By Larry Kudlow
Saturday, September 15, 2012
About 30 years ago, Paul Volcker launched a monumental
monetary effort to bring down inflation. As Fed chairman, he sold bonds,
removed cash from the economy and cared not one wit about rising interest rates.
And it worked. Gold plunged, King Dollar soared, and the drop-off in bank
reserves and money extinguished high inflation -- and actually launched a
multi-decade period of very low inflation.
This week, current Fed chairman Ben Bernanke embarked on
an absolute reversal of Volcker's policy. He is launching a monumental effort
to buy bonds and inject new money into the economy in order to reignite
economic growth and job creation. It's like history is repeating itself, but in
reverse. Gold is soaring, the dollar is falling. Something's wrong with this
picture.
Bernanke's QE3 is an unlimited Fed effort to buy mortgage
bonds with new cash. The plan -- which starts immediately -- envisions $40
billion of bond purchases and money-creation per month, coming to $480 billion
over the next year. And there are no limits to these purchases. These
operations are open-ended. This could last for years -- maybe in perpetuity --
until job creation shoots way up and unemployment comes way down.
Nothing like this has ever been used by our nation's
central bank. The Fed's balance sheet, which has ballooned from around $800
billion to $2.5 trillion under Bernanke, will go to $3 trillion, or $4
trillion, or who knows how high.
But here's the rub: More money doesn't necessarily mean
more growth. More Fed money won't increase after-tax rewards for risk,
entrepreneurship, business hiring and hard work. Keeping more of what you earn
after-tax is the true spark of economic growth. Not the Fed.
In the supply-side model, the combination of lower
marginal tax rates, lighter regulation and a downsized government in relation
to the economy is the growth-igniter. Money, on the other hand, determines the
value of the dollar exchange rate and subsequently the overall inflation rate.
A falling dollar (1970s) generates higher inflation; a rising dollar (1980s and
beyond) generates lower inflation.
This is the supply-side model as advanced by Nobelist
Robert Mundell and his colleague Arthur Laffer. In summary, easier taxes and
tighter money are the optimal growth solution. But what we have now are higher
taxes and easier money. A bad combination.
The Fed has created all this money in the last couple of
years. But it hasn't worked: $1.6 trillion of excess bank reserves are still
sitting idle at the Fed. No use. No risk. Virtually no loans. And the Fed is
enabling massive deficit spending by the White House and Treasury.
Now, one key political point is that Bernanke's desperate
money-pumping plan to rescue the economy is a very blunt admission that
Obamanomics has completely failed. The president is asking voters to give him
more time, which is a very weak argument. But his Fed chairman is essentially
saying we are running out of time and have to embark on this massive monetary
action. Mitt Romney should use the Bernanke argument, but not the Fed solution.
Some argue that Bernanke so desperately wants a
victorious Obama to reappoint him that he's printing money and driving up stock
prices on the eve of the election. I prefer not to believe this cynical
interpretation. As an old ex-Fed staffer, I would argue that it's not a
political agency. Although I have to admit, on the eve of the election, the
question is going to be asked.
More to the point, the Achilles' heel of the Bernanke
plan is the collapse of King Dollar, the result of printing so many new ones
for so long. That, in turn, will drive up commodity prices, especially energy
and food, and will do great damage to the middle class, which is already
suffering from income declines and rising living standards.
This is what happened in 2011, when QE2 did more harm
than good to the economy. Middle-class savers and retirees will also get their
heads handed to them because of rock-bottom interest rates. And bank lenders
may withhold credit since the difference between short and longer rates is so
narrow there's no incentive to make loans.
So at the end of the day, Obama's economic program of
tax, spend and regulate has been a dismal failure. And now his Fed chairman is
acting dramatically to bail him out. Guess what? It won't work.
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