Central Follies

Note: Mish was unavailable for our podcast today, so I am writing up the topics I had hoped to cover for my portion.

Perhaps not enough has been said about the folly of central planning, with ‘folly’ being a relatively neutral word along the spectrum of possible nouns that might describe what the central banks have been doing. Others might be ‘insanity’ or ‘absurdity.’

For many it is axiomatic that when the government tries to direct an economy by favoring this company over that one, or trying to pick a technology over another, it stands a better than even chance of doing it inefficiently.

But nothing can be more ruinous than attempting to steer the entire economy by fooling around with the price of money itself, as the Fed has been doing. Saying it in his usual eloquent form, John Hussman of Hussman funds puts it thusly (emphasis mine):

Keep in mind that the U.S. banking system has trillions of dollars sitting in idle deposits with the Fed already. Quantitative easing simply does not relieve any constraint that is binding on the economy. Rather, QE is a method by which the Fed hoards longer-duration, higher-yielding securities like U.S. Treasury bonds and replaces them with cash that bears zero interest.

At every moment in time, somebody has to hold that paper.

The only way for the holder to seek a higher return is to trade it for a more speculative asset, in which case whoever sells the speculative asset then has to hold the cash.

The process stops when all speculative assets are finally priced so richly and precariously that the people holding the cash have no further incentive to chase the speculative assets, and are simply willing to hold idle, zero-interest cash balances.

Why does the Fed want this? Simple. Chairman Bernanke believes that by creating a bubble in speculative assets, people will “feel” wealthier and keep consuming – regardless of the fact that real incomes are stagnant and debt burdens are already intolerable, and despite the fact that there is extremely weak evidence for any such “wealth effect” in the historical record.