Some details of why FED prescriptions are't working.

Keynesian Policies Are a Flop

Dear Laissez Faire Today Reader,

Douglas French

World unemployment is on the verge of breaking new records. This trend will continue until 2017. That's the news from the International Labour Organization (ILO) in their annual employment report.

Currently, 2009 is the record year for world joblessness, at 198 million. In its 2012 Global Employment Trends report (source), the ILO believes unemployment numbers will rise by over 5 million this year to reach 202 million, topping 2009's record.

The report goes on to predict that unemployment will rise further in 2014, to reach 205 million. "Unemployment remains as dire as it was during the crisis in 2009," Ekkehard Ernst, chief of the ILO's employment trends unit, told CNBC.

 

But how could this be? More Keynesian monetary power has been thrown at the global meltdown than ever in history. And why? To bring down unemployment. That's the problem that the Keynesian prescription is supposed to fix.

The U.S. central bank has increased its balance sheet from less than $900 billion pre-crash to a new record of $2.946 trillion on Jan. 16. The growth is expected to continue to $4 trillion with its latest plan to purchase $85 billion in Treasury and mortgage debt each and every month until the headline unemployment rate in the U.S. falls to 6.5%.

The Japanese government insists it's a major change that the Bank of Japan agreed recently to launch an "open-ended" commitment to ending deflation through asset purchases and adopted, for the first time, a firm 2% inflation target in a document jointly issued with political leaders. Somehow, everyone forgets the Japanese central bank has been stimulating that economy for more than two decades to no avail.

ECB chairman Mario Draghi has become the leader of the European Union. He wasn't elected by the people, but was elevated as such when he vowed to do "whatever it takes" to preserve the euro. He's now the face of the ECU. The Daily Bell writes,

"Therein lies the evidence of Draghi's divinity. He has vowed, like Beowulf pursuing Grendel, to slay the beast of European dissonance. His weapon is currency debasement, and his lair is the magnificence of the ECB headquarters.

He is, according to Reuters, a hero for the ages, at once modest and savvy, confident and yet inclusive. He is a leader of men and a wonderful wielder of the public purse."

Draghi was the Financial Times person of the year last year, the same honor bestowed on Ben Bernanke by Time magazine in 2009. In fact, Time called Draghi the "savior of Europe" last year, while Bernanke's picture graced the cover of The Atlantic above bold letters "THE HERO."

Yes, Keynesians believe more money and lower rates equal less unemployment. Central bankers have been elevated to godlike status, but the BOJ's, Bernanke's, and Draghi's not-so-secret sauce clearly hasn't worked.

Sure, many of the newly unemployed live outside the developed world, but when Ben and Mario start printing, the effects are felt all over the world.

"The main transmission mechanism of global spillovers has been through international trade, but regions such as Latin America and the Caribbean have also suffered from increased volatility of international capital flows," the CNBC report said.

The ILO also added, "The indecision of policymakers in several countries has led to uncertainty about future conditions and reinforced corporate tendencies to increase cash holdings or pay dividends, rather than expand capacity and hire new workers."

Indecisive? Hardly. Central bankers have one tool -- money printing. They do it either fast or slow. They already collectively have the pedal to the metal and are on the verge of flipping the jet propulsion switch.

However, Christina Romer, former chairwoman of President Obama's Council of Economic Advisers, writes in the Gray Lady that the Fed has moved slowly, and wonders, "Why are some policymakers threatening to undo the recent actions?" She's referring to comments by presidents at two Midwestern Federal Reserve banks.

"It is a very aggressive policy, and it is making me a little bit nervous that we are overcommitting to the easy policy," St. Louis Fed President James Bullard told reporters after a speech to the Wisconsin Bankers Association. "We are taking risk."

Kansas City Federal Reserve President Esther George, sounding almost Austrian, said, "Monetary policy, by contributing to financial imbalances and instability, can just as easily aggravate unemployment as heal it."

Romer and her husband, professor David Romer, believe pessimistic attitudes have hampered the central bank's effectiveness. The Romers write in a paper titled "The Most Dangerous Idea in Federal Reserve History: Monetary Policy Doesn't Matter" that pessimists at the Fed during the early 1930s led to "inaction in the face of the largest downturn in American history."

That sounds good, except the Fed did all it could to expand the money supply. In his book America's Great Depression, Murray Rothbard chronicles the Fed's continued actions from after the stock market crash of 1929 to 1932. Jeffrey Tucker quoted Rothbard at length in a recent article.

Following the stock market crash, Rothbard writes that the government's easy money program dropped rediscount rates 42%. Despite this move, the money supply remained constant while production and employment fell.

In 1931, the Fed did its best to inflate by raising controlled reserves. Citizens foiled this plan by converting their bank accounts to currency. Rothbard writes that "the will of the public caused bank reserves to decline by $400 million in the latter half of 1931, and the money supply, as a consequence, fell by over $4 billion in the same period."

The next year, while the Fed stimulated, banks did not lend the money out, but instead piled up excess reserves. Just as banks have done in the current crisis. "Naturally," Rothbard continues, "the banks, deeply worried by the bank failures that had been and were still taking place, were reluctant to expand their deposits further, and failed to do so."

Rothbard, evidently, isn't on the Romers' reading list. Today, the Fed is peddling as fast as it can, but commercial bankers and their regulators have their feet on the brakes. Maybe borrowers want to borrow when rates are low, but lenders sure don't want to lend, especially while they are still licking their wounds from the real estate crash.

It was the same in the early 1930s. As Rothbard summarized:

"In a time of depression and financial crisis, banks will be reluctant to lend or invest, (a) to avoid endangering the confidence of their customers, and (b) to avoid the risk of lending to or investing in ventures that might default. The artificial cheap money policy in 1932 greatly lowered interest rates all around, and, therefore, further discouraged the banks from making loans or investments."

Businesses are storing cash, waiting for the smoke to clear. Hiring people is expensive, and the Fed has trampled the primary signaling mechanism to the market. Austrian economists would say that these low rates only serve to deceive entrepreneurs into believing that people have saved more than they really have and that money should be invested in higher-order goods, such as factories and equipment.

In that case, these low rates only prop up the prices of real estate and other capital assets that likely need more downward adjustment from the boom. A normalization of rates will hasten that process and get people back to work.

But don't hold your breath. After all, Romer isn't reading Rothbard, and central bankers aren't perusing this space. They'll keep printing money that goes only to Wall Street speculation, the press will call them heroes, and you'll still be stuck trying to find your way out of their mess.

How do you navigate the topsy-turvy world created by these superhuman central banker heroes? Addison Wiggin has seen this train coming for years. Here are 47 ways you can protect yourself from a shrinking dollar.

More unemployment will mean more money printing, which will mean more unemployment, which will mean... surely you have it by now.

Sincerely,

Doug French

P.S. Readers of F.A. Hayek's great book A Tiger by the Tail could easily have predicted this quagmire. Decades ago, Hayek showed how central banking policy designed to correct unemployment only ends in creating more. He shows precisely how this happens too. Hayek's analysis is like a decoder ring for the world macroeconomic environment today.

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