The Printing Press and the Euromess
Sunday 13 March 2011
by: Dimitri B. Papadimitriou, t r u t h o u t | News Analysis
On March 15, Federal Reserve Bank officials will convene to decide on which way to direct - or redirect - their resources. Accusations that the Fed is running the printing press on overtime (as Republican budget maven Rep. Paul Ryan of Wisconsin put it) have been steadily on the rise. Monetary policies shorthanded as "printing money" and a European-style disaster will be portrayed as simply opposite shores of a small pond and ever more equations will be made between US financial troubles and those of Ireland and Southern Europe. As the run-up to the congressional debate on the debt ceiling proceeds (it has migrated from January to possibly July), the same accusations will crescendo.
Observers who complain about current monetary policy and at the same time worry that we're about to become the next Ireland, Greece, Italy or Spain fail to point out one key difference: our public debt is a promise to pay interest and principal in specific dollar amounts. The Fed can print those dollars as necessary, unlike troubled eurozone governments, which don't have the freedom to churn out euros.
In other words, the euromess and our own troubles aren't just differences of degree. To weaken the Fed's monetary power would weaken our strength. Without an engaged central bank, we'd be on the same financial footing as Europe - not exactly the territory we'd want to occupy. Despite the inflamed rhetoric, few economists are unaware of this structural divide.
Paying the government's bills through increases in government deficits, rather than by taxing or borrowing, has traditionally been frowned upon in English-speaking, developed countries, sometimes for good reasons. Excess money and government deficits are both serious problems in an economy that's operating at true full employment. The US isn't exactly about to hit that ceiling, though, with more than 13 million unemployed - almost nine percent of the labor force - plus a few million discouraged workers who go uncounted.
It's an open secret that political calls to squelch the Fed are nothing more than posturing: in the real world, attempts to stop the central bank from acting couldn't be carried out without refusing to supply funds that would quiet or prevent a bank panic. Even if legislation is enacted, it's almost certain to be abandoned at the first sign of its damaging effects.
This month's Fed meeting will determine whether or not it pulls back on the "quantitative easing" of the money supply - the rounds known as QE and QE2 - and predictions are that the program will continue, at least for now. What is certain to continue, and to increase, is the pushback against the Fed's use of "soft money" to finance these unprecedented purchases of long-dated Treasury bonds. Fiscal conservatives who oppose the policies may appear to be frugal and worthy, but QE critics have yet to show how a financial system without an active central bank would look. One snapshot: the grim picture of the European Union (EU) during the run-up to the current crisis.
Pain endurance feats by European countries without central banks have been chronicled elsewhere (most recently, see Paul Krugman's "Eurotrashed" for gory details). In addition to the human misery index, though, Europe's experiment with "hard money" is the story of another failure: a head-on collision between reality and an allegiance to the same orthodox policies we'll hear touted on the House floor. The approach that is being praised as prudent by politicians, pundits and financial officials proved simply impossible to implement in Europe.
The creed of the EU's unified monetary system - the euro - included tight control of the quantity of money in circulation and a banking system that relied on free market competition, rather than on government or central bank intervention. Keeping European monetary policy completely separate from the political power of the purse proved unworkable in the crisis, though, and officials finally recognized that the costs of a bailout could be handled only by special European financing facilities, the European Central Bank (ECB) and the International Monetary Fund (IMF).
The novel and controversial wall between European government treasuries and "the printing press" was unable to withstand the pressure of the current recession. Euro-area deficit limits were breeched by huge margins.
So, Europe set aside its principles in order to prevent default in Ireland, Greece, Portugal, Spain and probably Italy. The ECB took on a new role, behaving much as the US Fed and other national banks do. The effort to monetize the debt of troubled members is a European version of QE. The ECB is now helping foundering states in the same way that the Fed has helped the US government, by supporting the market for government securities. The European banking system is receiving aid from the public, and vice versa.
The US, meanwhile, has so far been able to contain its crisis by using familiar - however harshly criticized - policy tools ... like having the Fed purchase Treasury securities. Rarely mentioned is that the Fed returns to the Treasury all of its net profits (gross interest income minus expenses and research costs) from the interest it earns on these securities. This means that in terms of debt-servicing costs, too, the US is an enviable position compared with those of countries that borrow from the ECB.
In the eurozone, the hard-money policy commitments that were thought necessary to control inflation had to be abandoned. In the US, we're still being warned that the Fed's soft-money pumps are ushering in a ruinous inflation rate that will make America look like Argentina in the 1970's, or maybe Zimbabwe (according to MSNBC) or perhaps the Weimar Republic (according to Glenn Beck on Fox, of course). It's a bipolar paranoia from both the right (as in Ron Paul's book "End the Fed") and the left.
Inflation - the terminology ante has been upped to hyperinflation - has been anticipated for months and even years by some monetarists, and will be central in debt-ceiling talks. How real is the threat?
Despite the fear-mongering, the potential for inflation now seems irrelevant, even to many otherwise anti-Keynesian economists. The most important factor in its irrelevance is the current high unemployment rate. Historically, inflation rarely occurs when huge numbers of workers are unemployed and underemployed, and a healthy employment rate is nowhere in sight. The reality on the ground of longstanding and continuing low inflation rates has also demonstrated the science-fiction quality of the inflation threat.
In addition, research has not convincingly shown that the economic costs of even a five percent increase in the inflation rate would compare reasonably with the trillions of dollars in annual output lost since 2007. And finally, inflation - if it did occur - would also tend to increase tax revenues, which would hack away at the national deficit. That's because wages, profits and other forms of income generally rise almost in step with prices.
The so-called printing press, however helpful in a crisis, can't return the US to financial health. A nation's ability to create its own money can't generate unlimited wealth. Among the dangers we face, the first is a longstanding pattern of the Fed backing ever more risky assets after each period of financial stress. Our system works well, but it badly needs the kinds of regulation and reform that we've detailed as fiscal crisis remedies at the Levy Institute.
The Europeans are known for their expansive social safety nets. Our flexible central bank, though, is the financial safety net that trumps them all. Unlike in those countries whose troubled economies are chained to the euro, in the US, we can be grateful that we have the freedom of the press.
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