The Federal Reserve's Strategy is Pouring Gasoline Onto a Fire


If insanity is doing the same thing over and over and expecting different result, then the Federal Reserve (Fed) is completely nuts. It announced today that it would keep its bond-buying scheme (buying off the debt, basically) at its current level of $85 billions/month for "as long as it felt extra stimulus was needed." In other words, it will never stop with the current course of the economy.

Just look at this employment graph, showing every recession since 1945 and the time it took for employment to get back to its previous peak.

This is the slowest recovery since we keep track of them. Labor underutilization (the unemployed, the unemployed who are discouraged and part-time workers willing to work full-time) is also still above its pre-recession levels at 14.3%, although it is slowly decreasing.

Why so slow? For one thing, the infamous "Affordable" Care Act isn't helping at all; it's so affordable that many, including unions, want a waiver. With its employer mandate kicking in when a business has 50 employees, many will have an incentive to stay at 49 or fewer to hire part-time workers (under 30 hours), even in the public sector. Because of that, employment statistics get distorted as many people will take more than one job in order to work more hours. It might also exacerbate immigration problems, should a reform be one day adopted, as amnestied immigrants would be exempted from the employer mandate for some time.

The Fed, this pyromaniac fireman, isn't helping either. It encourages government spending by buying off its debt and by keeping near-null interest rates that encourage borrowing. Doing so will also encourages the formation of another bubble, as it did during the 1920s, 1960s and 1970s, 1990s and the early 2000s.

Bubble are easy to understand. Normally, interest rates are determined by the equilibrium between supply (wanting to save money) and demand (wanting to borrow money) for saving. If there are more borrowers, interest rates rise, and vice-versa if there are more savers.

However, when a central bank controls the interest rate, this equilibrium disappears. When interest rates are too low, projects deemed non-profitable because of the interest rate suddenly become affordable, prompting the investment. Soon enough, more and more of those projects are realized, creating a bubble since demand isn't supported by a proper supply. The longer it is inflated, the more painful the crash is as 1929 and 2008 can be a reminder of.

So if the Fed really wants to help the economy, it would stop its quantitative easing immediately so that government spending would have to decrease. In the long run, it would also disappear so that government can stop tampering with the monetary system. Its consequences (economic cycles and inflation, among others) have been well-known for centuries.