On the day that the Fed announced a plan to tepidly decrease the rate at which it swells its balance sheet (dropping from a rate of increase of $85 billion per month to only $75 billion—the horrors!), it pledged to keep the currency on the whipping post so long as it refused to debase its value.  The Fed will keep giving out free money “well past the time” that unemployment is reduced to below 6.5% (currently at about 7%), so long as inflation remains quiescent.  Never mind that the currency long ago yielded to the lash so far as asset prices are concerned.  The Fed does not like it that it can’t engineer enough consumer price inflation.  Here’s what it actually said in its post-Committee meeting press release (be forewarned—this is truth in all its banal, ugly glory):

The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.

The Fed doesn’t often openly and directly say why it wants inflation.  It, and all other central banks, have operated for so long on the premise that inflation: good; deflation: bad; that I wonder whether they even remember why it is they chant the mantra like Buddhist monks. 

It is because inflation reduces real wages, thus enabling labor markets to clear without having to rely on that nasty old laissez faire market mechanism of reducing wages the old-fashioned way, through nominal wage reductions.  Keynes noticed that nominal wages are stickier on the way down than most prices, so figured out the best mechanism for clearing labor markets would be to debase the currency.

Inflation also achieves another central banker aim.  It helps indebted countries that issue notes and bonds in their own currencies (the US, Japan, England, etc.) pay them back at what amounts to reduced rates of interest.  When the currency is losing value at a 2% clip per year (i.e., when inflation rates are 2% per year), a ten-year bond denominated in the losing currency that pays a coupon of 2.9% annually has a real interest rate of only 0.9%.  A steadily rising rate of inflation is catnip for indebted central governments.  Like a reduction in wages accruing through a debased currency conceals from workers how they’re really getting shafted, a de facto bond default attributable to a steadily worsening currency value doesn’t quite look like an outright failure to pay. It apparently feels better somehow to lose money on a bond, or to see a decline in purchasing power, when the truth arrives wrapped with an inflationary bow.

In the meantime, stock market indices reach new highs every day (including the day of the statement release, December 18, 2013), because even though the workforce is gainfully employed at the lowest rate in thirty years, and the economy can’t muster much more than about 2-3% annual growth, the stock market knows the Fed will continue flogging the currency until market morale is utterly euphoric. 

Everything is good news for stocks these days.  If an asteroid hit New York, the Dow would reach a new high on the day for the business that rebuilding would generate, or for the anticipated flood of new money the Fed would infuse into the economic system to stave off the untoward effects of asteroids.  Really, the Fed would do that, because it has only a hammer, and therefore sees every problem as a nail, including, it is easily imagined, asteroids.  And it devoutly believes in the efficacy of its hammer.  Printing money is to the Fed what castor oil was to your grandmother—a cure for all that ails. 

All this money printing arose because of the financial crisis of late 2008 and 2009, and though the crisis has passed, and the economic systems afflicted by it are as robust as demographically aging and declining economic systems can possibly be, the Fed won’t be satisfied until it sees the bubbles it is reflating pop again.  And then it will really get serious about money printing.  

If all this money printing seems to accrue only to the benefit of large financial system institutions, that’s because it does.  The Fed claims it hopes that the printing will trickle down into a more robust labor market (but fails to mention that it seeks that end by inflating away the value of everyone’s paycheck), but the true beneficiaries are the firms left standing after the near collapse of the system during the crisis.  It almost makes you wonder whether the Fed engineered the last crisis at the behest of its puppet master bankers in order that the playing field might be cleared of their upstart competitors.  Look at commercial banking (i.e., banks that take deposits from the public).  There were several very large regional and near-national banks competing in the market space occupied by commercial banks.  After the failure of Wachovia, Washington Mutual (and several others), now there are three—Bank of America, Wells Fargo and JPMorgan Chase.  And the name of that last one recalls a previous financial crisis, about a century preceding this latest one, where its founder seemed like the fireman who sets a fire so he can make himself out to be a hero, and on a property for which he is personally insured well in excess of the value. 

The primary beneficiary of the financial panic of 1907 was John Pierpont Morgan.  Aside from the panic wiping out several trusts which competed with his own bank, it also allowed a company controlled by him, US Steel, to buy out the upstart Tennessee Coal and Iron.  TCI owned most of the coal and iron ore in Jefferson County, Alabama, where Birmingham was quickly growing into a major rival for Pittsburgh and US Steel.  Birmingham never did overtake Pittsburgh as an iron and steel manufacturing center, even though its ore and coal were of higher quality and cheaper to produce.  But that surely had nothing to do with the panic and subsequent buyout.  JP Morgan “saved” TCI out of the goodness of his heart.

The point is, once the smoke cleared from the panic, the supposed savior of the financial system was also the primary beneficiary of the panic.  The same holds today.  The Fed caused the panic and swooped in to save the world from the fire it set.  The Fed’s power and prestige expanded to many times its previous size over the course of the panic, and the investment and commercial banks favored by the Fed got rich and eliminated competitors as a result.  It wouldn’t be entirely tin-foil-hattish to at least entertain the notion that the Fed and its favored banks just might have set the fire intentionally.

In any event, all that money with which the Fed is flooding the economic system mostly just sits around, filling up company balance sheets, or buying junk bonds.  Almost two and half trillion of it is parked at the Fed, in the form of excess bank reserves, where the Fed pays the banks who own it for the favor of storing it for them.  By comparison, before the crisis, when the Fed did not pay interest on excess reserves, the amount of excess reserves stored at the Fed was roughly zero.  That’s right, nothing.  Now the Fed prints money it claims to hope will trickle down to the job market and the money goes nowhere but right back to the Fed, for its banker buddies to get their money for nothing and their checks for free.  The only thing trickling down to the commoners who don’t have $2.5 trillion to stash at the Fed is the warm urine of a diluted currency. 

The reason the Fed can’t engineer inflation is twofold.  First, they are fighting deflationary forces that animate the life cycle of all mass-produced items.  The further along the output curve, the lower is the marginal cost of production (to a point, except in the case of natural monopolies).  And the more mature is a market, the lower the marginal cost of production, as all the best processes are discovered and deployed to the producer’s cost advantage over time.  There are very few markets in the developed world that aren’t mature, or for which demand is not fully supportable through present production capacities.   The normal trajectory of prices is decline.  To keep prices from declining requires massive monetary infusions, and that still might not be enough. 

For the extra money might just sit there, doing nothing except driving up the prices of assets, if, for every extra dollar that is added to the system, the velocity of all dollars commensurately declines.  Monetary velocity is now at an all-time low (in records going back to only the 1960’s, but still), and declines with each passing month.  Every new dollar just makes all the existing dollars less volatile.  It’s as if adding a new electron to a chemical reaction did nothing more than dilute the chemical effectiveness of all the existing electrons.  This is not surprising.  The economic system to which the dollars are being added is mature and aging rapidly.  Just like metabolism declines with age, so too does monetary velocity of the sort likely to spur inflation decline with the maturity of the economic system.  The older is the average age of the human beings comprising an economic system, the less energetic they, and their currency, will be.  Ask Japan how that monetary velocity thing goes with them.

And of course, there is another reason for the declining monetary velocity:  income inequality.  From a Gini coefficient low of about 38.5 in the US in the late 60’s, income distribution has steadily grown less equal, until today, it stands at about 47.7, in the territory of autocratic plutocracies worldwide (according to the CIA World Factbook, the US is sandwiched between Uruguay and the Philippines at 44th from last in income equality; Lesotho, formerly a province of South Africa, is worst, at 63.2, and Sweden is best at 23.0).  Rich people don’t do much of anything with their money except buy more assets.  Improvements in their welfare could hardly be imagined to have much effect on the demand for mass-produced consumer goods, thereby explaining, in part, the lack of monetary velocity and the inability of the Fed to spur inflation.  If the Fed really wanted consumer price inflation, it should just put the money it is printing directly into the consumers’ back pockets.  But no, the Fed means to preserve the status quo, enriching the plutocracy while hoping beyond hope its trickle down strategy will keep the peasants satiated and quiescent.  For the Fed, we really aren’t all in this together.  It is the great mass of humanity versus the capitalist overlords and their financiers, and it doesn’t take a Dylanesque prophet to see in which direction the winds are blowing. 

Thus is the economic reality observed and bemoaned by no less than Pope Francis.  The economic systems of the world cannot long exist solely to serve the few.  They become impossibly unstable when they do, which is why the US economic system in its present configuration is doomed, no matter how high to the sky grow its stock market trees.