A few months ago I wrote about the saying "there's no free lunch" in the context of so-called "free" services that require users to surrender their privacy as a condition of use. Today I'm writing about a different kind of free lunch, but I wanted to make clear that I'm not talking about the same thing just because I use similar language.
Today's Good Counsel is about economics, and more particularly about the role of the government in the economy. I should preface this by saying that I have next to zero formal education in economics, so I'm approaching this as a layperson. I have read a great deal about the subject. I also don't think that you need to hold a Ph.D. in Economics to grasp policy issues even as you leave the maths and hard-core theory to others. In fact, one of the more important things I've read is that economics education tends to be extremely orthodox and conservative in its orientation, and if you know anything about me you should know that I am an enemy of orthodoxy in almost everything (I remain opposed to the use of the designated hitter, but that is a topic for another day).
I should also say that this is an enormously complicated subject, and one that can't be distilled into a single blog post of reasonable length. But we can try.
Finally, I should further say that while this entry is long, I think the payoff is worth it, in that this is something that not many people really understand, and we are pretty much being victimized by a huge screw job.
That diversion aside, let's get down to business.
We have a rather weird set of current conditions.
By some measures, the American economy is roaring. The stock market is at record levels. Gross national income is up. The unemployment rate is down.
By other measures, the American economy is stagnant. Job-creation is limping along at moderate levels, at about 200,000 new jobs a month. (A basic fact of the American economy is that we need about 150,000 new jobs each month to keep up with population growth, because that many workers enter the workforce, net of those who leave it due to retirement, death, or other reasons.)
By still other measures, the American economy is in recession. There are millions of long-term unemployed people--otherwise healthy and available for work--whose unemployment insurance benefits have run out or soon will. These are people who have been out of work and actively seeking work for at least 99 weeks--that's almost two years. Years of stimulus of various types have failed to move the needle on inflation, which is historically low. And interest rates are at the rock-bottom.
And I think if you asked the average person on the street what they thought of the economy, that person would say, "Hey, times are tough." That may be the most important indicator of all.
One of the weirder consequences of all of this is that despite that fact basic fact--that a lot of people think we're mired in a long-term down period--the political will in Washington is to do things that are really counter to what needs to be done here. Now, I'm the first to acknowledge that what Washington thinks and what the people think are often out-of-sync. But official Washington, and especially people who ought to know better, seem to think that it's government spending that is the cause of our ills.
Thus we get genuinely stupid economic policy, like the sequester, and artificial fiscal constructs, like the debt limit, that serve literally no prudent purpose.
We are attempting to fight with both hands tied behind our back, so to speak. Here's why:
Principle 1: The government fisc is not like your family's budget.
If you want to spend money, whether it's to buy a box of noodles for your supper or to buy a house, you first have to get the money. You can get that money by working, or by receiving it as a gift, or by receiving a return on an investment, or by borrowing it. Your spending is limited by your capacity in each of those areas. You can get more money by increasing your work or by increasing your borrowing, but if you spend freely you will eventually reach a point at which you will be maxed out.
For that reason, you MUST constrain yourself, foregoing things that you might like to have to ensure that you have enough resources for things you need.
But, as I have said previously, the federal government doesn't have any such restriction, because the federal government can create money at will. You can't do that; you have to convince other people to give you money (usually in exchange for services) in order to have money.
Principle 2: What most people think of as "money" is just symbolic of value.
I mentioned before that there are some artificial restrictions on the government with regard to monetary policy. One of them is the control that Congress exerts over fiscal policy, through the budgeting and appropriations processes. That's actually a good artificial restriction, because we are a representative democracy, and we like to make sure that our decision-making process is democratic in nature. We also have the federal debt limit. We have the Federal Reserve, which controls monetary policy in a less democratic way, using authority delegated to it by Congress.
It's important to recognize that just because the government can create money at will, in the sense of having the ability, does not mean that it does or should, in the sense of having the desire, or may, in the sense of having the authority. But I am not really talking about those things as real restrictions on the ability to act.
