009 the mortgage market was dead. Banks owned many mortgages that seemingly had no value as no one wanted to buy them, and this lack of liquidity put banking at a standstill. If banks could not sell some of the assets they held, then they had no way to make new loans, so a major source of new economic activity — credit — was missing.
We had recently elected a new president, bailed out the auto manufacturers and passed a historic $700 billion-plus stimulus package, but the credit market was still in a deep freeze. On March 19, 2009, the Fed announced that it stood ready to purchase mortgage-backed bonds, which meant that the Fed was going to print new dollars and use those dollars to buy bonds backed by mortgages from banks. The goal was to have the banks use these new funds to make new loans in order to help our economy recover faster.
Since that time, the Fed's balance sheet has increased by more than $1.5 trillion, meaning that the Fed has printed that much money out of thin air and used it to buy a mixture of bonds. This process is "quantitative easing."
Last summer, the Fed announced that it would use the money it received from the bonds it owns (the payment of interest and principal) to purchase U.S. Treasury bonds, thereby keeping all of the new money it had printed in the economy. Why would they do this? Because their original efforts had failed. The minutes released of the most recent Fed meeting reveal that the group is on the verge of printing even more dollars, perhaps as much as another trillion, all in an effort to stimulate the economy.
The Fed has several mandates, including using monetary policy to work toward full employment. Unfortunately, the Fed uses the blunt instruments of low interest rates and monetary expansion (the printing of dollars) to do the job. With interest rates already hovering around zero, there was only one thing to do — print money. While the printing of new dollars is not having the desired effect of lowering unemployment, it is having a tremendous impact on our economy because of how these new dollars get their value. They take it from the rest of us.
When the Fed prints dollars in this way, those dollars were not earned in any way; there's nothing behind them. So how do they have value? The answer is by piggybacking on all of the other dollars already in existence.
This means that if the Fed prints $1 it is assumed to have the same value as all the other dollars that already exist. Now if the Fed only printed $1 when there are trillions of dollars already in circulation that would not be a problem.
But when the Fed prints $1.5 trillion, it has a major impact — dilution. The Fed is watering down the value of all of the dollars that we as citizens already hold. It is like making orange juice from concentrate. If you make a pitcher of juice with the recommended amount of water it tastes great. What happens to the taste if you add one drop of extra water? Not much. What if you add an extra cup? It might be noticeable. What if you added an extra quart of water? It would taste terrible. This is exactly what the Fed is doing to our dollars.
In this example, all of the goods and productive ability of the United States are represented by the orange juice concentrate. The water that mixes with the concentrate is represented by the dollars in circulation. Too few dollars means the concentration is too strong and can only be shared by a few people. Too many dollars means that the value is spread too thinly and thereby all of the dollars are worth less than they would have been.
The Fed is spreading our value too thinly. They have diluted the value, or purchasing power, of all of the dollars in circulation by printing so many more. This has led to a tremendous rise in the price of hard assets.
Have you noticed the price of oil is back over $80 per barrel? Have you seen that the price of corn is up over 50 percent this year? Perhaps you've noticed the increase in prices at the grocery store, or the gas station. The same thing is happening in the stock market. Because a share of stock is basically a claim of ownership of a company, when dollars are diluted it takes more of them to represent the value of the company — hence, shares go higher. This has nothing to do with a change in the value of the company, just the number of dollars that it takes to represent that value.
On the other side of this coin is the effect of the Fed's purchasing program, or how they are getting the new dollars in the system — by purchasing bonds. This causes the interest rate paid on bonds to go lower because there is a very large buyer in the marketplace who does not care about yield or price. The goal of the Fed is not to earn a fair return, but simply to own the assets to take them out of circulation and replace them with dollars. As yields go lower, the price of bonds goes higher. What happens to those who traffic in or trade bonds, such as investment banks and the investing arms of commercial banks? They make an awful lot of money. What happens to investors who rely on interest-paying securities? Simply put, they lose, as they must take more risk to earn a respectable rate of interest.
This leaves us at a very difficult crossroads. The Fed is pushing on a rope, trying to restart the economy by encouraging lending (putting new dollars in the system) and also by making our exports more competitive by making them cheaper. It is not working, so they are doing even more of the same. As the Fed floods the market with new dollars, they are enriching those who trade bonds and stock but impoverishing those of modest means by making food and energy more expensive, as well as ruining the savings plan of seniors by forcing interest rates artificially low.
Day by day, week by week, dollar by dollar, the value of America is being transferred from all of those who have saved to the very few who create and trade securities, all in the name of making things better.
Rodney Johnson is a graduate of Georgetown University and formerly worked on Wall Street for Prudential Securities. He is currently the president of HS Dent, an independent economic research company based in Tampa.
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