If you had told any financial observer in 2008 that the Federal Reserve would expand its balance sheet fivefold in five years, you’d have encountered astonished disbelief, followed by the assertion that if ever such a thing unfolded a Weimar Republic-like hyperinflation would ensue. After all, in the inflation-beset 1970s and early 1980s, when the Consumer Price Index was roaring ahead at a 13% annual clip and interest rates were headed for the moon— short-term rates peaked at 21.5% and long-term Treasurys at 15.75%—the monetary base (currency plus bank reserves on deposit at the Fed) had increased 225% from 1970 to 1981, a 12-year period.
Contrast that to the 400% surge in the monetary base since 2008. While there are valid arguments that Washington has been changing the CPI to understate the rise in the cost of everyday products and services, there’s no gainsaying the fact that we are, thankfully, nowhere near the horrors of the 1970s.
What gives is that we focused too much on the bloat of the monetary base and not nearly enough on the unprecedented suppression of both short- and long-term interest rates. Never before had our central bank knocked down the overnight cost of money to near 0%. And never before had it attempted to beat the longer-term cost of money to a fraction of its real price. (In the early 1960s the original Operation Twist–named after the dance made famous by Chubby Checker–was mercifully short-lived. It had been undertaken in a misbegotten effort to strengthen the dollar.)
Only a handful of economists, most notably FORBES columnist David Malpass, have pointed out that this monetary version of price controls is a form of credit allocation. The federal government easily got all the cash it wanted at ultracheap rates, i.e., deficits without tears. Big companies had no trouble accessing credit and putting their balance sheets in pristine order. But credit to small and new businesses dried up, a drought magnified enormously by bank regulators who told their charges to reduce risk and to document six ways to Sunday any loans to a nonbig borrower. Remember, small and new businesses are the source of most new jobs. Through its quantitative easings the Fed effectively sucked up much of the financial market’s short-term credit that normally would have gone to these businesses.
Malpass observes: “The U.S. private sector has been facing one of the tightest money/regulatory policies in history.”