How Bad Monetary Policy Will End the Welfare State


It’s a presidential election year in the US. There are millions of Americans still underwater on their mortgages. US house prices have neither bottomed nor recovered. And the Fed is doing all it can to prevent another great wave of foreclosures in an election year.

The past two months of action in the markets isn’t helping anyone in government.

In April, after five days in a row of falling stock prices in the US, you’d expect the powers that be to do something.

And they did. Federal Reserve Vice Chairman Janet Yellen told investors that the Fed would leave interest rates low until 2014 and maybe even until 2015. ‘Further easing actions could be warranted,’ she added.

Now that the first few weeks of May have seen the Dow wipe off 5.6%, Boston Federal Reserve President Eric Rosengren has called for further easing.

Adding to the easing talk is China. Recently the International Business Times wrote, China’s interest-rate swaps market has priced in three to four benchmark interest rate cuts over the next year, reflecting growing pessimism over the world’s second-largest economy and expectations of more aggressive monetary easing.

Investors love this kind of talk. It means free money will be around for another few years. And not just in America. Chinese money supply grew by 13.4% in the last year, according to the People’s Bank of China. Yuan-denominated loans grew by 1 trillion yen in March, or $160 billion. Reserve requirements at local banks were cut in April.

I’d suggest to you that officials in China and America are encouraging credit growth through monetary policy for the same reasons: to prevent rising political and social instability.

In China, the government of Wen Jiabao balances inflation concerns with growth concerns. If bank loans grow too fast, you get inflation and soaring prices (bad for stability). On the other hand, if credit growth contracts too quickly you get fallen house and stock prices and rising unemployment (also bad for stability).

If you know someone who believes that central bank easing is the key to sparking a real economic recovery, tell him he’s dreaming. Any short-term rallies in stocks due to news flow like this are a complete distraction from more serious issues. It should be ignored, or at least heavily discounted.

This is the point I want to make: the failure of monetary policy worldwide has begun to have political consequences.

For the past couple of years I’ve showed readers of Australian Wealth Gameplan how unsound money has brought us to the end of the Western Welfare State. Bad monetary policy results in the steady debasement of the currency. The less stable and reliable the currency is, the less trust ordinary people have in the political system (the people who defend and use the currency as a weapon and instrument of power).

In China, the political system is losing the trust of the people for many reasons; financial, political, ethical, and economic. There’s a tendency to look at the Chinese political system from the outside and view it as monolithic, where there is unanimity on all decisions. That’s not the case, of course.

Many people might find it inconceivable that the Chinese Communist Party could be yet another indirect victim of the Global Financial Crisis. But the Party is not so different from the European Central Bank or the Federal Reserve. They are institutions trying to manage and control complex systems. That’s a losing proposition in a complex world.

Prepare for the inconceivable.

Dan Denning
Editor, Australian Wealth Gameplan

From the Archives…

Free of the Dragon: Why the Energy Market Doesn’t Need China
2012-05-25 – Kris Sayce

China Stirs Up Troubled Waters in the South China Sea
2012-05-24 – Dan Denning

How Chinese Stocks Are Fading Fast
2012-05-23 – Lars Henriksson

LNG: Why Australia Will Be a New Global Gas Leader
2012-05-22 – Dr. Kent Moors

A Shocking Week for China’s Economy
2012-04-21 – Dr. Alex Cowie

How Bad Monetary Policy Will End the Welfare State