Federal Reserve Printing Money

August 17th, 2011 | Author: | Finance & Investing
A whole lot has been said about this practice but no one has made clear what the problem is in comprehensible terms and how it affects your plan for retirement; so here goes.
 
The Federal Reserve Bank can inject as much or as little money into the “system” as it would like and can do so with very little consequence to itself. If, and when, the Fed’s leadership is corrupt, incompetent, and/or foolish, this amount of power is a problem. When the Fed’s leadership is smart, courageous, and selfless (Volcker) it’s no problem at all. In this regard, the workings and actions of the Federal Reserve make it no different than any other organization. Good organizations benefit citizens, while bad ones harm them.
 
Since 2007 the Federal Reserve has been injecting money into the banking system to the tune of trillions of dollars. Many see the simple fact of injection as a mistake, in and of itself. It isn’t and here is why:
Prior to mid-2007 the money addicted citizens of the United States spent like drunken sailors in every corner of the economy (with all apologies to drunken sailors who I have been informed have the good sense to stop buying drinks when the money runs out). The habit of over-imbibing was established for at least 9 years (the two years of low interest rates leading up to Y2K, the three years to offset the internet bubble, and the four years leading to the real estate bubble).

One seldom, if ever, can instantaneously wean an alcoholic or addict from the substance of choice. Stopping too quickly overwhelms the person’s system emotionally and physically beyond bearing. So too would have been the case if the Fed failed to inject money into the system, especially in the last four months of 2008. The entire world would have collapsed like an overwhelmed, although well-intentioned, alcoholic. No one would be left standing.

Instead of weaning the system instantaneously the Fed chose to do no weaning at all. It should have reduced the amount of injection beginning in March of 2009 when capital markets started to unfreeze and scaled back until it made a decision to eliminate injection. What actually took place was the Fed injected until it ran out of serum and syringes in June of 2011, and in doing so, facilitated an additional $4 trillion of US Government debt.

The initial flow of funds into the economy was essential. The failure to wean the flow was a stopgap probably required to offset the Obama Administration’s economy-destroying policies. But, this continued flow is troublesome and here is why:

The overall economy hasn’t grown (isn’t more valuable) but the amount of dollars has. This growth of the money supply makes each dollar worth less. Think of it like this: ABC Company has 2,000,000 shares of it’s stock outstanding. Each share sells for $4, making the entire company worth $8,000,000. Despite the fact the company is not growing (it may even be contracting), ABC needs money and decides to sell 1,000,000 more shares of stock. Now there are 3,000,000 shares outstanding, but the business is still worth only $8,000,000, thereby reducing the value of each share from $4 to $2.66. Those who owned shares in the company before the sale, each see the value of their investment decline by one third, after the sale.

So far the only instance this has really hurt the US is in oil prices because, as the dollar has fallen, the price of oil has increased. But this “minimized” harm is due only because 1) so many people are out of work and 2) the other major world economies are even weaker. If there was full employment, or if Europe didn’t have it’s own troubles, U.S. price inflation across the board would be much worse.

Because of these other troubles, things, stock market aside, have calmed briefly. The real issue going forward which must be grappled with is: Will the government stop borrowing, reduce taxes and regulation, balance the budget, and eliminate the deficit over a sustainable period of time? Or will they go on taxing and spending, counter even to the drunken sailor’s approach, who at least stops when he runs out of money?

Dana is the president of The Barfield Group, which has provided industry leading Financial Advice, Investment Services, and helped people Plan for Retirement for more than 20 years. He is a frequent speaker and writer on finance, business ownership, and wealth building related topics.



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