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The Unintended Consequences Of Human Action

September 20, 2012

Economics, Economy, Finance, Markets

With QE3 the Federal Reserve has initiated another massive round of money printing, buying $40 billion worth of mortgage securities while continuing to reinvest its income from the securities  purchased during QE1 and QE2. In addition the Fed has changed the emphasis of its mandate, from targeting price stability to making itself responsible for employment, promising that money printing will continue until the Fed succeeds in bringing down unemployment. Other central banks are pursuing similar strategies. The ECB has unleashed its own round of unlimited money printing while the Bank of Japan recently announced that it is to buy another $126 billion of bonds, bringing the total accumulated so far in its  battle against deflation to approximately 20 percent of Japanese GDP. Most tea leaf readers are also predicting another round of money printing from the Bank of England.

Against all this is the backdrop of a slowing world economy. Make no mistake. The Fed is running scared knowing that the cumulative effect of both QE1 and QE2 was barely sufficient to hold deflation at bay. The problem, as we have noted previously, is that the Fed is basing its actions on a mechanistic view of the economy (both Monetarist and Keynesian) which does not take sufficient account of the unintended consequences of human action.

Borrowers are impaired from too much debt which affects their repayment ability, as well as from a cautious deflationary psychology which makes them reluctant to borrow money and invest in assets which may fall in price. However, lenders are also impaired both from the deflationary psychology which makes for stricter regulatory oversight and more cautious lending, as well as from ultra-low interest rates. Lenders will not lend if they cannot obtain a return greater than the overheads they incur in making a loan. This is why Bank of America and other leading banks are cutting overheads and laying off so many employees, not despite low yields, but because of them.

Consequently, despite the inflationary intentions behind the Fed’s actions the unintended consequences are deflationary as financial institutions are forced to tighten up on lending and credit, which, until 2008 have been the driving forces behind the growth of the economy. Market volatility will continue as asset prices veer back and forth between the effects of monetary stimulus and the deflationary forces unleashed by a generational deleveraging event. Ultimately, either the Fed will win or the market will win. Personally, I’m not looking forward to either outcome.

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The Law of unintended consequences holds that almost all human actions have at least one unintended consequence. Unintended consequences are a common phenomenon, due to the complexity of the world and human over-confidence.” – Author Unknown

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About Malcolm Greenhill

Malcolm Greenhill is President of Sterling Futures, a fee-based financial advisory firm, based in San Francisco. I write about wealth related issues in the broadest sense of the word. When I am not writing, reading, working and spending time with family, I try to spend as much time as possible backpacking in the wilderness.

View all posts by Malcolm Greenhill

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6 Comments on “The Unintended Consequences Of Human Action”

  1. synapticcohesion Says:

    The Fed is not printing money for the average Joe. But the average Joe is paying the inflation tax on printing dollars for certain corporations and financial institutions.

    Reply

    • Malcolm Greenhill Says:

      Thank you for this. I agree with your comment. I believe that the financial elite have captured the government and engineered a massive transfer of wealth from the ‘average Joe’ to the banks and other financial institutions. Without this transfer these companies would have disappeared and the shareholders would have been wiped out.

      Reply

  2. Gregory Zaretsky Says:

    Malcolm, I must admit that you lost me. How can you speak of deflation and a “generational deleveraging event” if central banks are printing money? Having lots of paper chasing limited supply of good has always been inflationary. I must be missing something, but what?

    Gregory

    Reply

  3. James C. Finn Says:

    Hi Malcolm – always insightful. I gather from your notes and from the evidence, that the velocity of money will remain low for some time to come – which brings to mind the old locution about the continued futility of repeating the same action but expecting a different result (but really, three times?!). It would seem that the “brains” in Washington would have figured out that for printing this money to have any effect, they need to circumvent the very system of loan distribution they have supported and built – that a new approach is necessary to increase that velocity to the Atlases of the world: say, allowing more lenient lending to otherwise responsible small and medium size businesses as well as sole proprietors (thru expanded authority of the SBA perhaps?). That this might better serve the purposes of everyone seems to be lost on the Bernanke’s of the world. Or, because presumably they are not that stupid intellectually, they just don’t want to take their political supporters and cronies out of the profit loop, do they? I am beginning to think your perspective is right and we are all just f’d! Hello deflation – and subsequently rampaging inflation.

    Jim Finn

    Reply

    • Malcolm Greenhill Says:

      Jim, thank you for your comment. I’m not sure the Fed has the power to increase the velocity of money. This is determined by human psychology and right now, with a negative social mood, the prevailing psychology is one of caution and conservatism for both lenders and borrows. This translates into deflation as, at the margin, less people want to both borrow and lend i.e. there is a reduction in credit. With the fiscal cliff looming it is unclear how another large spending bill or stimulus would be passed. At some point (we might have reached it already) Treasury bond prices will top and interest rates will start to rise to compensate for the increased default risk as a result of all the money printing. Falling Treasury bond prices are deflationary as it means total credit is contracting. That will be one signal that the end game is close.

      Reply

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