Bloomberg News economic opinion columnist Caroline Baum still believes in the efficacy of money printing in affecting real economic outcomes.  She laments that it appears all the monetarist economists have followed Milton Friedman to the grave:

Academics, such as Princeton’s Alan Blinder and Harvard’s Martin Feldstein, are claiming there’s very little the Federal Reserve can do to stimulate the U.S. economy. Newspaper headlines deliver the same message: the Fed is “Low on Ammo.” The public is feted with explanations — couched in technical terms, such as the “zero-bound” and a “liquidity trap” — as to why the Fed’s hands are tied.

She observes that the Fed’s hands are hardly tied.  It can print all the money it wishes to print, and intimates that is exactly what the Fed should be doing, whether by buying long bonds, as Bernanke hinted might be next in his speech at Jackson Hole, or by buying anything really (“Tootsie Rolls”) with printed money.

And all this is well and good and true.  There is no upper limit to the amount of money the Fed can create.  But what will change if it goes all-in on money creation?  After a short (<2 years?) time of illusory price increases fooling people into believing demand has expanded, it will be revealed that nothing has changed about the underlying supply and demand metrics, except that more has been produced to meet the illusory demand, and now prices must fall–even more so than they would have fallen before the monetary expansion–to accommodate the excess supply (Mr. Friedman’s analysis in Monetary Mischief).  Ironically, it appears Ms. Baum and the monetarists didn’t pay attention in Uncle Milty’s class when he explained the consequences of inflationary monetary policy.  Friedman lamented the ineffectiveness of inflationary monetary policy to sustainably change real economic outcomes, even while acknowledging the temptation to inflate is always strong.

Friedman was a monetarist in that he believed economic dislocations are in some cases attributable to money supply fluctuations.  He, along with Anna Schwartz, authored the seminal work on money and the Great Depression, A Monetary History of the United States, 1867-1960.  In it, he observed how the outflow of gold from the Treasury at the start of the depression exacerbated financial system woes and caused prices to plunge.  Which was undeniably true until 1933, when Roosevelt abandoned the gold standard and the economy began tepidly growing.  

But we aren’t on a gold standard today, and haven’t been since Nixon abandoned in the early 70’s the $35/oz fixed price of gold and dollars agreed upon in Bretton-Woods after World War Two.

The simple fact is that this is not the Great Depression, and money shortages are not even an ancillary problem to what ails us.  There is plenty of money.  As Bernanke observed, the technology of a printing press ensures a steady supply.  No need to go digging in Alaska or South Africa to find more money.

Logic dictates that if the problem is not a shortage of money, then the solution can’t be an increase in the money supply.   In fact, monetarism of the sort expounded by Friedman and his acolytes is very nearly irrelevant to economic systems that use fiat currencies whose supply is unlimited, except on the oversupply side.    Friedman and the monetarists believed that steadily increasing the money supply by about 1-2% per year would provide for economic expansion without inflation or deflation–easy enough to accomplish with fiat currencies.  The effects of inflation due to monetary oversupply– illusory and temporary price and demand increases resulting in overproduction and severe price contractions later–is the monetarist danger to avoid with a fiat currency.  Undersupply, as experienced during the first stages of the Great Depression, simply is not relevant.   This is not a repeat of monetary history, not even for monetarists.

In fact, an oversupplied currency is the immediate cause of this contraction.  The Fed, fearing deflation as if it were the devil incarnate, saw prices that wished to fall in the early aughts and began furiously increasing the money supply.  Had the reason prices wished to fall been due to money shortages (such as happened in the early thirties during the Great Depression), this would have been the appropriate prescription.  But it wasn’t.  Prices wished to fall for a number of reasons (efficiencies of production due to information-age technologies; demographic and thereby demand stagnation; international wage arbitrage bringing down the cost/price of imported goods), none having anything to do with the money supply.   The increased money supply was able to forestall overall price declines that would have happened without it, but this was purely a monetary phenomenon.  It was inflation because it prevented prices from falling as they wished.  But it “cured” price declines that were not a monetary phenomenon, i.e., that were not deflation.  All the excess money had to find a place to go, and it happened upon two asset classes–housing and commodities–that had not yet suffered an inflationary boom such as the stock markets. 

Housing made sense because securitization meant that massive trade deficits could be financed through selling the world a piece of America.  Commodities, which are traded internationally, suffered for two reasons.  First, an excess supply of the currency used to price them meant prices had to increase.  Second, demand in some corners of the world (China, India) was not wishing to decline or stagnate, such as it was in the West and Japan.

A true monetarist, that understands money supply changes prices but nothing real over the long run, would understand that the Fed is in fact powerless to do anything to sustainably improve economic performance by manipulations of the money supply.  The problem, going back to the early aughts, was oversupplied demand and prices that wished to fall because of lowered costs of production.  The Fed did exactly the opposite of what it should have done in the aughts, and are doing so again now.  The results are apt to be the same.

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