The Fed: An Elegantly Complex House Atop an Illusory Foundation

In a piece by Bonner and Partners titled, How Dumb is the Fed?, the authors drive home the point that although the Fed is dumb enough to recklessly experiment with the economy, they are certainly NOT dumb enough to relinquish control of their capacity to manipulate markets.

The article makes a strong point, and we’d like explore it further, as it implicitly contains a simple and seemingly paradoxical question: how can such a “smart” group of people do something so recklessly “dumb”?

Obviously, the question answers itself: the Fed’s economic experiments are based on a faulty assumption. In this case, the assumption is that printing money is not only permissible but a necessary component of managing the economy; essentially, something of “real” value can come out of nothing.

This error in judgement is comparable to building a highly complex and intelligently-designed house atop a high-risk foundation. No matter how many intelligent people you employ to build and design such a house above foundation, its potential for collapse remains the same, making such a home not only risky but virtually valueless.

Unfortunately, not only does this foundation ground the Fed’s experiments, it also expands the government’s control over people’s financial assets.

The problem with the Fed’s QE (Quantitative Easing) experiment is that it completely abolishes the natural price discovery process for everything dollar-denominated, distorting the true prices of goods and services.

So, how does QE advance government’s bidding? Government’s capacity to increase taxes is limited, the process itself being relatively lengthy, inefficient, and generally prone to resistance from the political class as well as the general public. The last thing government wants is to spark a tax revolt. So instead, government uses a far more subtle tool: the power to manipulate fiat currency.

If government wants to raise several hundreds of millions to fund certain projects or programs, it will simply print more money. On the surface, the government ledger will appear to have increased without imposing any taxes. But we all know that eventually someone has to pay; that someone will be on the losing side of this game...and it ain’t going to be the government.

As Dan Sanchez writes in a Mises.org article:

“Creating new money does not create any additional stuff to go around. So if creating money got the government more stuff, that means others sharing the same world of scarcity must have less stuff. It’s a zero-sum game; a win-lose situation.”

Money, in itself, does not constitute true wealth. It is “the stuff we buy with money” that gives us what we need to sustain ourselves, the “stuff” that adds value to our lives. So when money is created out of thin air with nothing of real value exchanged or produced to back it up, such a strategy leads to a potentially severe reduction of money’s purchasing power (inflation).

Nothing comes from fake money other than fake wealth and fake prosperity.

The danger in this situation is what might happen if the government were to reverse the process, thereby allowing natural price discovery to reinstate itself: abolishing fake money will invariably pull the rug from everyone’s fake prosperity. And for this reason alone, neither government nor the Fed will ever pull back from the reigns that artificially control the economy.

The only “sound” way to protect yourself is to reduce your exposure to fake prosperity by holding “real” assets.

Gold and silver cannot be artificially created. They can be government-monitored and bank-controlled, which provides a few reasons why you might want to avoid CUSIP-tagged assets. But generally, buying precious metals will protect you from the Fed’s empty shell game.

Ultimately, the choice is simple: real wealth trumps fake wealth--a common-sense assumption and a solid foundation upon which only real prosperity can be built.

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