The Federal Reserve System has the power to create money, which it puts into the U.S. economy by buying Treasury bonds or other financial assets. The chart above, which comes from the Federal Reserve Bank of St. Louis, shows how the money supply has more than tripled since Barack Obama was sworn in as President.
Recently Ben Bernanke, the chair of the Federal Reserve Board, announced that the Fed will spend $40 billion a month to buy mortgage-backed securities (aka toxic assets) until employment is back to normal.
The theory behind this is that putting more money into circulation will stimulate economic activity, because banks will increase their lending to American small businesses and consumers. As economist Michael Hudson (shown in the video in my previous post) pointed out, this hasn’t happened. The big Wall Street banks have more profitable things to do with their money. What the Fed’s action does is to relieve the big Wall Street banks of the consequences of the 2001-2007 house price bubble and set the stage for a new bubble.
Another of the Fed’s policies has been to hold down interest rates to virtually zero. The theory behind this is that Americans will borrow more and this will stimulate economic activity. The actual result has been to artificially stimulate the stock market by driving money out of bank savings accounts.
Taking myself as an example, I get virtually no interest on my bank account. This means that as a result of inflation, which is low but not zero, my savings are worth less in real terms than they were at the beginning. This creates an incentive to venture out into the financial markets. But since stock prices are being lifted by something other than the perceived value of the companies issuing the stock, there is bound to be a fall.
One cause (or definition) of inflation is too much money chasing too few goods. During the past three years, the Federal Reserve System has more than tripled the amount of U.S. dollars, but this has not gone into increased production of U.S. goods. Inflation is low in historic terms, but there is no guarantee this will continue. I don’t see how this can possibly end well.
The “monetary base” is spendable money, including cash and coins, bank accounts and money market funds. There are other measures of the money supply, which include bank savings certificates, Treasury bonds and certain other kinds of financial assets.