• Matthew Fuzi

Behold, The Money Printer: A Point of No Return for Monetary Policy?

Updated: Aug 10, 2020

Beware the allure of free money. Image Source: Pixabay

While much of the world weathers the aftershocks and attempts to prevent a resurgence of COVID-19, the novel Coronavirus continues to ravage the United States after a series of failed attempts to contain the spread of the virus.

The ongoing and crippling resurgence is only recently beginning to show the earliest signs of slowing across the most afflicted states, whilst several states in the process of reopening are now attempting to mitigate their own second waves.

Among the most syndicated issues surrounding COVID-19 has been the impact of pandemic restrictions on the economy and private enterprise. The most visible symptoms of which have been a sudden 350% increase in the unemployment rate during the month of April and the shuttering of hundreds of thousands of small businesses nationwide.

Likewise, Congress has been no less tumultuous in attempting to alleviate these persistent economic woes. Gridlock on the House floor over the weekly amount continued benefit payments has led to a recent lapse in federal unemployment benefits.

Meanwhile, The U.S. Senate is debating another proposed emergency aid package, the details of which are raising eyebrows. Allocating funds to bolster federal unemployment benefits to the end of the year (albeit at a reduced rate of $200/week), support struggling businesses, reopen schools, and provide direct payments to households, the leading Republican proposal amounts to a nearly $1.1 trillion increase in the federal budget.

By contrast, the Democratic proposal tops out at nearly $3.5 trillion in addition to the current federal budget, and would include noticeably larger allocations in each of these categories, including the sustaining of federal unemployment benefits at $600/week, as well as including an additional $1 trillion in allocations for direct aid to states and more than $200 billion in aid for housing relief.

It is a mainstream acceptance of highly-interventionist fiscal policy, backed by a rapidly-expansionary monetary policy, that has economists concerned about both the short-term impacts, as well as the long-term implications, of such an approach by U.S. policymakers.

The U.S. Dollar: A Fiat Among Fiats

The U.S. Dollar is recognized worldwide as being among the world's most reliable fiat currencies; legal tenders are backed by the governments that issue it, as opposed to commodity currencies which derive their value from the equivalent amount of a particular raw good such as gold.

As fiat currencies have no intrinsic value, their exchange value is determined largely by the monetary policy of its issuing government. In the case of the United States Dollar, the Federal Reserve, the central bank of the United States, does this through controlling interest rates via the federal funds rate. Using open-market operations, the Federal Reserve uses the sale and purchase of U.S. government debt securities, i.e., Treasury bonds, to regulate the supply of dollars in circulation.

It is also through the process of purchasing these Treasurys that the Fed creates new currency; in purchasing new securities, the central bank simply credits the value of the new securities to balance sheets of its member banks and debtors, effectively printing new dollars “out of thin air."

To this end, ever since President Richard Nixon removed the U.S. Dollar from the Gold Standard in 1971, the primary financial instrument backing the value of the U.S. Dollar has been the increasing amount of outstanding government debt.

Beyond the Horizon: A New Direction for Monetary Policy

In response to the COVID-19 pandemic and the near-unprecedented spike in unemployment that it has created, the priorities of both lawmakers and the Fed alike have been to sustain economic activity by stimulating investing and consumption, as opposed to saving.

Thus, the Fed has pursued a policy of rapidly decreasing interest rates, with the federal funds rate at nearly 0%, while Congress continues to pursue a series of stimulus bills meant to shore up economic activity and avert a deepening of the recession.

Given the trillion dollar price tag associated with both active bills, it is becoming evident that the fiscal and monetary direction of the United States is entering a new paradigm. One of uncompromising Keynesian expansionism, as well as a departure from the independence of the Federal Reserve, which has many pundits describing this shift as the beginning of a new era in U.S. economic policy.

This new age of financial and macroeconomic policymaking will feature a set of new priorities. Regulators will no longer be preoccupied with the maintaining of stable rates of interest and inflation, but rather with weighing the opportunities and risks of astronomic stimulus expenditure as well as government intervention in capital markets.

