Many people don’t know what the Federal Reserve does, or even what it is supposed to do. To get bare bones, the Federal Reserve regulates how much money there is in the economy. The answer to the question “What is the Fed supposed to do?” is easy. Congress has laid out mission for the Federal Reserve: to ensure maximum employment (i.e., everyone who wants a job can get a job) and stable prices (theoretically this means an inflation rate of zero).
It doesn’t take an economist to figure out that the two goals are opposed to one another. High inflation means more money, which generally means more jobs. High employment means a lot of people are spending a lot of money, theoretically causing inflation. So to be clear: more jobs = more inflation, fewer jobs = less inflation/deflation.
Today the Federal Reserve is looking at a situation in which unemployment is high, dragging down the rate of inflation to nearly zero. So the answer is obvious, right? The Fed should inflate away. The problem is, that when the Federal Reserve inflates the money supply, bankers and the federal government receive all the new money. Unless you happen to have an electronic bank account linked directly to the Federal Reserve bank in New York, you don’t. That’s great for bankers and the government, but what about John C. Retiree who gets nothing? His dollars are essentially diluted. His money is worth less today than it was yesterday. Just as when stock options are given to CEOs, thereby diluting the shares of investors, when new dollars are handed out to only a select few, the rest see their dollars lose value.
Your savings are being slowly stripped of their value by a major dollar dilution being led by the Federal Reserve. This dollar dilution is called “quantitative easing” (QE). If you see those words in the newspaper, consider it a sign that you’re getting poorer. The Federal Reserve has already undertaken one cycle of QE. It is now planning another, which is being called QE 2.
The Fed is supposed to target price stability, but this week Fed chairman Ben Bernanke started to spin the issue with a speech outlining why it would be just fine to steal your money with inflation. It’s titled “Revisiting Monetary Policy in a Low-Inflation Environment.” In short, Bernanke & Co. believe the only way to pull the country out of its economic slump is by inflating the currency. In theory, the dollar devaluation caused by the policy will make exports from the U.S. more attractive to foreign buyers. This would be a great idea if exports were responsible for the end of any recession since the Korean War. The U.S. has fallen so far behind in exports that I can’t imagine a situation in which trade expansion will lead the U.S. out of this economic trough. That goal is hurt further by Democratic opposition to free trade deals. There are currently deals pending with multiple countries, including a no-brainer deal with Colombia. Democrats oppose the deals because their union supporters see trade as a disadvantage to the country.
The bottom line: the intentions of Ben & Co. may be good, but they are hurting America’s savers and consumers in the long run for a short-term political win. Sure, they might inflate away today’s problems and make them seem to disappear for a while, but in reality the Fed will be repeating the same policies that got America into a housing disaster in the first place. Look for more trouble down the road.