Value Destroyers Like Bernanke Fancy Themselves Magician Economists

Economics is not magic. Yet today, many prominent economists insist on pulling off an economic rabbit hat trick when they propose getting something for nothing. Economists who advocate solving the world’s economic woes with an inflationary central bank, or even a trillion dollar coin, have lost sight of the basics of their profession.

Worse are the central bankers who implement these policies. In a futile attempt to juice labor markets, U.S. Federal Reserve Chairman Ben Bernanke expands on the third round of quantitative easing this month by adding in $45 billion monthly purchases of U.S. sovereign debt, and the Bank of Japan—caving to pressure from its new prime minister—raised its inflation target last week to attempt similar monetary stimulus and finance government spending.

They have all forgotten a founding tenet of economics that French economist Jean-Baptiste Say discovered in 1803: People supply what they demand.

For example, let’s say that in any given month, a carpenter builds 15 chairs and an apple grower harvests 30 apples. They can consume 15 chairs’ worth or 30 apples’ worth of other goods. Either individual has the option of saving his production instead of trading it away, thereby opting to fulfill future demand. Conversely, they could demand more than they produce in the present by promising to supply more chairs or applies in the future, thus issuing debt. Both still must ultimately consume what they produce in the long run.

Money expedites trade between individuals by dramatically reducing transaction costs. By denominating the value of a chair, apple, etc. in easily portable units that everyone accepts, a buyer of one person’s supply need not be the supplier of the same person’s demand. The carpenter and apple grower can now spend more time making chairs and picking apples and less time finding mutually beneficial transactions.

More money doesn’t make everyone richer; more production does. The carpenter and apple grower don’t want money per se, but the value of their products that money represents. Increasing the currency in circulation doesn’t change the fact that there are still 15 new chairs and 30 new apples per month in our example.

Economists who advocate raining down dollar, euro, and yen bills from their high-flying helicopters say this needs to be done to gin up flagging demand, but this puts the cart before the horse. One cannot demand anything without first having something to supply. The crisis today is not that economies aren’t demanding enough value, but that they aren’t creating enough value.

Consider what happens in our example when a central bank prints more money. The newly minted currency makes its way into the economy through purchases of sovereign debt held by certain individuals authorized to do business directly with the central bank, called primary dealers (in real life, these are large financial firms). The carpenter is one of these lucky few, while the apple grower is not.  He receives the money before his fruit-growing friend, and now has not only more currency at his disposal but also more value. The central bank diluted the value of one dollar and gave the carpenter more of them. He is now richer, the apple grower is now poorer, and the economy is worse off due to the central bank having distorted the natural allocation of value created through free interactions in the market.

Inflating the supply of money is inherently redistributive. In recent years, redistributive monetary policy has benefited finance at the expense of other productive industries. Consider the U.S. bubble economy of the mid-1990s. Cheap money from the U.S. Federal Reserve redistributed value from the rest of the economy to primary dealers within the financial industry. Even after the 2008 crisis exposed the industry’s inefficiencies and bloated size, the Fed continued to support the employment of its financier friends through zero-interest rate policy.

According to my calculations on data from the Bureau of Labor Statistics and the Federal Reserve, employment in business management and finance during the past 20 years correlated negatively at a moderate magnitude with changes in the interbank interest rate. Simply, financial employment increased when interest rates decreased. Moreover, production suffered while finance boomed. Industrial employment had a strong positive correlation with the interbank rate over the same period.

Another pernicious effect from the printing presses running overtime is inflation. The signs are already out there. Major stock indices have recovered to their pre-crisis highs, despite the global economy still being stuck in a rut. The International Monetary Fund’s commodity price index has increased by over 100 percent in just over two years. And a trip to the grocery store these days requires bracing for a case of sticker shock for fresh produce like apples. Once primary dealers start lending their new money, generalized inflation will be a real danger, threatening price stability.

Central bankers—whether Ben Bernanke, Mark Carney, or Mario Draghi—can only use monetary policy-driven redistribution and inflation to tread water in a sea of distorted economic incentives for so long. Eventually, productive individuals go broke and so do the inefficient living off of them. The economy crashes. Houdini economists have yet to realize something every magician knows well: At some point the show must end.