Washington & Wall Street: 'Bitcoin Economy' Surges, Real Economy Deflates

Last week, the Federal Open Market Committee (FOMC) told the financial markets what they wanted to hear, namely that the Federal Reserve is going to moderate massive purchases of Treasury debt and mortgage securities.

The news of the “tapering” of Fed bond purchases sent stock prices soaring, this on the notion that the US economy is improving. Would that it were so. 

Cardiff Garcia of FTAlphaville reports that the FOMC reduced slightly the rate of bond purchases:

Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month.

The trouble is that Ben Bernanke, Janet Yellen, and the rest of the FOMC remain in fantasy land when it comes to the causes of our shared economic malaise. While parts of the US economy are doing pretty well, the housing and financial sectors are in a terrible funk. Read the last installment of Washington & Wall Street, “Regulation Likely to Slow the Housing Recovery in 2013,” if you want the gnarly details.

There are a couple of basic problems with how American economists and investors look at the economy and issues such as consumer demand. For example, consider this statement by the FOMC last week:

Fiscal policy is restraining economic growth, although the extent of restraint may be diminishing. Inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

Really? The liberal/socialist view of demand-side economists championed by the likes of Paul Krugman holds that a failure by government to spend (and borrow) more is somehow restraining the US economy. In reality, however, we are in a period of extended economic hangover following from the housing boom of the 2000s, when many jobs were supported by speculative credit creation and equally dicey housing activity, both in the US and internationally. Just read the frightening article from The New York Times, “Irish Try to Eradicate Ghosts of a Housing Crash,” and the idea is clear. All of the bad debt behind the housing boom ultimately came about due to the irresponsible Fed money expansion policies under Alan Greenspan.

Decelerating consumer spending (and higher saving) in the private sector and shrinkage of credit private are causing poor job creation, but the good news is that real production and real job creation are slowly coming back. Yet the neo-Keynesian socialists led by Krugman et al. want to put the US economy back on a heroin drip of public spending and higher deficits to immediately stimulate consumption. 

Truth be told, the only way to really fix the US economy in a stable, long-term fashion is to focus on fiscal reform and deficit reduction. When they consider the statement above that inflation is running below the Fed’s targets, all economists should be given pause.  

Even though the US central bank has grown its balance sheet 300% since 2008, the pace of economic activity continues to fall even as financial bubbles proliferate around the world. Even with interest rates near zero and the Fed monetizing most of the Treasury’s debt issuance, the only accomplishment of the FOMC has been to create financial bubbles in everything from single-family homes to the ersatz currency known as Bitcoin. In a very real sense, the soaring value of Bitcoin vs. the dollar tells you that financial inflation is brisk even as deflation haunts the real economy.

The cost of living for all Americans continues to rise, but the volume of spending and all transactions generally is still anemic, even falling. Consider this chart from the Federal Reserve Bank of St. Louis showing the velocity of money, which has been falling rapidly since 2007 and is now at the lowest level since the Great Depression.

“The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period,” notes the St. Louis Fed. “In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.  The frequency of currency exchange can be used to determine the velocity of a given component of the money supply, providing some insight into whether consumers and businesses are saving or spending their money.”

While the majority of the FOMC thinks or at least says they believe that the reduction in government spending is responsible for the lax economic environment, in fact it is a function of the end of 20 years of credit-fueled boom facilitated by the Fed. The speculative “Bitcoin Economy” is surging – at least for now – but the real economy continues to deflate. Americans are shunning the consumer economy, paying down debt, and pulling back on spending more than they earn. The members of the FOMC think this is bad for some reason. Only when the Fed and Congress focus on spurring real growth via tax and spending cuts will we see growth in real jobs and spending that is sustainable.


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