Fed magic

Today, we return to familiar territory. We have seen it before: the slowdown in the economy. The over-pricing of assets (particularly stocks). The huge increase in debt. The Feds’ quantitative easing (QE) programme.

But for all its familiarity, it remains strange and mysterious.

Let’s backtrack.

The foundation for today’s peculiar economy was laid in the ‘60s and ‘70s. In 1968, America’s money became – effectively – removed from gold. In 1971, foreign nations could no longer redeem their dollars for gold, making the dollar the world’s monetary reserve.

Thenceforth, the supply of money and credit was largely taken out of the invisible hands of a free economy, and given to PhD economists working for the US central bank, the Fed.

These economists had a theory, one that seems childishly naive, yet nevertheless seems to work in practice, so far. The more you could get people to borrow, they reasoned, the more demand for goods and services, and the more the economy would produce, giving everyone more access to jobs, incomes, and the satisfaction of getting something for nothing.

The theory maintained that as long as consumer prices didn’t get out of control, more and more credit could be added, stimulating growth.

After some shilly-shallying around in the ‘70s, the new credit-driven economy began to take shape in the ‘80s. Since then, $33trn of spending, buying, investing, producing, consuming and speculating has taken place – funded entirely by additional credit.

That is, if the level of debt/GDP had kept steady, there have been approximately $1trn per year less economic activity over the last three decades.

Is that a success for the PhDs? Or what?

“Or what?” is our guess and our question.


Bill Bonner on markets, economics & the madness of crowds

To sign-up to Bill's free daily email just enter your email address below

Because these emails are completely free, we do have to fund them with advertising. Occasionally we will send you promotional emails, however we will never give, sell or rent your email address to any other companies.For more information, please see our Privacy policy.


During almost that entire time, from 1980 to 2013, not only did consumer prices not get out of control, instead, they seemed to come more into control, with gradually falling consumer price index (CPI) numbers (aided by jiving the figures!) from over 13% in 1980 to barely 1% today.

But here is the curious and incomprehensible part.

If you earned $100 a week, you could normally spend $100 a week. If you had $10 in savings, your savings would represent stored-up purchasing power. So you might choose, in one week, to spend that too. In that week, you would enjoy $110 worth of what the world had on offer. And the economy around you would enjoy an extra $10 worth of demand.

But the $33trn spent by Americans over the last four decades did not come from savings. Instead, it came out of the blue – from central banks and the banking system. It did not represent resources that had been set aside – like seed corn – to prime future growth.

No one ever deprived himself of a single meal or as much as a single beer to save the money. No one troubled himself to work even a single hour to earn it. No one toiled or spun.

Now, if the guy with the saved $10 lent it to someone else, and the borrower spent it, it would have the same effect as if he had spent it himself. So, if the economy had borrowed $33trn from savings and spent it, you’d see the same effect, right?

And what if the $10 or the $33trn couldn’t be paid back? Then, the savings would be lost. The savers would be out. But at least it would make sense. The autos, shopping malls, vacations, retirements, silly gadgets, health care scams, parasitic legal actions, and false-shuffle financial products would have been funded by real money. They would exist for a reason, if not necessarily a good one.

But what happens if the $33trn of pure credit, unbacked by savings, cannot be repaid? Who is out? Who loses?

And how did all those real things: the $33trn worth of goods and services come to exist in the first place, if there were no real money or resources ever made available to fund them?

Is anyone else concerned about this? Are we all alone here?

• Don't miss Bill's next Daily Reckoning. To receive the next article straight into your inbox as soon as he's written it, enter your email address below.

Because these emails are completely free, we do have to fund them with advertising. Occasionally we will send you promotional emails, however we will never give, sell or rent your email address to any other companies.For more information, please see our Privacy policy.

[xyz_lbx_custom_shortcode id=5]

• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

7 Responses

  1. 16/04/2014, Bankeronwheels wrote

    Bill Bonner asks today if anyone is concerned – of course, there are many.
    If the 33 trillion dollars had been issued to the people, not the banks, then all the banks would get is what was left over (savings), instead of which the banks issued it to the people and charged interest. So they had the ‘capital’ and the earnings.Now that fewer people want their money the banks have less income, and there is less ‘capital’ in circulation.
    Surely the bankers have had their day, the ‘Central Banks’, under control, should issue the capital as required and the bankers could do their job of looking after the surplus, only.
    Simples.

  2. 16/04/2014, LERENARD wrote

    I am looking forward to Bernanke’s master plan of dropping money in the streets from helicopters when all else has failed. Just hoping I will be in a drop zone when it happens….!

  3. 16/04/2014, PaulB wrote

    But in the ongoing global economic wars won’t the nations with the greatest paper debt [unless the balloon goes up] be the winners?

  4. 16/04/2014, OldmaninDorset wrote

    I blame credit cards. I’m guilty of buying stuff I didn’t need with money I didn’t have. But not any more.
    In the UK we hear today that inflation has fallen. Apparently this proves that the Government’s policies are working. I think it proves that any statistics can be manipulated. There is an increasing dependency on food banks: the cracks are showing.
    Last week, Moneyweek magazine featured a small terraced house in Hackney which was for sale at £995,000. What madness! If interest rates were where they should be, the whole financial system would collapse. Any so-called recovery is merely a positive blip on the steeply-descending red line which represents the true state of our economy.
    Am I concerned – you betcha! Can I do anything about it? Probably not, apart from greater self-sufficiency and voting for the best of a bad bunch at the next general election.

  5. 17/04/2014, sodit wrote

    The trouble is the $33tr. is all mixed up with the real savings of individuals. If the $33tr isn’t paid back who loses? What’s the betting it’s the real savers who lose and those who’ve handled the imaginary savings who see that turned into real wealth.

    Isn’t that what’s already been happening with the bail out of the banks?

  6. 17/04/2014, Will I am not wrote

    Savers are like rabbits in the headlights at the moment.
    We feel lucky that our savings haven’t been confiscated,
    Pensioners are currently being blamed for the debt of the young spenders. Weren’t they taught at a tender age to save a little and spend a little ?

  7. 17/04/2014, fromHerefordUK wrote

    An very elegant explanation of QE from Bill. We should all be concerned. Put me in mind of an episode of south park ( the space cash ) where aliens turn up with a load of phoney space cash and guess what… See wiki link http://southpark.wikia.com/wiki/Intergalactic_Police for a better synopsis or better still just watch it

Comment on this article

MoneyWeek magazine

Latest issue:

Magazine cover
Hard cash

What's next for gold and silver?

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

FREE REPORT:
What you should really do with your money (2014 Edition)


How to buy and sell penny shares

A beginner's guide to investing in gold

How to invest in British fracking