Archive Economics Sacred Doctrine

Quantitative Easing and Substitutionary Atonement

In attempting to explain to my wife why investing in the stock market right now is not such a good idea, I came up with a little graph, which at one glance reveals the matter succinctly. Here it is:

djia fed comparison

It shows that the stock market growth of recent years has less to do with fundamental economic growth, which has been anemic, than with the action of the Federal Reserve. The Dow Jones Industrial Average has been rising in close correlation with the growth of the Fed’s balance sheet. The Fed’s program of “quantitative easing” has been nothing less than a boon for the stock market.

What we have here is the Fed’s version of “blessing.” It is blessing the stock market by assuming the “curse” – debts – of big banks, and exchanging them for deposits, which those banks can then turn around and lend. That money appears to be going into speculation, not productive activity. And voila! We have a stock market boom. Such a blessing cannot endure, despite what prognosticators may say.

The fresh funds provided by the Fed in exchange for this debt are no “godsend.” They only add to already existing funds on the money market seeking for returns in a return-starved economy. And so they only serve to feed asset bubbles. Which is why they are being funneled into speculation on the stock market, yielding the direct correlation to be seen in the graph between the Dow on the one hand and the Fed’s balance sheet on the other. This gives an appearance of prosperity, but in fact is only turning the stock market into a casino.

That’s not all. This “blessing” of stock market growth is balanced by the Fed’s assuming the curse of debt burden. Hence the Fed is functioning as mediator, the absolver of debt. But this Christ-like function is only an appearance. For the Fed cannot wipe the slate clean, cannot atone for these debts, cannot defray them. It can only assume them. They continue their existence, and will eventually have to be sold back onto the market, draining it of liquidity and precipitating a downturn (or even a crash), or be held until maturity or default.

In the end, the bonds, consisting mainly of treasury paper and mortgage-backed securities, will have to be either repaid or defaulted on. For the time being at least, treasury paper can be counted on, but the mortgage-backed securities are another story. If they are defaulted on, they blow a hole in the holder’s balance sheet: all of a sudden, liabilities are left without corresponding assets.

If this were to happen to the Fed, the shortfall would still have to be made up, for contrary to popular opinion, the Fed cannot “print” money directly, but only issue it against market-valued assets. There are always assets on its balance sheet to offset the liability of note issue. And so, a reduction on the asset side of its balance sheet would have to be compensated by a reduction on the liability side, either by reducing member bank deposits or eliminating notes issued. How that exactly would work, I have no idea, but the effect would be highly deflationary, as it would collapse the money supply to the money market.

Quite obviously, the Fed’s program of quantitative easing cannot go on forever. Adding $1 trillion-plus a year to its balance sheet will eventually lead to its collapse. So it is trying to backtrack. But every hint of “tapering” leads to market disruption — which is not the desired outcome.

Summing up, we can conclude that the Fed’s little adventure in substitutionary atonement only points up the artificiality of man’s efforts to bequeath himself blessings. In the economy, as in life, atonement is not attained by shifting debts and passing on burdens. It is attained by paying up. For redemption to function, one needs someone with the requisite amount of legal tender ready and willing to make a final settlement of “all debts public and private.” In the temporal as in the spiritual economy, there are no free lunches.

By Ruben Alvarado

Mr. Ruben Alvarado is an independent scholar, publisher, and translator living to the east of Arnhem in the Netherlands. His writings, which span a wide variety of issues, can be found at WordBridge Publishing, Common Law Review, and Common Law Economics.