Suppose I cut a piece of paper into the size of a dollar bill, drew a portrait of myself on it, and wrote that it had a value equal to "One Hundred Harringtons" on it. If I went to Kroger, filled up my grocery basket, and went to the register, what are the chances that the cashier would accept my paper as payment for my groceries? The answer obviously is zero. That paper has no value.
Of course, if I handed them a $100 Federal Reserve Note with a picture of Benjamin Franklin on it, the cashier would (after ascertaining that it was real) likely give me my groceries, and, if I'm lucky, hand me a few Federal Reserve Notes and maybe some coins back as change.
Obviously there is a difference between my 100-Harringtons bill and American currency, but it's not exactly the difference you think. To show you why, consider what would happen if I cut a small slip of paper out of the Sunday newspaper that offers me a free candy bar, and presented that to the cashier in exchange for a Twix. That transaction would probably go through without difficulty.
The reason why Kroger accepts my $100 dollar bill and free-Twix coupon is that Kroger has a great deal of confidence that it will be able to give that bill (or that coupon) to someone else and get $100 (or the cost of a Twix) in value for it.
But there really isn't any substantive difference between my 100-Harringtons bill and my writing Kroger a personal check for the amount due, either. A check is an instruction to my bank to pay Kroger the amount of the check, but Kroger has no way of knowing whether my bank will actually honor the check--they are willing to take it because, if the check is dishonored, they can activate a robust structural response that is likely to result in them being paid--everything from private collections efforts, to reporting to check bureaus, to bringing criminal charges, if necessary.
If you took away or significantly modified that structural response--which is a creation and function of government (although, in this case, for convenience's sake it's mostly state government)--then check acceptance would become a thing of the past. But that doesn't mean that checks and dollar bills are substantively different from each other.
In a way, the government's establishment of the concept of
"recourse" in check-writing--the ability of a financially wronged party
to force the other party to make good on a transaction--is effectively
the same as creating a private currency system. Just as dollar bills
symbolize holdings, so do checks, just with more flexibility.
the other hand, the value associated with dollar bills is transferred
with the bills themselves. You could think of dollar bills as checks
payable to the person who holds them--the "bearer"--for specified
Principle 3: There are only two meaningful restrictions on a government's ability to create money.
The government creates money. It does so in complicated ways that are beyond the scope of this entry, and we impose a lot of restrictions on the way money gets created, ostensibly in order to prevent abuse of the process. Suffice it to say that the government creates dollars as symbols of value and injects them into the economy for use as a medium of exchange--a go-between that allows all goods and services to be priced using a consistent unit so that market participants can engage in greater specialization without harming their ability to trade.
The dollar has value by reference to what it will buy at a given point in time. A dollar might buy six minutes of unskilled labor or a quarter-pound of ground beef or one day of wireless telephone service. The precise numbers don't matter and are in fact in constant flux, but the point is that tradesmen accept dollars for their labor or ground beef or telephone service because they know that they can use those dollars to buy other things they need.
For that reason, the effectiveness of money depends on (a) whether it is accepted and (b) at what rate for a given trade. The government's interest is in ensuring that trades can happen as easily as possible (as a general rule; the government uses other tools, such as taxation, to regulate trading), which means that it must put enough money into circulation to account for the transactions that are likely to occur, but not so much that tradesmen won't accept it or demand too much of it for given trades. Finding that balance can be difficult.
The two meaningful restrictions on the government's ability to create money, therefore, are acceptance, sometimes known as confidence, and inflation.
the broader scale, the dollar enjoys broad acceptance, not just in the
United States, but worldwide. For large purchases, like a tanker of oil,
the dollar is used as the medium of exchange even when the U.S. isn't
involved in the transaction. Moreover, when foreign governments need to
park money for a while--a process known as currency reserve--they
generally park it in dollar-denominated bank accounts.
reason for all this confidence is because the dollar is viewed as the
most stable currency; it is viewed as such because the American economy
is the strongest in the world and because, despite all of our gridlock
in Washington, we still have the most stable and responsible process for
managing our monetary policy.
