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We've
speculated in TSI commentaries that unwavering devotion to bad economic theory
(a type of stupidity) is the most likely reason for the Fed's introduction of
a new inflation program at this time. There are other plausible explanations,
but in general terms it boils down to this: the Fed is either stupid, or
evil, or stupid and evil. There is no fourth possibility that makes any
sense. It is either evil enough to inflate the currency in an effort to help
banks (or the re-election chances of Obama*) even though it knows that doing
so will harm the overall economy; or it is stupid enough to believe that the
economy can be helped by creating money out of nothing and distorting the
price signals upon which an efficient market relies; or it is evil enough and
stupid enough to believe that it can transfer wealth to the banks and simultaneously
create a net benefit for the overall economy. We'll go with evil and stupid.
The timing of the new policy was probably determined by the deteriorating
employment situation, but the Fed may well be trying to kill multiple birds
with a single stone. In any case, regardless of the reasoning behind the
Fed's latest policy move, the Fed exists primarily to enable growth in the
government and secondarily to enable growth in the banking industry. Growth
in government is enabled because a government with a captive central bank
will never run short of money, irrespective of how big its deficits become
and how far into debt it goes. Growth in the banking industry is enabled
because the central bank's unlimited power to create new bank reserves means
that banks need never run short of reserves, irrespective of how reckless
they are in their lending and borrowing.
It is clear
from the following chart that the Fed has succeeded in its primary objective.
The chart shows spending by the US federal government as a percentage of GDP
from 1880 through to 2012. In 1880 the federal government spent about 3% of
GDP. In 1913, the year the Federal Reserve came into existence, the federal
government also spent about 3% of GDP. In other words, as a percentage of GDP
there was no growth in the US federal government during the 33 years prior to
the inauguration of the Federal Reserve. An ultra-long-term upward trend then
began. Ignoring the war-related spikes during the late-1910s and the first
half of the 1940s, there has been steady growth in the US federal government
from 1913 through to the present. Currently, US federal government spending
equates to about 24% of GDP. This means that since the birth of the Federal
Reserve the cumulative increase in the size of the US federal government is
about 700% greater than the cumulative increase in US GDP.
 
Chart Source: www.usgovernmentspending.com
Would a
Republican victory in this year's US Presidential election reverse the upward
trend in the size of the federal government? If history is a guide, the
answer is no. In fact, over the past thirty years the size of the US federal
government, as indicated by federal government spending as a percentage of
GDP, increased by more during Republican administrations than during
Democratic administrations. The Republicans often talk a good game (they pay
lip service to smaller government), but in practice they are usually just as
bad as or worse than their Democratic counterparts. One of the main reasons
is that the Republicans are generally in favour of
boosting the amount of money spent on the military. An increase in military
spending is always politically easy to accomplish because most Americans are
proud of their armed forces, but of the main areas of US government spending
the most unproductive is the military. We are certainly not in favour of government spending on public works programs in
an effort to create jobs, but it would be much better for the government to
spend money building a bridge in the US than blowing up a bridge in the
Middle East.
So, a
Romney-Ryan victory in November would probably change the composition of the
federal budget, but believing that it would result in a smaller government is
an example of the triumph of hope over experience. Regardless of who wins in
November, it's a good bet that the US federal government will be a bigger
part of the economy four years from now than it is today. And as always, the
government growth will be enabled by the Federal Reserve.
The extent of
the Fed's success in achieving its secondary objective (enabling growth in
the banking industry) is less easy to establish. This is because the big
banks periodically go way too far and blow themselves up. The Fed then bails
them out, either immediately and directly via the injection of new money or
gradually and indirectly by manipulating the yield curve and altering regulations,
but the periodic blow-ups mean that there hasn't been a consistent
ultra-long-term upward trend in the banking industry relative to the overall
economy. The US financial sector's performance has been lumpy, although it
has still managed to grow from about 3.5% of GDP at the introduction of the
Fed to about 8% of GDP today.
The bottom
line is that we can speculate about why the Fed introduced a new inflation
program at this particular time, but in the grand scheme of things it doesn't
matter. A specific policy move by the Fed will generally be a reaction to
recent economic data and short-term considerations, but the Fed doesn't exist
for the purpose of fine-tuning the economy (although the current Fed chairman
and governors may well be politically naive enough and economically
illiterate enough to believe that it does). It is a tool that facilitates the
growth of the government and the banking industry.
*In last
week's Interim Update we outlined our reasons for thinking that the Fed did
not act with the aim of boosting Obama's re-election chances. We also said
that in the unlikely event that it did act for this reason, the move could
backfire. An informal Facebook survey conducted by the Federal Reserve Bank
of San Francisco underlines the possibility that the Fed's move could hinder
rather than help the Obama campaign. As noted in a WSJ
blog entry on 17th September, the Facebook survey indicated an overwhelmingly
negative public response to QE3.
Steve Saville
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