The Many Downsides of Central Bank Printing Money

The US Federal Reserve Bank (the Fed), the European Central Bank (ECB) and the Bank of Japan (BoJ) have each launched an aggressive new bond-buying program to push down the cost of debt and to thereby add stimulus to their flagging economies.  Through this “Quantitative Easing” (QE or in plain language, “money-printing”) the Fed will buy $500 billion per year in mortgage backed securities.  That’s about as big as US federal budget deficit.  The Fed increased its asset holdings from $800 billion in 2008 to almost $3 trillion now, largely in treasury bills with longer maturities than before.  The ECB announced it will buy unlimited amounts of European Union (EU) government member debt to push down high interest rates faced by some EU members (especially Italy, Spain, Greece, Portugal and Ireland).  The BoJ plans to buy 5 trillion Yen of US Treasury bills and 5 trillion Yen of Japanese government bonds by the end of 2013.

Printing money at this pace risks runaway inflation, yet US inflation is currently tame (all-items CPI is 1.7%) and there are no warning signs that alarm the Fed.  Still, beyond central bank control, events such as an unexpected war, a natural disaster, legislative lunacy or a severe trade dislocation could trigger inflation, and that would make it much costlier for nations to roll over the debt held by their central bank.  This is not unimaginable.  Consider the late 1980s when the President Carter-Iran standoff pushed US mortgage rates above 17%.

The Fed could step in to fight intolerable levels of inflation by selling from its warehouse of bonds, but that would drain growth from the economy.  If the economy were already in recession (as may happen if politicians push us off the fiscal cliff) then the Fed would have no tool that simultaneously fights inflation and rescues the economy from a vicious recession.  So, implicit in the latest QE is a prayer that the Congress and White House behave rationally.

By nature, central bankers are not wild and crazy guys.  They resort to these unprecedented actions because the governments are not doing their job.   In the US, the Congress and White House have been using a cowardly “continuing resolution” tactic to keep government operating instead of passing a genuine budget, and they have played “chicken” with wild spending and tax increases that lead to deep recession.

In the EU, a half dozen of the government members have high unemployment and budgets with chronic annual deficits of 5% of GDP or more, attributable to intra-EU trade deficits, inflexible labor policies, grandiose social safety nets, and risk-appropriate (high) interest rates demanded by those in the private sector who would fund the big-spenders’ deficits.  The ECB is trying to help these undisciplined EU members with monetary tough love.

If the Fed cannot keep the cost of federal borrowing in check, the pressure to hike taxes and thereby stifle the economy will become horrendous.  If the ECB cannot discipline the wild-spenders in Mediterranean countries, then it will be unable to convince Germany, northern EU members and US financiers to back financial market access for the “happy-go-lucky” EU members.  If the EU disintegrates, it will be a less fertile market for US commodities and high-tech goods.  That will push more Americans off the payrolls.

Alan Daley is a retired businessman living in Florida and following public policy issues from the consumers’ perspective.