If we do things that
undermine confidence in the dollar--especially among foreign
nations--then acceptance of the dollar will go down and it will cost
more dollars to obtain the same goods and services. That is therefore a
real restriction on the government's ability to create money.
The other real restriction on money creation is inflation.
Most people have a grasp of inflation in the sense that they understand
that the cost of things gets higher over time. Many people also
understand, in the abstract, that to the extent that the government
prints money that is not backed by anything--in other words, handing out
money for nothing in return--then inflation will result.
don't really understand why that is. But they understand that
inflation is bad because it makes things cost more dollars. Too much
inflation can also be bad because it undermines acceptance; if people
believe their dollars will be worth a lot less in the future, they are
less likely to accept dollars (which is another way of saying that they will demand more dollars for their goods or services).
Principle 4: The government has been enormously unfair in the way it has been increasing the money supply.
So, what does this mean for monetary policy?
With the way our monetary system, the Federal Reserve System, is set up, the government has the ability to create money simply by increasing the value of private banks' accounts at the Federal Reserve. As a practical matter, the Federal Reserve accounts for these transactions as loans to banks that carry interest and will eventually require repayment. But there is no inherent, structural reason why repayment has to be required.
There is a political reason why repayment has to be required--namely, that providing free money to banks that are already enormously wealthy is, one would hope, a terrible political loser. Yet there is very little difference between the "bailout" of 2008-09 (which continues to this day) and the giving of free money to banks, because the money was lent at virtually no interest and with no collateral. Banks, not individuals, benefited from the increase in the money supply--but it's all Americans who bear the burden of inflation and reduced acceptance of dollars. After all, we rely on the value of the dollars we have and earn to pay for things we need to live.
In fact, it's even worse than that. One of the other things the Fed has been doing over the last few years is a project known as "quantitative easing." Essentially, the Fed uses its money-creation ability to buy financial assets on the open market--things like government bonds, mortgage-backed securities, etc.--as a method of propping up asset prices. The "easing" refers to the cushioning of the "blow" of falling asset prices.
The Fed has spent an astonishing $3.3 trillion through three rounds of quantitative easing. That's just over $10,000 for every man, woman, and child in the U.S.
Now, I think the Federal Reserve System is, by and large, a good system that has a lot of benefits. You will not find me aligning myself with the dilettantes who oppose the Fed and seek a financial system based on the gold standard. I have news for those people: Gold no more has intrinsic value than anything else.
However, I find quantitative easing, as the Fed has practiced it, to be enormously unfair for a couple of reasons. One, it bails banks out of bad assets by paying them at par--full nominal value!--for assets that are likely bad, which eliminates the incentives that banks have to avoid making those kinds of loans in the first place. (Witness what happened when the Fed announced earlier this year that it would scale back QE in 2014--the stock market fell over 4% in a few days. That tells me that the upper end of the financial system knows it is getting a great deal.) Two, that program favors the kinds of people who hold those kinds of assets in the first place--people who have lots of money to begin with--to the exclusion of people of modest means.
It didn't have to be that way. In fact, it could have been done in a way that would give the same net result to the banks while allowing
all Americans to benefit. Rather than handing $3.3 trillion, mostly to banks, the Fed could have handed $10,000 to each of us. Most of us would have spent it by buying goods or paying off debts, which would have stimulated the economy, helped banks out of bad assets (loans), and had a multiplying effect throughout the economy, creating millions of jobs and ending the federal budget deficit.
Instead, we got nothing for it. Except precisely what we have, as noted at the outset: Some parts of the economy--the high end of the financial system--are roaring, while the broad swath of people are suffering.
Time will tell whether this activity will have a real cost to the economy in terms of monetary policy. The bankers' lunch may or may not have been free. (Signs point to continued low inflation.) But this long explanation will have been worth it if you, the reader, recognize that relative to where we are now, we could have had a "free lunch." We had an opportunity to use monetary policy to improve the financial lives of all Americans on a more-or-less equal basis, while still getting all of the benefits we got anyway (in terms of economic stability), and that opportunity has been wasted.
It should make you angry. If more people understood the basic facts, they'd be angry, too. I know I am.