Monetary policy mistakes we are suffering today, started in 2008. Fed Chair Ben Bernanke embarked on a new, unproven and dangerous policy called Modern Monetary Theory or MMT. The Fed Reserve’s FOMC abandoned Austrian Economics and embraced its opposite, MMT. Chairs Yellen and Powell followed. The new Chairman of the Fed Reserves, Kevin Warsh, says he will not. I pray he will reduce the amount of liquidity in the economy.
MMT’s Achilles heal is the failed belief that the Fed Reserve could create unlimited amounts of currency (US Dollars) with no repercussions. The Fed embarked on Quantitative Easing in 2008 and created $8 Trillion new “dollars.”
What happens to a commodity when there is too much of it? Its value declines. Dollars are no exception.
When the Fed Reserve ballooned its balance sheet from $800 Billion to $9 Trillion, the end game was set. Economist Brian Wesbury calls this “abundant reserve.” Bankers call it excess liquidity. Bottom line: the number dollar in circulation makes a difference in the purchasing power or strength of the dollar.
More dollars in circulation, leads to less purchasing power of those dollars. Devaluing the dollar’s purchasing power leads to price inflation.
The Fed Reserve’s first objective is to hold the value of the dollar, do not let it decline. Excess money supply devalues the dollar’s purchasing power. That is the root of inflation.
As the value of the US Dollar declines, it can buy less. This caused price inflation (the buyer must give more dollars for the same commodify). Today’s inflation is not caused by scarcity but by dollar devaluation.
There are three parts to the MMT and QE puzzle: the Federal Reserve “printed” US Dollars (actually increased the amount of liquidity), the Treasury Department issued Treasury debt (bonds, bills and notes) and Congress spent the excess money on more government programs.
Instead of living within our means, politicians decided to go into debt. They don’t pay that debt back, we do. So, why elect a politician that puts you into crushing debt?
The solution is simple, painful and absolutely mandatory. The Fed Reserve must reduce its balance sheet by destroying excess US Dollars (reducing Liquidity or money supply).
And now for the rest of the story…the Fed can’t just “print” a bunch of dollars, they need a counter entry provided by the Treasury Department. Each dollar created using Quantitative Easing (QE) is counter balanced by a Treasury Bond, Bill or Note. Debt.
Ergo, when the Fed destroys excess liquidity in the economy, the Department of Treasury must also redeem and retireTreasury debt instruments. We should rejoice because that means we citizens have less debt to pay off. Yes, we pay the debt when Treasury issues bonds and notes.
The third leg is Congress. It must severely reduce spending. The current, and past, level of federal spending is absolutely not sustainable. Everyone’s favorite pork project has to be cut. The size and scope of our government must be constrained.
Over the past century we have become addicted to deficit spending, going into debt more and more just to continue our profligate spending habits. Our politicians must also live within its means. We individuals have this discipline in our own lives, now we must demand the same discipline of bureaucrats and politicians, of both parties.
Even with $38 Trillion in hard debt and another $40 Trillion in unfunded commitments, our private economy is strong enough to pay down this massive debt in a decade if we start now, by severely reducing spending and retiring federal debt instruments when they mature.
The formula is simple, limit federal spending to 2% below GDP and dedicate another 2% of tax revenue to actively paying down the debt. Neither bureaucrats nor politicians can be trusted to limit their spending on themselves. We citizens must do it. Future generations will appreciate this. We will have done our duty to pass along a Constitutional Republic.
Jay Davidson is founder and CEO of a commercial bank, a student of the Austrian School of Economics and a dedicated capitalist. There is a direct connection between individual right and responsibility, our Constitution, capitalism, and the intent of our Creator.