The study of human history reveals a plethora of examples where we find the orthodox knowledge of that time to have been significantly flawed. Given our temporal advantage in looking back over history, many of yesterday’s “truths” are laughable today.
A few examples come immediately to mind. Pre-scientific societies from ancient Greece to China believed that the earth was flat for centuries until Aristotle challenged this belief based on scientific observation. In astronomy, the geocentric model dominated the field all the way into the 16th century. And from antiquity well into the 19th century, humans believed that bloodletting could cure an almost inexhaustible list of ailments. In fact, George Washington died most likely not because of the throat infection he had contracted but rather thanks to the massive amount of blood drained from his body at the hands of his physician. The practice remained popular for so long mostly because germ theory and microbiology had yet to make their mark on history. It’s always better to do something rather than nothing, right?
Fast-forward to the market collapse of 2008-2009 and the subsequent “Great Recession,” and we’re right back to bleeding the patient. Only today’s patient is the United States economy and our modern form of bloodletting is now coyly termed “quantitative easing”. It’s the same voodoo that killed the first President of the United States. Only this time, instead of speeding a few patients along to an untimely end, the very life-blood of our nation is being siphoned off by a group of “economists” who are so firmly entrenched in Keynesian orthodoxy that they refuse to see what is staring them squarely in the face. But they have to do something, right?
The Federal Reserve responded to the Mortgage-Backed Security (MBS) crisis of 2008-2009 by essentially printing up over a trillion dollars out of thin air to purchase the “toxic debt” held by Fannie Mae and Freddie Mac. The Fed balance sheet went from around 800 billion in US Treasury debt before the crisis to a combined Treasury and MBS balance of $2.1 trillion. When a money supply is inflated, the amount of goods and services in an economy stays the same, while the number of dollars competing for those goods and services expands. This money supply inflation causes the prices of goods and services to rise. The purchasing power of one’s money in such an event is literally leeched away and given to the entity that has created the new money. This initial phase of economic bloodletting was labeled “quantitative easing” and soon became known as QE1 (which undoubtedly sounds better than “money printing round 1” or “counterfeiting phase 1”). For all of the money that was printed, the economy did not recover. QE1 was followed in November of 2010 by more of the same: QE2. This second round added an additional $600 billion to the Fed’s balance sheet, bleeding more wealth from the lower and middle class and adding nothing in terms of sustainable growth to the beleaguered economy. But they have to do something, right?
And here we are now. The Dow Jones limps along at just above 11,000 and unemployment is effectively where it was in 2009. All is not well. Never fear, the world’s great phlebotomist appears to be sterilizing his needles for another round of QE. A little over two weeks ago, Ben Bernanke called up his buddy Charles Evans at the Chicago Federal Reserve Bank and sent him out as a sort of expeditionary force to prepare the public for more medicine. Then Monday, just before the two day Federal Open Market Committee meeting that concludes on Wednesday, September 21, Bernanke is purported to be in favor of higher levels of inflation. It looks to me like Bernanke’s bad habits die hard, and that we will likely see additional QE very soon. Get ready for some more needles or, if you’d rather avoid the pain, exchange some more of your Federal Reserve Notes for gold and silver.
Disclosure: I am long AGQ.
Disclosure: I am long AGQ.