A detailed look at the economic disadvantages of monetary policy implemented by the Federal Reserve Bank.

1. Published by Moneycation™
Newsletter: December 2013
Monetary policy and Main Street
It is no secret Federal Reserve monetary policy has
passed over long-term economic stability for a shortterm economic fix originally intended to kickstart Main
Street's economy. Central bank officials reason that by stimulating Main Street via Wall Street, the
economy is better off in the long run. However, if using metrics such as wage growth, job creation,
labor participation and corporate revenues as a percent of global market share, then monetary
policy seems less sure footed and more swaggered.
The central bank claims it has been seeking to maintain its dual mandate of inflation control and
employment, but has contributed to the devaluation of the dollar, which is just as bad as price
inflation and with little job creation success.
Econometric equations, no matter how elaborate and sophisticated, are just as capable of weaving
fabricated quantitative justification for an elitist economic status quo as statistical samples and
political rhetoric are riddled with fallacy. The fact of the matter is economics is not science,
therefore no amount of mathematical reasoning is completely accurate in terms of determining how
a particular policy affects a whole economy's performance. Investment banker Jeremy Grantham
put it this way in GMO LLCs quarterly letter:
“Economics is a very soft science but it has delusions of hardness or what has been
called physics envy. One of my few economic heroes, Kenneth Boulding, said that while
mathematics had indeed introduced rigor into economics, it unfortunately also brought
mortis.”
To be fair, at least the wealthy are getting richer, which is slightly better than no one getting
wealthier. In effect, loose monetary policy has been a windfall for Wall Street, but not necessarily
Main Street. Even a Stockhouse interview with ex-fed official Andrew Huszar admit to this in the
following quote
“While there had been only trivial relief for Main Street, the U.S. central bank's bond
purchases had been an absolute coup for Wall Street. The banks hadn't just benefited
from the lower cost of making loans. They'd also enjoyed huge capital gains on the
rising values of their securities holdings and fat commissions from brokering most of
the Fed's QE transactions. Wall Street had experienced its most profitable year ever in
2009, and 2010 was starting off in much the same way.”

2. Huszar goes on to say the monetary steroids applied via mass asset purchases and quantitative
easing lowered the incentive and pressure for Congress. Thus, the economic problems that caused
the Great Recession have not actually been dealt with despite the Dodd Frank Act, regulator
lawsuits and more pressure on financial institutions to maintain and raise capital reserve
requirements.
“As for the rest of America, good luck. Because QE was relentlessly pumping money
into the financial markets during the past five years, it killed the urgency for
Washington to confront a real crisis: that of a structurally unsound U.S. economy.”
With hundreds of billions of dollars being pumped into the U.S. economy by the Federal Reserve
Bank, one might think monetary policy's capacity to stimulate the economy would be massive.
After all, the federal slowdown of October 2013 only cost a fraction of the Fed's quantitative
easing program, yet its effects were far reaching. Moreover, according to Standard & Poor's rating
agency, the federal government partial shutdown that began in late September 2013 removed $24
billion from the economy and .06% of gross domestic product in the fourth fiscal quarter. Yet, the
Federal Reserve Bank's “quantitative easing” also known as U.S. debt monetization has been
creating $85 billion per month to purchase U.S. Treasury debt and mortgage backed securities.
Another fear is that monetary policy is becoming increasingly ineffective for Main Street. This is
evident in the chart below where GDP rose for decades while household income remained flat.
Now it seems that monetary policy can't even grow the GDP as GDP per capita has not surpassed
its peak in 2007. In other words, despite trillions of dollars of stimulus and near zero percent
interest rates, household income has continued to decline and GDP per capita has remained flat for
seven years.
U.S. gross domestic product vs. median household income
Image license: US-PD

3. Congressional testimony
On November 14, 2013, The Federal Reserve Chair nominee Janet Yellen answered questions
about the impact of monetary policy on Main St. and one of her answers is that the broad focus of
policy is to generally benefit all Americans through a “ripple effect” rather than a “trickle down
effect”. She also stated that current policy has to make use of alternatives due to a lack of scope in
traditional approaches to economic regulation. Her testimony to Congress did not seem inspiring or
encouraging due to a lack of detailed examples of just how a macro-focused policy benefits a wide
swathe of individual Americans.
In other words, just because there is a wealth effect doesn't really mean the ripples through Main
St. could not be waves. Yellen herself stated low rates do harm savers who are not necessarily
home or stock owners. In addition, according to Senator Schumer (D-NY), middle-class incomes
are declining, which doesn't point to a very effective monetary policy indeed. It seems quite
possible the Federal Reserve Bank has an agenda other than lowering unemployment and keeping
inflation in check. Summary points of the testimony are below:
• Accounting Standards: Effects of changes
• FSOC metric: Transparency for non-bank institutions
• One size fits all policy for smaller financial institutions too onerous
• P/E ratios don't suggest bubble; Equity Risk Premium doesn't indicate bubble
• Volcker rule: Maintain integrity of investor protection “firewall”
• 27 lower rate votes by Yellen, 0 rate increases
• Diminish volatility in financial markets via “communication”
• Low rate deference to Congressional mandate
• Monetary policy as response to weak fiscal policy and tapering
Senator Corker addressed the failure or lack of effectiveness of the trickle down effect. Low rates
have helped asset prices such as stocks and home prices, which according to Yellen is broadly
beneficial. However, as Senator Corker alluded to, home and stock ownership is elitist as not
everyone owns these assets. Additionally, Yellen also stated the Federal Government has no
business in influencing the stock market. This seems to indicate that the Fed is relying on indirect
economic impact than direct impact. Nevertheless, according to following quote from the Option
Queen newsletter, the Fed's metrics are all wrong:
“An additional unspoken concern is with the measurement of price to earnings ratios
(PE). With interest rates near zero, the PE calculations are out of whack because no
accommodation for a low interest rate environment is being made. It is our belief that
given a fed perpetuated environment of ongoing abnormally low interest rates, PE
should be adjusted to reflect the resulting artificially low cost of money, especially if
compared with times when the cost of money was much higher. If that measurement
were made today, we believe that PEs would not reflect a cheap market, but one that is
getting somewhat frothy.”

4. Questionable policy
This opening anecdote points to the difference between monetary policy's influence on Wall Street
vs. Main Street or mainstream America. Main street, it seems, is more sensitive to less money
being withdrawn from fiscal policy than it is to more money being used to help Wall Street. In
other words, and on first note, monetary policy is questionable in its ability to actually help
Americans, which it is intended to do. The primary beneficiaries of monetary policy are not the
majority of Americans because the wealth effect being generated by the Federal Reserve Bank is
not increasing loan activity, isn't encouraging employers to hire more and does not benefit
individuals and households that do not own equity via stock markets.
Dollar devaluation
The problem of dollar devaluation is evident over time. For example, for $1,000 to have the same
intrinsic worth as it did in 1971 it would now have to equal $5,517.00 in 2011 dollars according to
the U.S. Bureau of Labor Statistics. Now suppose someone put $1,000.00 into a Treasury Bond in
1971 at a 5 percent interest rate and also pays income tax of 28 percent after redemption. That
$1,000.00 bond would now be worth $5,470.89 according to the U.S. Treasury.
The problem is that is even less than the amount of money required to maintain the value from
1971, $46.11 less to be exact. Conclusion, anything lower than 5 percent is insufficient to build
suitable retirement due to inflation. It is for this reason, specific investments such as Treasury
Inflation Protection Securities or TIPS are bought to provide inflation protection.
Money supply
To illustrate the failure of monetary policy's attempt to boost the U.S. economy that the majority
rely on to earn a living one need not look far. A look at the U.S. money supply in the graph below
illustrates this. M1 is one of three measures of money supply and accounts for the sum of total
currency in circulation and transaction deposits and has climbed over $80 billion in just a few short
years.
M2 is the sum of M1 with savings deposits and retail money market mutual funds per The Federal
Reserve Board. The value of M2 is surpassing $10 trillion. In effect, by authorizing the creation of
so much money, the central bank is devaluing the dollar and its purchasing power. What is evident
in both these charts is that the U.S. money supply has grown a little short of exponentially in the
recent past.

5. Image source: http://en.wikipedia.org/wiki/File:Money-creation.gif

6. This money creation trend cannot continue without negative consequence to the economy. It also
reflects just how bad the underlying economy actually is because if the economy were healthy, that
much liquidity floating around would lead to substantial inflation. So what if the economy does not
improve enough? Will money supply continue it's upward climb? The answer is quite possibly and
potentially without inflationary consequences.
Economic asset “bubbles”
Loose monetary policy stimulates asset bubbles because price trends attract capital and become a
money magnet, both nationally and internationally. When investors spot a bubble with room to
expand, that represents opportunity provided the exit out of the bubble prior to its bursting is
orderly and well calculated. The growth created by asset bubbles serves as a stimulus for economic
expansion, and expansion that may otherwise be impossible to attain with more practical, but
stable economic policies.
To illustrate further, as with large companies, developed countries with large economies like the
U.S. have to grow GDP in the hundreds of billions to expand at a rate that can support increased
hiring and substantiate significant capital investment into industrial research, business
development, and government sponsored programs. The need for economic bubbles suggests it is
quite possible the U.S. has reached its economic apex where continued economic expansion at a
consistent rate higher than 1-2% is difficult, and possibly even unsustainable.
Despite the negative effects of bubbles they are also economic catalysts. Bubbles attract investment
capital from foreign countries, create wealth and fuel investments spawned by the increase in asset
values. Without bubbles, financial and economic stasis would be more likely, and although that is
more stable, it also has less near-term economic benefit. For example, consider an economy
without asset inflation, and with GDP growth that remains steady at 1-2%. Such an economy may
only keep up with population growth and currency purchasing power, and does necessarily
increase or decrease in size.
A bubble stimulated economy may grow 3-5% for several years straight. Moreover, according to
Department of Commerce GDP data, U.S. GDP grew an average of 3.82% each year between
1992-2000. That is year over year data as well meaning 3.82% compounded over the previous
year's growth. Although in the 1990s the bubble was actually based in real technological
innovation, a reasonable interest rate environment existed and inflation was actually kept in check
by tightening the creation of U.S. currency per the CATO Institute This bubble was conceivably
caused by over-exuberant investors rather than loose monetary policy. This is not the case with the
equity bubble believed to have been formed with the help of the central bank's current policy of
quantitative easing.
The contrast between industry led asset inflation versus monetary policy led price rises is striking.
Even after the tech bubble of the 1990s had burst, annual GDP did not decline below 1%, a
relatively small price to pay for a bubble that created a lot of jobs, attracted a lot of foreign capital,
and generated massive revenue. The housing bubble that burst in 2008 was not as healthy and was
fueled by inaccurate derivatives valuations, loose lending policies and a surge of speculative real
estate purchases and construction. Interest rates were also much lower in the mid-2000s than the

7. 1990s. Yet this led to a four year average GDP growth of 2.95%, low unemployment and large
corporate, foreign and individual investments. Without this bubble, economic growth may have
only averaged 1-2%, and a recession still might have occurred afterward.
The current economic climate is clearly not healthy and amounts to kicking the can down the road
in exchange for short-term growth. Government spending is out out of control with an excess of
hundreds of billions of dollars each year at the fiscal level, and a cumulative spending pattern in
the trillions of dollars at the monetary level. The big credit card in the sky is losing a strong credit
utilization ratio, which in turn lowers national credibility and raises the cost of national debt via
government security yields. The first domino of economic decline, and possibly more have been
tipped and the clues are evident everywhere. Low labor force participation, declining corporate
revenue, hemorrhaging government debt, chronic currency devaluation and rising precious metal
prices are just a few of the clues.
The magnitude of monetary policy is huge, and when the time comes for the Federal Reserve Bank
to seel its multi-trillion dollar stake in U.S. Treasuries and mortgage backed securities, the results
could be massive. The reason a selling of Fed assets is co influential is because of the massive
value they hold,. Moreover, under the law of supply and demand, a rising supply lowers asset
values and raises yields on Treasuries.
In terms of interest rates, if the economy suddenly grows at a fast rate, tightening access to capital
and interest rates on borrowed funds would not necessarily be performed fast enough to prevent a
corresponding sharp rise in inflation. The result could be economic whiplash as inflation rises
alongside a money supply that can't easily be shrunk.
Debt monetization
The term debt monetization is disliked by the Federal Reserve Bank because it describes the less
economically and socially palatable side of economic stimulus. By buying U.S. Treasury securities,
the central bank is financing the federal government's overspending and earning interest on it. This
is a pattern that cannot continue indefinitely despite the banks statement that it will continue
quantitative easing for as long as necessary. The fact is, as long as necessary is not economically
feasible because of the risk of inflation and to economic growth.
Interest rates versus financial regulations
The Dodd-Frank Act, originally created to overcome risks associated with banking de-regulation
acts as a damper on monetary policy such as low interest rates. This is because stricter capital
requirements for banks and tighter loan application procedures make it more difficult to purchase a
home despite historically low mortgage interest rates facilitated by the Federal Reserve Bank.
Nevertheless, financial institutions have pushed back against the legislation by lobbying for delays
and exemptions.
Another key component of the Dodd-Frank Act is the Volcker Rule. This rule curbs financial
institutions freedom within securities markets and will be voted on by regulators this month.
Furthermore, The Volcker Rule prevents banks from trading in financial securities for their own
benefit rather than that of their clients per the New York Times. To be clear, this rule is a fiscal

8. regulation and not a monetary one, meaning it is not necessarily implemented in conjunction with
the goals of monetary policy, but may counteract some of the effects of monetary for better or for
worse.
Despite the conflict between monetary policy and fiscal regulations, the traditional belief is that
investment rises when commercial interest rates are low. This has been the case to an extent, but
the resulting investments have not included extensive rehiring, Instead corporations have used
cheap money to implement stock buyback programs, and finance capital expenditures on
equipment that improves efficiency. In other words, companies are using the money to get richer
and not necessarily to expand.
Concluding thoughts
At best monetary policy has kept the U.S. economy afloat until something better happens. A
federal sequester, persistent annual fiscal deficits, continual above average unemployment and
declining corporate revenues do not indicate something better has actually happened. Thanks to the
Federal Reserve Bank, a business friendly environment and macro-economy has been maintained,
but businesses aren't exactly gaining market share and increasing their competitive positioning on a
global scale as the U.S. share of global GDP is also shrinking while the population continues to
rise. Mainstream Americans have little to show from monetary policy other than retirement plans
that have risen due to increases in the valuation of high-risk assets. Those rises in equity valuations
will not continue indefinitely and are also a stop-gap until the economy improves in a substantial
enough way to benefit Main Street.
Sources:
1. “MarketWatch”; Shutdown has taken $24 billion out of the economy; S&P; Steve Goldstein; October 16, 2013.
2. “U.S. Treasury”; Growth Calculator
3. “Bureau of Labor Statistics”; Inflation Calculator
4. “WikiCommons”; Money Creation; Akokkone; February 17, 2012.
5. “WikiCommons”; Components of US money supply; Autopilot, December 12, 2010.
6. “Federal Reserve Board”; What is money supply? