The Federal Reserve is sidelined for the foreseeable future. It’s been reduced to a monetizing role, taking on more and more of our nation’s growing debt to support much-needed fiscal spending.

A quick glance at this chart makes it obvious how aggressively the Fed has been buying up federal debt.

The Fed’s policy of keeping rates very low indefinitely is not going to fuel a robust economic recovery. So the fiscal spending is necessary to create the economic demand required to bring us back to full employment over the next six or seven years.

With the Fed sidelined and the government having to embark on more and more spending programs to boost employment levels, the economy could easily end up heading in one of two directions…

Either very high inflation (between 5% and 10% a year), or runaway deflation. Neither option is good. But the deflationary path is more dangerous and far more debilitating.

We can turn to Europe to see where this leads. If we look at the growth of the European Central Bank (ECB) balance sheet over the past 12 years, we can see an expansion in excess of 5 trillion euros! This is enormous.

And it’s not just the eurozone. The chart below shows the increase in assets by the world’s major central banks – the Bank of Japan (BOJ), People’s Bank of China (PBOC), and also the Federal Reserve and the ECB. We can see an increase of $20 trillion since 2007.

This is staggering. The net effect, however, has been deflationary. Japan, Europe, and the U.S. are showing flat to negative economic growth, all while their balance sheets have ballooned. China’s growth rate has slowed dramatically.

Clearly the idea that zero or negative rates will lead to strong economic demand is severely flawed.

The following graph is most telling. It shows us how GDP has fared in the Euro area (19 countries) relative to the expansion of central bank assets.

As central bank assets have surged, the GDP has crashed. Why Fed chief Jerome Powell is now trying the same flawed strategy in the U.S. is more than a little puzzling.

Clearly, there is no evidence that quantitative easing – in which the central bank buys bonds or other securities to pump money into the system – actually promotes strong economic growth.

Economies used to manage much higher trend growth without any quantitative easing whatsoever.

Do the central banks perhaps have a hidden agenda that can explain the logic behind this strategy? Is it simply an act of desperation to try to fend off deflationary pressures?

What is clear is that after 30 years of failures in Japan and 12 years of failures in Europe, we shouldn’t have too many doubts about how this flawed strategy will work in the U.S.

Without the fiscal side of the equation picking up the slack in demand, it will end terribly. With sufficient fiscal spending, at least we will have a fighting chance.

Yes, the debt situation would be dangerously high. But the alternative would be worse. A lot will depend on how Congress and the president act over the coming years.

Bottom line: Quantitative easing doesn’t do very much to promote growth. It actually lowers inflation and growth expectations and decimates bank earnings.

It does serve the purpose, however, of covering up the mistakes central bankers and politicians have been making for years, which helps them keep their cushy jobs.

The graph below summarizes pretty well how the bottom 50% of the economy fare with lower rates.

Is the dismal relative drop in their collective net worth an intentional effect of the central bank’s policy, or simply an ugly by-product?

I don’t know. I do know, though, that this trend is not sustainable indefinitely. At some point, the bottom 50% will revolt.


Andy Krieger
Editor, Money Trends

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