Modern Central Banking 101: 3 ways to boost asset market inflation
The effect is the same, the only thing that changes is who bears the debt burden
Over the past half century the US economy has morphed into a massive financial bubble. After exiting the Bretton-Woods monetary order and closing the gold window, the US solved its massive inflation problem by (a) inflating asset markets (stocks, bonds, real estate, etc.) while simultaneously doing everything it can to (b) suppress consumer inflation and keep wages down (such as union busting, women entering the workforce, offshoring/globalization, etc.).
A plethora of US policies designed to achieve these dual goals has made it an attractive venue for investment of excess dollars paid to exporting countries after they could no longer exchange their dollar surplus for gold, creating a way to recycle excess dollars back into the US…which bolstered US purchasing power in the world. Tax cuts on income from asset price inflation were also implemented, allowing the proceeds of this inflation to be recycled back into the asset markets. Tax exemptions on income that is kept in the market provides another incentive to keep the inflation from spilling over into the real economy. Corporate executives began taking low-tax stock options as compensation instead of regular wages, giving them a huge incentive for buybacks and other schemes that bid up stock prices. The government made a deal with Arabs to sell crude oil in dollars, dollar-denominated debt from institutions like the IMF and World Bank proliferated, etc., all of which created demand for dollars (to buy oil, pay back loans, etc.). These are just some of the measures that the US government has taken to drive the modern finance economy.
Side note: A result of this policy is the massive increase of wealth inequality that took off in the 1970s and continues to accelerate to astronomical levels today. This is an inevitable result of (a) and (b) mentioned above, and will only continue to worsen so long as the US financial bubble is propped up in this manner.
The biggest risk in the bubble era is the possibility that the US asset bubble will pop, and the inflation monster it has managed to keep caged inside will explode into the world…the dollar would collapse, the US would lose its global position, and other countries would ascend to the top of the world powers. This would be very bad for the US because its economy is entirely supported by US hegemonic power to force US dominance over key sectors around the world, and to prevent competition. If the bubble pops, and the door opens to truly competitive markets around the world, people would quickly realize how junky and/or outrageously over-priced US products like Microsoft, Apple, Boeing, Tesla, pharmaceuticals, etc., really are…and would run to buy from competitors who sell better products at lower prices.
Actually, all of this is presently happening. Right now. We are living through a historic moment, the collapse of the greatest empire in world history. The pandemic arguably made matters worse, by shaking the markets and global economy enough to cause spillover inflation into the consumer economy. Price shocks owing to whip effects put upward pressure on wages, cementing the consumer inflation. And wages had to grow to keep up with housing cost explosions caused by asset market inflation spilling into real estate assets…otherwise a mortgage default crisis could trigger another massive instability like the one that occurred in 2008-9, and shut down the construction industry which is a primary component of the real economy (i.e., one that provides jobs, and other traditional economy activity).
Ok, so what is the US doing to combat this threat? Well, the answer has been more of the same: (a) asset inflation and (b) wage suppression. However, the emphasis is lately more (a) than (b), which is why we are seeing consumer inflation continuing to rise. The US has three primary ways to bolster asset market inflation:
Federal Reserve Bank Open Market Operations (debtor=Fed). Basically, the Fed borrows money from itself, and uses that money to purchase massive amounts of financial assets and thereby bid up asset prices. The Fed typically buys bonds, especially treasuries, in order to avoid intervening in the markets in a way that would favor particular assets. Instead, the bonds they buy gives money to investors who would otherwise own those bonds, and they then move that money into other parts of the asset markets. This diffusion of inflation from the Fed into the bond market and then into broader markets causes a general increase in the price of assets across the board.
Low interest rates (debtor=banks). When the Fed sets low interest rates, then demand for loans increases, and money pours into the economy, and is dominantly channeled into asset markets (real estate, etc.). The prevalence of mortgage debt means that money is channeled out of the consumer economy and into the financial economy. Banks create this money, and owe it to themselves. In this regime, the banks make more profit on service fees and other businesses than they do from the interest paid on the loans. Businesses tend to run their entire operations, including payroll, on loaned money (including corporate paper, etc.) owing to the low borrowing costs.
High interest rates (debtor=government). It may seem odd that the opposite of #2 above would also produce the same effect: asset inflation. But that is exactly what it does, like a ratchet tool the handle moves both ways but the working end only goes in one direction. In this regime the market gets a huge boost from the rise in debt service paid to bondholders at higher interest rates, which floods the asset markets and bids up asset prices. In this case, the primary debtor that is borrowing to inflate the asset market is the US government, simply because it is the largest bondholder in the world and therefore it ends up paying the lion’s share of higher debt service that pumps up the asset market.
The US has been using (2) for a long time period, but this arguably caused a higher than sustainable proliferation of consumer debt and consequent risk in the financial sector, which is what caused the 2008-9 crisis. Then in the 2008-9 crisis the Fed soon emerged with tool (1), which was initially called “quantitative easing.” Over the years the Fed ended up buying a huge asset portfolio this way, almost $10 trillion. Yes, that is $10 trillion that the Fed created out of thin air and pumped into asset markets to keep stocks, bonds, real estate, etc., going up, up, up, up, up. But after a while they realized that this was only making the problem worse, and they tried to wind down their asset holdings. The first attempt failed. Then they tried again, while simultaneously switching from (2)→(3)…hiking interest rates. So while the Fed is trying to allow its assets to mature without buying more to replace them, others are purchasing those assets instead and they are reaping a high rate of return that is paid by the US government…much of which is going onto the US national debt ledger.
Ok, I know this is a lot, but I wanted to make this short and simple as possible. If you have any questions, please ask in the comments below!