The blind leading the blind?

Readers may have noticed a paper from the Richmond Federal Reserve that was extremely critical of the monetary policies of the European Central Bank.  The Telegraph reports:

The US Federal Reserve has launched a blistering attack on the European Central Bank, calling for quantitative easing across the board to lift the eurozone fully out of its slump.

In a rare breach of central bank etiquette, a paper by the Richmond Fed said the ECB is hamstrung by institutional problems and acts on the mistaken premise that excess debt is the cause of the eurozone crisis when the real cause is the collapse of growth, which has, in turn, spawned a debt crisis that could have been avoided.

“The ECB lacks a coherent strategy for creating the monetary base required to sustain the money creation necessary for a growing economy,” said the paper, written in July by Robert Hetzel, the bank’s senior economist.

It called for direct action to buy “bundles” of small business loans, as well as “packages of government debt” across EMU states, including German Bunds. “The ECB will have to be clear that surplus countries will experience inflation above 2pc for extended periods of time,” and must be prepared to “explain to the German public” that this is desirable.

“Most important, the ECB needs to start by recognising that Europe’s problems are more than structural. It needs to stop using monetary policy as a lever for achieving structural changes and to end its contractionary policy.”

. . .

The ECB brushed aside the advice on Thursday, leaving the main policy rate at 0.5pc. The decision to sit tight comes despite shrinking liquidity in the eurozone and a credit shock imported from the US, and amounts to “passive” tightening.

. . .

Long-term borrowing costs have jumped by more than 60 basis points across the eurozone since the Fed shifted gears in May and began to signal an early end to QE, aggravating the credit crunch across southern Europe.

The IMF warned last week that the tapering of bond purchases by the Fed risks reigniting the EMU debt crisis. “Recovery remains elusive,” it said.

There’s more at the link.

The key phrase in the Richmond Fed’s criticism is “The ECB lacks a coherent strategy for creating the monetary base required to sustain the money creation necessary for a growing economy.”  For ‘money creation’ read ‘quantitative easing’ (QE) – the same policy that the Fed has applied in this country since the 2007/08 financial crisis.  This has resulted in the US money supply growing to potentially hyperinflationary levels, as we discussed earlier this week.

It’s not only ironic, but supremely insensitive, that the Fed’s advice to the ECB to embrace more QE comes at a time when the Fed is showing every sign of recognizing that its QE program has gone too far, and it’s considering backing away from it.  This is creating problems of its own.  The Telegraph again:

The Federal Reserve began to purchase assets back in November 2008, shortly after the failure of Lehman Brothers. It was one of the wisest decisions the bank has ever made. Faced with the threat of a 1930s-style banking meltdown and a repeat of the Great Depression, the Fed provided the US economy with the financial equivalent of powerful antibiotics.

The patient duly improved and, before long, the debate shifted away from the scale of any economic collapse to the pace of any future recovery.

So far, however, the pace of recovery has been disappointing, even though the Fed is now on its third phase of quantitative easing. Although plenty of excuses are on offer – from the disruptive economic and financial effects of the Japanese earthquake and subsequent tsunami, to the eurozone crisis and all the way through to this year’s self-inflicted sequestration – the reality is that quantitative easing does not appear to be delivering the hoped-for US economic recovery.

Quantitative easing is no longer acting as a powerful antibiotic. It has become, instead, an addictive painkiller: nice to be on but, as with so many other painkillers, accompanied by unwanted side-effects.

Three spring to mind. First, quantitative easing creates winners and losers, and by doing so may constrain aggregate demand. By boosting asset prices, those who are financially asset-rich end up much better off.

By lowering the exchange rate, those who live off wage income alone, faced with higher import prices, end up worse off. Putting to one side the ethics of this process, the resulting redistribution of income and wealth is likely to constrain spending: the winners tend to be lower marginal spenders than the losers.

Second, persistently low interest rates encourage inefficient and unproductive companies to continue their bad habits. They carry on as economic “zombies”, reducing opportunities for new companies to enter the fray.

The result is weaker productivity growth for the economy as a whole, an outcome experienced by both the US and the UK in recent years.

Third, persistent monetary support encourages the creation of financial bubbles that may serve only to create future instability. Even with the US economy moribund, the stock market has, for the most part, continued to make gains – there is, if you like, a growing gap between financial hope and economic reality.

. . .

In the absence of a decent recovery in economic activity, central bankers find themselves caught between the devil and the deep blue sea. They increasingly recognise that the addiction itself may be harming economic progress, but they are also acutely aware that a premature exit may lead to nasty global upheavals.

The Fed may want to taper but, in its attempts to do so, the risk is that the flame of economic recovery is snuffed out altogether.

Again, more at the link.

The inimitable Karl Denninger recognizes this folly for what it is.

You can only have real growth in the economy through mining, growing (from the ground) or manufacturing something.  All other forms of alleged “growth” are illusory.

The premise that by making money “easier” one “stimulates” growth is horsecrap.  What you stimulate is leverage — that is, the sensitivity to either improvements or declines in the economy in the outcome that people experience.  By increasing the denominator you increase the cost of living in nominal currency units and this inherently decreases everyone’s standard of living.

More at the link.  Go read the whole thing.

He’s right, of course.  Printing money – a.k.a. QE – does nothing but dilute the value of the currency in circulation.  As Ann Barnhardt said some time ago (and we reported here):

If we call the economy of the U.S. $15 Trillion, and the Obama regime and Federal Reserve dilute the currency by $1 Trillion per year (which they are at minimum), this results in a 6.66% reduction in purchasing power annually (1 divided by 15). Thus, personal income AND spending must increase at 6.66% annually in order for the economy to merely tread water at the consumer level. Any “growth” rate LESS than the dilution rate is therefore ECONOMIC CONTRACTION.

That’s economic and mathematical reality.  There’s no fakery involved, no public relations machine, no quibbling – just pure numbers.  Mathematics is a science, not an art.  It can’t be fooled.  If you do things that are mathematically demonstrable to be stupid, sooner or later your stupidity will catch up with you.  Not ‘may’ – will.  In this case, over the duration of the current economic crisis, the US economy hasn’t grown at even a quarter of the 6.66% rate required to ‘tread water at the consumer level’ – and all of us, except the few rich fat cats at the top of the economic heap, have experienced the results;  declining purchasing power, the loss of value of our savings, and an overall drop in living standards.

That’s just the beginning compared to what’s coming.  For the Fed to advise the ECB to duplicate and perpetuate its own errors isn’t just the blind leading the blind – it’s the blind trying to prevent the sighted from seeing at all!  Guess where that will lead?



  1. Not so much the blind leading the blind, as deluded visionaries totally disconnected from economic reality leading other deluded fools deeper into the desert, knowing they have enough water with them, and hoping we can find some for ourselves in the same direction.

  2. So-stick screwdrivers into the economic machinery, push parts to where they would never go in the course of normal operation, then step back and declare, "Look, this machine is all messed up. We better stick screwdrivers into it."

    Got it.

  3. Ritchie – that is politics in a nutshell, not just the Fed. A pol that tells the people "it'll fix itself" and does nothing, won't get re-elected even if he's right! So, the "must" do SOMETHING, even if that makes it worse. No crisis, no call to action. Right now, the best course of action is for the government to get out of the way, and let market forces work. Politically, however, that's a non-sequiter.

  4. I find it a little embarrassing that we, of all countries, should tell the EU what to do, how to make things work. Maybe if we send Barney Frank and Chris Dodd over there they'll be impressed enough to listen.

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