The dangers of printing trillions more dollars

Aug 10, 2010

Ouzilly, France,

Yesterday's markets barely moved in any significant direction, so we will ignore them and go on to today. It's a big day for the men who rule us. The Fed's Open Market Committee meets to decide what to do.

On the table are a number of small steps...and one big one.

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Barron's highlights the big one on this week's cover:

"Why the Fed will soon print $2 trillion," is its headline. The idea behind the headline is simple enough. The recovery is a flop. All that stimulus spending has done nothing. Unemployment is not getting better. Consumers aren't shopping. Banks aren't lending. And the money supply is actually FALLING.

What to do? The Fed has already shot off its monetary ammunition. It has been lending money without asking anything in return for the last 2 years. What else can it do?

Well, it has still has some weapons it can use. Quantitative easing, for example.

The idea of QE is that it permits a central bank to fund its government's deficit by printing money. The Fed prints money. It uses the new cash to buy US Treasury debt (or anything else, for that matter.) Result: more money in the system.

Maybe it is fear of inflation that is driving the dollar back down. Have you noticed that after all the "End of the Euro" talk, the European currency is actually back to $1.32?

Stocks, too, may be reacting largely to fears of inflation. If you think higher rates of inflation are coming, owning a piece of a real business is surely better than holding cash. Cash (or bonds) can become totally worthless. A business - if it can survive the financial crisis - will still be worth something...and maybe even more than it was before.

But inflation is no sure thing - at least not anytime soon. The Fed increased the monetary foundation of the dollar-based world by $1.25 trillion when it bought up Wall Street's toxic debts. Still, for the most part, prices continued to fall.

How so? Because money wasn't changing hands...because people preferred to hold onto their cash rather than spend it. Which is what people do when they're worried about the future. Unless, that is, they're worried about inflation. Then, they spend money as fast as possible.

Therein lies a big conundrum for the Fed.

"Damn the risks of triggering a bit of inflation and some modest investment bubbles," says Barrons. "The alternatives are far worse."

But that's just the problem. The alternatives are not worse.

The Fed cannot really create a 'bit of inflation.' Not when the market is scared, and generally de-leveraging. People save. They buy US Treasury bonds. They watch their money and worry. The velocity of money slows, so that even if you add more money to the system, prices still do not rise.

It is like adding snow to the top of a mountain. As long as it remains cold, it just builds up. But when it out!

There is nearly $60 trillion worth of dollar-denominated debt in the world . The value of that debt rests on the value of the money in which it is calibrated. As long as people think the dollar is more-or-less okay, they're willing to have and to hold US dollar debt. The snow stays where it is.

But what would happen if the Fed really did print $2 trillion? Maybe nothing. Or maybe something. Maybe something that was WORSE than the soft depression we're experiencing now - an avalanche or a flood.

People might suddenly want to get rid of dollars - in all forms. Then what? Consumer (and probably asset) prices would soar. Bonds would collapse. You could forget about financing any more deficits. Then, in order to restore faith in the dollar and the Fed's credibility, you'd have to do what Paul Volcker did in '79. You'd have to get ahead of the inflation rate, with Fed-imposed interest rates even higher than the CPI. Those rates would send the economy into a tailspin of de-leveraging, debt cancellation and depression. When Volcker did it, America had its worst recession since the Great Depression. And that was without Quantitative Easing, derivatives, subprime, trade deficits, trillion-dollar federal deficits, housing bubbles, or any of the other maladies we suffer today. The next downturn would be much, much worse.

In other words, the effect of printing trillions more dollars would probably be to cause an even deeper depression than the one the authorities think they are trying to avoid.

They won't do it...not yet.

*** Too much stuff.

People come to think what they must think when they must think it. With stagnant incomes, towering debts, and no real hope of increasing their purchasing power, they're beginning to think that they don't need so much stuff.

"Rethinking the pursuit of happiness in a recession," is a headline from the New York Times. The article talks about people who live quite happily and comfortably with little stuff and little income. One couple has an income of $24,000 per year - and no debt. They make a point of having 100 personal items - or less. They could earn more money, but they don't need to. Because they are no longer supporting so much stuff.

"The idea that you need to go bigger to be happy is false," says the woman in question.

"Studies of consumption and happiness show that people are happier when they spend money on experiences rather than material objects," says the TIMES.

And when people downsize their lives intentionally they end up with more time and money to spend on experiences - such as vacations. Or tennis lessons. Or reading a good book.

You take a vacation. Even if it isn't perfect, you tend to remember the good parts for a long time. An object, on the other hand, gives its satisfaction very quickly...and then becomes a source of expense and nuisance.

We spent the last week cleaning out the garage and the workshop.

"I just can't believe it. I mean, how fast things fill up. We bought this place 15 years ago. It was huge. It was empty. I thought we could fill it with junk for the rest of our lives. But now it's so full, we have to throw things out. Besides, I've had enough of this. I want to get rid of all this. From now on, I want to lead a simpler, more organized life."

Elizabeth seemed ready to take up the "less is more" chant herself.

"No, I don't necessarily want less...I want better. And that means being more choosy and getting rid of junk. We keep things for years and years thinking we'll need them. Then, we don't need them at all and have to throw them out."

Damien (our gardener) backed up a big wagon in front of the garage. Old paint cans. Bicycles with broken wheels. Pieces of steel. Cardboard boxes. A rusty barbecue. Everything went into the wagon.

"Wait...Damien...what's that you're throwing away...?"

Once he gets started, Damien is hard to stop. In his hands was an antique - a hoe-like metal object used for raking the coals out of a brick bread oven.

"Wait a minute...let's save that."

"Why, what good is it?"

"I don't's an antique..."

"Well, if we wait long enough, everything will be an antique..."

"Good point." The hoe went into the wagon too.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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1 Responses to "The dangers of printing trillions more dollars"

Shuvankar bhowmik

Aug 11, 2010

Eye opening article

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