It will be an era of unparalleled monetary expansion and quantitative easing. One marked by an increased reliance on fiscal spending in order to stimulate economic growth. One marked by a mind-boggling uptick in government borrowing and skyrocketing budget deficits. One marked by the creation of new central bank reserves for the purpose of debt buying, where the nominally-independent banks will play a critical role in bankrolling fiscal stimulus. One marked by central banks shouldering a remarkable degree of corporate debt and lending capital to any accredited private entity.

As the Economist observes:

America’s government is set to run a deficit of 15% of GDP this year — A figure that will go up if more stimulus is needed. Across the rich world, the IMF says gross government debt will rise by $6 trillion to $66 trillion at the end of this year, or from 105% of GDP to 122% — A greater increase than was seen in any year during the global financial crisis.
Together, the Fed and Treasury are now backstopping 11% of America’s entire stock of business debt. Across the rich world, governments and central banks are following suit.

And yet, insight of these realizations, the new economic order will likely have some peculiarities.

Despite the ballooning money supply, inflation will remain low for the foreseeable future, as the slowdown in U.S. aggregate demand means minimal upwards pressure on pricing.

Alongside record low interest rates, government borrowing will become more affordable, making fiscal spending cheaper in the process. This will be useful for governments in the developed world, as in a post-pandemic society where supply chains are in ruins and a rapidly-aging population strains pension and healthcare systems, calls for increasing public spending on infrastructure and welfare will dominate public policy discourse in the decades come.

Ironically, if interest rates and inflationary pressures remain relatively low in this ultra-Keynesian future, servicing government debt may still be a genuine possibility for future policymakers.

And yet, it is these two variables, interest and inflation, that could ultimately derail the efficacy of this new ultra-interventionist policy. As this neo-Keynesian approach will rely upon the absurdity of both low interest rates as well as low inflation, an increase in either could result in massive disruption and potential collapse.

Moreover, the uncertainty of future government administrations, diplomatic tensions and trade projections will impart this degree of unpredictability into future of monetary objectives, especially for the United States.

In short, despite the short-term benefits to central banks and legislators, the innate fragility of this new monetary direction cannot be understated.

Investment Alternatives

Given the dramatic and extraordinary shift in monetary priorities, the risk of inflationary pressure in a post-pandemic world means it is liable that the value of the U.S. dollar will continue its downward spiral.

This has many current savers priming themselves to become investors. The question remains however; where should seasoned and newly-minted investors invest?

In response to persistent volatility in more traditional assets like stocks and mortgage-backed securities, some have turned to commodity trading, the most profitable as of late being gold. Since the beginning of January, the price of gold has soared from $1529 an ounce, to more than $2000 an ounce as of August 5th, and many monetarists have taken this as a sign of the Gold Standard’s functionality over currency fiat.

Alas, in the words of Shakespeare: “All that glisters is not gold."

Gold tends to excite short-term speculators over long-term investors, contributing to gold’s notorious volatility as many speculators are liable to sell their gold assets in within the span of a few years. This is especially true during global economic crises and recessions, when distrust in fiat currencies leads some actors to seek alternatives.

Add to this a wildly-fluctuating Consumer Price Index ratio, and on average, gold falls short of meeting its previous value by more than 50%, making it a poor hedge against inflation.

Still, other commodity traders have not been deterred, looking to petroleum, which has managed to rally over the summer after plunging to a record negative $37 per barrel in the wake of COVID-19 fears and a price war between Saudi Arabia and Russia. Now trading at roughly $40 per barrel, many are citing crude's recovery as a sign of its investment-grade viability.

Nevertheless, living up to the title of "black gold”, crude oil remains a risky instrument of speculation. On top of the short-term nature of most futures contracts, the highly-politicized nature of the petroleum industry, particularly the conflicts between OPEC members and Russia, as well as the accelerating development of renewable energy