By Ravi Kant
Some basic facts of the 2008 financial crisis: One could argue that the major cause for the collapse of the US stock market was low interest rates by Alan Greenspan and Larry Summer’s call for deregulation of the Glass-Steagall Act. Together, it created the stock as well as the housing bubble in the US. The impact of the collapse of the US stock market was felt across the global financial market affecting billions of lives across the continents. Soon, the major central bankers were involved in the biggest rescue mission of the financial market after the “The Great Depression” of 1929.
Bernake’s role in U.S economy
In February 2006, Ben Bernanke replaced Alan Greenspan as the chairman of the Board of Governors of the Federal Reserve System. Bernanke was responsible for guiding the monetary policy of the U.S economy during 2008. As Federal Reserve chairman, he created many financial tools to suppress the global recession. These included among others, lowering the interest rate, operation twist and forward guidance. According to him, the Great Depression of 1929 was a byproduct of a liquidity crisis. He thought that the only way out of such financial crisis is to provide much needed liquidity to the banks and in the market. Quantitative Easing (QE) was one byproduct of such thinking. It had been operational in Japan for the past 20 years. Runs on the banks were tapered with such monetary policies.
Quantitative Easing as a monetary tool
Quantitative Easing is a monetary term defined as massive currency printing by the Central Bank to avoid a deflationary crisis in the short term. However, that extra currency never goes to individuals, but ends up in bank balance sheets as form of excess reserves. In a span of three years starting in 2008, Bernanke was involved in massive currency printing worth 3.8 trillion dollars. That easy money did not surge any real demand in the economy. On the contrary it got soaked up in the already popped up stock and housing markets. The result was the biggest stock bubble created in US history since 1929.
Negative effects of QE
QE affected not just the U.S., but also other economies in the form of food inflation. It led to massive political upheaval in the middle east and regions across Africa. The adversaries of the “QE” policy are from all spectrums of society. Boom and bust cycles follow a certain trend. Bernanke opened a Pandora’s box by refusing to use any monetary policies to counter the bust. The central banker was targeting inflation to avoid the deflationary crisis, which was hovering over the US economy after the 2008 crisis. Using QE was the right medicine at the wrong time.
The key to the growth is innovation/technology improvements, social needs and demand rather than financial engineering. Financial engineering in the form of QE or zero interest rate policy or negative interest rate policy can be good to boost growth in the short term. However, in the longer term QE has adverse consequences on the macroeconomic stability and people at large.
The illusion of “helicopter money”
Despite all the monetary measures taken in eight years, Bernanke was not able to achieve the target 2% inflation. As fiscal and monetary policy reached their limits, Bernanke turned to “helicopter money” to boost global growth. In normal situations, governments lend money from the Central bank by issuing bonds or securities depending upon the need and state of the economy but in case of helicopter money, the government itself acts as a central bank and prints as much money as it takes to boost growth. Helicopter money is a political abuse of fiscal policy measures as it gives politicians an unlimited access to monetary resources.
America and the world at large are curious about the economic policy of the new president elect Trump. A little insight to his statements from the election campaign will give us a clear understanding about “Trumponomics.” During the campaign, President Trump threatened the Federal Reserve’s independence and heaped criticism on Fed chair Janet Yellen. His “bully” behavior shows that he no longer will allow the American economy to be solely dependent on monetary policy for growth. Trump proposed a loose fiscal policy of $1 trillion dollar of infrastructure spending as well as a large defense budget to boost growth.
One of the key problems with fiscal policy proposed by Trump is that it questions the very idea of existence of fiat money and also transfers asubstantial amount of wealth from the poor and middle class to rich.
“Helicopter money” results in hyper-inflation as seen in the case of Zimbabwe and Venezuela where inflation reached 1500% and 2000% of its previous level, respectively. Such fiscal policies might end a centralized economy and open the doors for free markets. It could also establish a new international monetary system. The question that confronts Donald Trump is whether he is willing to take such a gamble with the U.S. Dollar as a reserve currency.