Alarming Inaction: Biden and Harris Ignore Out of Control Money Supply

Economic theories and their application have a tendency to fluctuate according to the global economic climate. In the beginning of my teaching career in economics during the 1980s, a significant focus was placed on the money supply as a crucial instrument of economic policy due to high levels of inflation. The then popular Keynesian approach, suggesting that entities such as the Federal Reserve should actively modulate interest rates to control the economy was losing favor. In the very same period, alongside the USA, numerous nations were grappling with the double predicament of recession and elevated inflation.

A small philosophical group called Monetarists, spearheaded by Milton Friedman from the University of Chicago, began to gain prominence. They stressed upon the importance of the role of the money supply in governing economies and its chief consideration in deciding inflation. As per their argument, inflation was largely caused by an excess of money in circulation. This excess led to incentives for demand and subsequent price hikes.

The argument put forth by the Friedman-led monetarists suggested central banks should stop constantly adjusting interest rates and rather concentrate on restraining money growth. By doing so, as production increased, prices could be kept stable. They argued that the problem of inflation was essentially a problem of overabundance in financial resource. Therefore, they suggested that the Federal Reserve should act to reduce monetary growth to tackle it. However, it’s baffling to note how this philosophy has received scant attention in recent years.

This indifference is glaring especially now, when we are in one of the most precarious economic epochs since the latter part of 2008. In contrast to that era, the term ‘money supply’ is conspicuously absent from the lexicon of the current Federal Reserve. It is tragicomic that our current economic woes largely stem from a massive peacetime expansion in the money supply, executed without any substantive discussions on the idea in the last hundred years.

Paul Volcker convinced the Federal Open Market Committee to regulate money growth and remain steadfast despite the inherent volatility in interest rates, output, and employment. This resulted in some business and consumer interest rates skyrocketing to 20%. To sell bonds, the federal government had to offer a 14% guarantee for 30-year contracts. Unemployment surged along with drops in output as a result.

The high interest rates brought about by this move attracted foreign investment, leading to a stronger dollar. This, in turn, severely harmed sectors that depended on exports, such as farming, steel, and automobiles, or those which competed with imports. Despite the dark times, there was a silver lining. Inflation indeed began to fall, though it took its time.

The experience served to illustrate the validity of the monetarist school of thought, at least partially—controlling the volume of money had a direct impact on inflation. According to traditional understanding, the money supply is made up of circulating currency – bills and coins, along with bank deposits that can be employed for payments. Metrics such as M1, M2, and M3 were put in place depending on the types of deposits included – ranging from checking and saving accounts to certificates of deposit and even money-market mutual funds.

With the turn of the century, the Federal Reserve, led by Alan Greenspan, reacted to the 9/11 catastrophe by reducing interest rates, necessitating a surge in the money supply—an increment that escaped public notice. Then came the devastation of the housing market collapse. Emerging financial entities like hedge funds began trading new financial instruments called derivative securities. These derivative securities tied their value to other financial instruments like home mortgages.

The collapse was imminent when Bear Stearns went under in mid-March 2008. When Lehman Brothers followed suit in October that same year, the specter of a market crash worse than 1929 loomed large. By twisting their statutory authority to its limits, the Federal Reserve and the Treasury managed to rescue the country with a tremendous bailout.

These bad loans were swallowed by new securities and hidden away in unknown funds named ‘Maiden Lane’. Both the Wall Street and the general economy narrowly evaded a calamity. However, mysteriously, the notion of ‘money supply’ was wiped from the collective memory of pundits, journalists, and the common public.

Given the circumstances, the subsequent spike in M2 was not particularly alarming. It rose by 10.3% in the year following Bear Stearns’ downfall and peaked at a mere 17% three years after the Lehman Brothers panic. However, nothing could compare to the crisis that COVID-19 brought in 2020. With the advent of the worst global pandemic in the last century, the Federal Reserve in their earnestness ramped up the money supply.

Responding to the initial announcement about COVID-19, the Federal Reserve increased M2 by 25.3%. They continued in this vein, eventually leading to a 40.6% cumulative increase in the money supply two years after the initial COVID-19 case in America. This level of growth of the money supply was unprecedented in the peaceful history of the nation.

It is interesting to note the absence of any significant discussion or media coverage of this historical surge in money supply. This inflation had severe political consequences, contributing largely to shifting the government power in the last elections. This issue, further fueled by the Ukraine war, spiked farmland prices in a way not observed since the perilous times leading up to the 1980s farm crisis.

Yet, the extraordinary inflationary pressures were ignored, and major economic sectors were left to pay the price. The current economic landscape is in an undeniable state of peril. The Federal Reserve finds itself between a rock and a hard place. Despite successfully releasing some pressure from the money supply, to soften its target rates, the Federal Reserve had to create more money; the figure for March was 40.7% higher than five years ago. Coupled with other policies, this demonstrates our economy’s significant problems.

Until this dangerous monetary trend enters the general discourse and the necessary adjustments are made, all other policy measures will be hobbled. Thus, the urgent need to acknowledge the elephant in the room – the surge in the money supply, its implications, and its proper management – cannot be overstated.