The Federal Reserve has finally ended its quantitative easing programs. Since the financial crisis of 2008, the Fed has pursued what seemed like an endless policy of asset purchases. As recently as September 2008 the monetary base in the US was just a hair over $800 bn. Today this figure is just shy of $4.2 trillion, for a total increase of 425%.
For its part Janet Yellen and her gang of Fed economists are probably pretty pleased with themselves. Unemployment is down, headline inflation remains muted, and the word on Wall Street is that a worse crisis has been averted. The stock market is at record highs, and banks (and bankers) are back to their pre-crisis eminence.
One of the true marks of a great economist is an ability to see past the obvious outcomes and into the veiled results of policies. Friedrich Bastiat’s great essay on “that which is seen, and that which is not seen” provides a cautionary parable that disastrous analyses result when people don’t bother looking further than the immediate results of an action.
Nowhere is this lesson more instructive than with the Fed’s QE policies of the past 6 years.
Consider the Austrian business cycle theory. The nub of the theory is that changes in the money market have broader results on the greater economy. In its most succinct form, when a central bank pushes interest rates lower than they should be (by buying assets, for example), the greater economy gets distorted. Some of these distortions are immediately apparent, as consumers buy more goods and everyone takes on more debt as a result of lower interest rates. Some of the distortions are not immediately apparent. The investment decision of firms gets skewed as interest rates no longer reflect savings preferences, and the whole economy becomes fragile over time as erroneous investments add up (what Mises’ coined “malinvestments”).
When a financial crisis or economic recession hits, it’s almost never because of some event that apparently happened at the same time. The crisis of 2008 did not occur because of the collapse of Lehman Brothers. It happened because the whole financial system and greater economy were fragile following years of cheap credit at the hands of the Greenspan Fed. If anything, Lehman was a result of this and a great (if unfortunate) example of the type of bad business decisions firms are lured into by loose money. It wasn’t the cause of the troubles but a result of them. And if Lehman didn’t go under to spark the credit crunch, some other fragile financial institution would have.
The Great Depression is a similar case in point. It wasn’t the stock market crash in 1929 that “created” the Great Depression. It was a decade of loose money policies by the Fed that created a shaky economy. Again, if anything the stock market crash was the result of stock prices being too buoyant and in need of a repricing to reflect economic fundamentals. Just like today, stocks rose to such storied heights as a result of cheap credit, not because of the seemingly “great” investments funded by it.
The Fed has lowered interest rates since July 2006. We have just come off the the period with the most rapid and extreme increase in the money supply ever recorded in American history. The seeds of the next Austrian business cycle have been sown. In fact, they are probably especially fertile seeds when one considers that the monetary policy has been so loose by historical standards. Just as cheap credit of the 1920s beget the Great Depression, that of the 1990s beget the dot-com bust and that of the mid-2000s beget the crisis of 2008, this most recent period will also give birth to a financial crisis.
When the next crisis comes there will no doubt be economists and commentators who blame it on some proximal event, like the failure of a large important financial institution. Don’t be fooled. The seeds of the next crisis are already sown. Fed policy under Ben Bernanke and Janet Yellen has distorted the economy in a way that makes it precariously fragile, and susceptible to collapse.
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