According to Ben
Bernanke, pulling back on aggressive policy measures too soon would pose a
real risk of damaging a still-fragile recovery.
The Fed chief is of the
view that, for the purposes of financial stability, a continuation of the
central bank’s aggressive stimulus, conducted through purchases of Treasury
and mortgage securities, remains the optimal approach.
In response to the
financial crisis and the deep recession of 2007–09, the Fed not only lowered
official rates effectively to zero, but also bought more than $2.5 trillion
in assets in an effort to keep long-term rates low.
But is it true that a
loose monetary stance provides support to economic activity? Furthermore, if
this is the case, then why, after such an aggressive lowering of interest
rates and massive expansion of the Fed’s balance sheet, does the economic
recovery remain fragile?
Surely, if loose monetary
policy could revive economic activity, then a very loose policy should
produce very strong economic growth—so why hasn’t it happened this way?
Contrary to popular
thinking, loose monetary policy, which leads to a misallocation of resources,
weakens the economy’s ability to generate final goods and services, i.e.,
real wealth.
This means that loose
monetary policy not only cannot provide support to the economy, but on
the contrary undermines the foundations for economic growth.
The so-called recovery
that Bernanke and most commentators are referring to is nothing more than the
revival of various nonproductive or bubble activities, which in a true free
market environment wouldn’t emerge in the first place.
These bubble activities
are funded by means of loose monetary policies, which divert real wealth from
wealth-generating activities, thereby weakening the process of wealth
generation.
From this we can infer
that a still fragile economic recovery, i.e., a fragile revival of bubble
activities despite the very loose Fed monetary stance, could mean that the
wealth formation process must have been badly hurt.
If our assessment is
valid then obviously the sooner the loose stance is reversed, the better it
is going to be for the economy.
Needless to say, those
who benefit from bubble activities are not going to like this, since the
diversion of real wealth to them from wealth generators will slow down or
cease all together.
A fall in economic
activity in this case would in fact be the demise of various bubble
activities.
Contrary to Bernanke, we
can conclude that the continuation of loose monetary policies could only lead
to financial instability and prolong the economic crisis.
Some commentators, among
them Bernanke himself, blame the fragile economic recovery on banks’
reluctance to aggressively lend out the money pumped by the Fed. Without the
cooperation of banks, the Fed’s aggressive pumping is not translated into a
strong expansion in the money supply.
On this, the growth
momentum of commercial banks lending shows softening. Year-on-year the rate
of growth of real estate loans fell to 0.1% in February from 2.3% in the
prior month.
The yearly rate of growth
of business loans eased to 11.3% last month from 13.5% in January.
Also the growth momentum
of commercial banks consumer loans eased last month. The yearly rate of
growth softened to 3.8% from 3.9% in January.
The pace of overall
commercial bank lending, which includes lending to government, eased visibly
last month. Year-on-year the rate of growth fell to 3.7% from 6.2% in
January.
The growth momentum of inflationary
lending remains in a visible decline with the yearly rate of growth closing
at 6.2% in February from 11.3% in January.
The banks’ reluctance to
lend is also seen in the strong increase in their holdings of surplus cash.
In the week ending March 6, excess cash reserves stood at $1.648 trillion
against $1.546 trillion in March last year and $0.8 trillion in January 2009.
Also note that in the week ending March 6, the yearly rate of growth of the
Fed’s balance sheet jumped to 7.6% from 4.7% in February.
We suggest that if the
pool of real wealth is stagnant or declining, then regardless of whether
banks start lending, no meaningful economic expansion can emerge.
Once the pool of real
wealth comes under pressure, the number of good quality borrowers tends to
decline. Obviously, this tends to reduce the supply of lending.
Summary and
Conclusion
According to Fed Chairman
Ben Bernanke, pulling back on aggressive policy measures too soon would pose
a threat to economic recovery. Our analysis indicates, however, that the
sooner the Fed reverses its loose stance the better it is going to be for the
underlying fundamentals of the US economy. A reversal in the current loose
stance, while good news for wealth generators, is going to undermine various
nonproductive wealth consuming activities. Meanwhile the growth momentum of
US commercial bank lending displays a visible weakening.
