Link: Fed meeting minutes.

The direct quotation from the Federal Open Market Committee (23 – 24 October):

“A number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity-extension program.”

The question is: what is all this going to achieve? And I think that the Fed needs to check their model assumptions.

There is a best case/worse case scenario that we can look at here. In the best case scenario:

  1. the stimulus causes interest rates to go down and borrowing to go up,
  2. which will result in more investment,
  3. which will result in more companies starting up and/or expanding,
  4. which will increase the number of jobs,
  5. which results in more income for the work force,
  6. which results in more spending,
  7. and everything improves.
  8. With some inflation.

In the worst-case scenario, we skip the in-between steps and all that the money supply increase does is cause higher inflation (more money around + same amount of goods to buy = inflation).

But even if we assume that the best case scenario is more likely to be the economic response of rational individuals, there is a structural issue here. And what is it? The problem is that the above theories imply a closed economy. The extra money must have nowhere else to go but into the economy that’s being stimulated.

Unfortunately, in a world of no capital controls, any extra liquidity will flow to where it earns the highest return. And as the noble prize-winner Joseph Stieglitz points out: that is not the United States. So what happens to any extra stimulus? Into the banks it flows, and then out to China and India and the emerging markets where it can earn a better return.

And that actually makes a lot of harmonic sense. Because if you consider how strong the demand is for US dollars, you would conclude that the US dollar should be rapidly appreciating against all major currencies.

Only it isn’t. And that can only be because the Fed is printing the dollars to meet that increasing demand. So the rest of the world is effectively being taxed by not getting the natural appreciation in value that should be occurring in their dollar investments.

Karma. And print away.