Suppose a family of four was setting down to desert after dinner; a pie is cut into eight equal pieces. Each member of the family received two slices. Now, suppose one member of the family said, “Let’s create eight additional slices and split the pie into sixteen equal pieces.” Clearly, if each member of the family received four slices there would be no practical reason (other than a smaller serving size) to create the additional slices. The amount of pie each family member received would be exactly the same.
Suppose that the pie cutting member of the family has an ulterior motive. He wants more pie at the expense of everyone else. So after slicing the pie sixteen ways, he gives everyone the same two slices they previously had and keeps the eight additional slices for himself. Someone in the family might remark, “My slice of pie is smaller and less filling.” “No, you are mistaken,” he lies. “You are receiving the same amount of pie you always have.”
This little story gives us insights as to why the Federal Reserve inflates the supply of money. Have you been trying to make sense of the incessant claims by policymakers and some economists that in order to save the economy the Federal Reserve has to engage in a new round of quantitative easing? The Fed tells us that our inflation targets may be too low and may need to be increased. You might be asking yourself the obvious question—how would more inflation help the economy?
The answer is, it won’t. In the pie example, after cutting the pie in eight pieces, each of the four people expected two slices. If you cut the pie into sixteen slices and gave everybody four slices, increasing the number of pie slices will have no effect. But when people expect two slices, if the pie cutter increases the number of pie slices to sixteen, the pie cutter will have slices to keep for himself or to give to other favored pie eaters—increasing the number of pie slices has an effect. And that is exactly what the Federal Reserve does. When the Fed increases the supply of money and credit, the new money is not injected equally throughout the economy. For some, due to inflation, their slice of the pie shrinks; others get more.
Admittedly my pie analogy is simplistic. I use it to help cut through the idea that we should leave policy to the experts. But how can an expert like Ben Bernanke be so wrong? Some say he is an innocent Chauncey Gardner character; others believe he is simply a puppet whose strings are pulled by his banking masters. The more likely explanation is that Ben Bernanke is who he seems—a bright but limited man being guided by incorrect theories that have taught him that bright men can and should control the economy. The end result of our hubris will be suffering on a larger scale than we can imagine. No, our is not a typo—it is our collective hubris that empowers Bernanke’s personal hubris.
Regardless of Bernanke’s motives the question remains: who is getting the new slices of pie? Here are some recent examples:
This week the New York Times reported that “the real wage and salary income of finance industry employees based in Manhattan rose nearly 20 percent in the first quarter of this year. That surge helped make Manhattan the fastest-growing county in the United States in terms of terms of year-over-year gains in income.”
This week when asked about receiving bags of cash from Iran, Afghanistan President Hamid Karzai said “This is normal…The U.S. gives us large bundles of cash as well.”
Of course, asset bubbles form as new money is injected in explosive amounts. Grain prices and other commodities have increased sharply with wheat and corn both up over 50% this year. If firms try to pass on their higher costs through higher prices, family budgets feel the pressure of the increase. When firms are unable to raise prices due to market pressure, they feel increased pressure to reduce labor costs and unemployment increases.
Bloomberg reported yesterday on the Fed-induced bubble in junk bonds: “The lowest-rated junk bonds are the most expensive corporate debt following a Federal Reserve- induced rally in high-risk assets, adding to concern fixed- income securities are overvalued.” No doubt after this bubble bursts, “for our own good,” we will be giving our pie to those who recklessly invested again.
Yet, we are told, if not for the heroic efforts of Ben Bernanke, we would have a terrible depression and no pie at all. Of course, a clear thinking child could see through the lies. A child might ask: “Has Ben Bernanke created even one new pie?” The answer, of course, is “no”—his policies have helped to redistribute the pie: Ordinary Americans who are not subsidized have given their share of the pie to the financial services industry, to contractors waging war in Afghanistan, to General Motors, to junk bond investors, and you name it.
This is an uncomfortable post to write. I have always taught that free market economies expand the supply of the proverbial pie. On a free market, there is no reason to see the world through win-lose eyes. Yet, we no longer have anything resembling a free market. For many Americans, their share of the pie is now contracting; a new round of quantitative easing will only reduce their share of the pie further.