Archive for October 25th, 2011

The Gold Standard would Prevent Economic Bubbles

By just about every measure the U.S. economy continues to be mired in a depression.  Unemployment remains high.  Housing prices are still falling. Retail sales are lackluster.  Since Barack Obama became president in 2009 the national debt has ballooned by about $4 trillion with very little to show for it – unless you consider the rebound and hearty growth of the stock market.

Yes, while Main Street continues to struggle to make ends meet, Wall Street is prospering.  After losing more than half of its value due to the financial crisis of 2008, the Dow Jones Industrial Average has bounced back brilliantly recapturing more than 75 percent of its value lost.  The numbers are enough to make even a casual observer of the markets sit up and take notice.  The big question is why the disconnect between a significantly rising stock market on the one hand and a depressed economy on the other?

When the Dow was making its precipitous decline in November 2008 Ben Bernanke and his Federal Open Market Committee (FOMC) announced Quantitative Easing 1 (QE1).  From November 25, 2008 to March 31, 2010 the Federal Reserve Bank pumped about $1.5 trillion into the economy by purchasing treasury bonds from its primary dealers (banks such as Goldman Sachs and J.P. Morgan).  After bottoming out at 6626 in March 2009, the Dow went up a remarkable 65 percent to 10927 by the end of March 2010.

After QE1 ended, the markets began to drop once again.   In August 2010 Bernanke formally announced that QE2 would start in November.  On August 27, 2010 the Dow closed at 10150. When QE2 concluded at the end of June 2011 after close to $700 billion more was pumped into the economy through treasury purchases the Dow closed at 12582 – a 24 percent increase.

When QE2 ended the Dow experienced a 15 percent drop in value.  But In the last two weeks with no fan fair, the Fed has purchased $39.9 billion of treasuries from banks in the same fashion it did during QE1 and QE2.  Needless to say, stocks made an about face and have rebounded higher by about 9 percent.

So what does all this tell us?  It tells us that the boom and bust theory of the Austrian School of Economics is vindicated.  That is to say that monetary policy conducted by the Federal Reserve (low interest rates, monetizing federal debt, and asset purchases) causes artificial booms (bubbles) in the economy.  There is no economic reason for the stock market to be up in the current economy except for the aforementioned correlation between Fed asset purchases and rising stock prices.  It is clear over the long haul that the current stock market cannot maintain its price level without the Fed propping it up. Similar to the dot.com and housing bubbles before it, when the Fed pulls support from the current stock market bubble it begins to burst.  It is only a matter of time before a permanent bursting of the bubble happens.

There is only one way to prevent the Fed from inflating the dollar to benefit its member banks and therefore wreak havoc on the rest of us.  There is only one way to prevent the Fed from inflating the dollar thereby causing financial bubbles which have contributed greatly to the widening gap between rich and poor.  A gold backed dollar would restrict the Fed’s ability to manipulate the currency.  It would protect savings and purchasing power.  And in the above case it would have prevented the current stock market bubble which when it bursts will devastate millions of Americans who will then realize how phony their financial health actually was.

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