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EDITORIAL: The Fed’s bubble fuel

The path to killer inflation is paved with easy money

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The consequences of the Federal Reserve's loose-money policy are starting to hit home. Even members of the Federal Open Market Committee are concerned, as revealed in the Wednesday release of the minutes of a meeting earlier this year. The document doesn't name names but says that "several participants" expressed doubts about the wisdom of the Fed's commitment to buy $85 billion in bonds month-after-month until the economy improves. That won't be soon, so they're worried that the money-pumping effort is setting the stage for dramatic inflation and another asset bubble, similar to the housing bubble that set off the collapse of the economy in 2007.

The Federal Reserve's mission is to reduce unemployment and keep inflation down. It has a single tool to accomplish these goals: monetary policy. The tool isn't up to the task, as recent history has shown. At the start of the Great Recession, the Fed embarked on a policy of expansion. The economy didn't get better, so the Fed switched to what it called Operation Twist, to drive down interest rates by substituting longer-term securities for the short-term bonds it has traditionally held. That didn't solve anything, either. For its third trick, the Fed opened the money spigot with another round of quantitative easing known as QE3. Under this scheme, the Fed continues to purchase $45 billion in Treasury bonds and $40 billion in mortgage-backed securities until unemployment drops to 6.5 percent.

Creating all this money out of thin air is overheating the printing press at the Treasury. The Fed's balance sheet has swelled beyond $3 trillion, triple its 2008 value. This extraordinary effort has indeed kept interest rates close to zero, and that's not necessarily a good thing. Easy money advocates insist the low rates will inspire the private sector to borrow cheap money for investing to create jobs and reduce unemployment. Instead, the economy remains stagnant, with unemployment still at 7.9 percent.

Low interest rates haven't proved to be magic. While the housing sector has improved as some consumers take advantage to buy new homes, lenders don't get much return on their investment. Consequently, lenders have become extremely picky, lending only to the small number of borrowers who pose almost no risk. Many companies are sitting on large cash reserves; they're not investing because they're scared of the red tape that keeps unreeling from Washington. Companies big and small are terrified of the havoc created by the passage of Obamacare. Even those in the golden years of retirement are feeling the pinch because their savings and investment accounts are pulling in near-zero yields. That leaves them with less money to buy goods and services.

The stock market has climbed even as the real economy has failed to grow. That's a warning signal that the gains could be nothing more than an asset bubble that will pop when the Fed is forced to reverse course to curb inflation. The Fed must realize continuing down this path of failure only makes it harder for the economy to recover.

The Washington Times

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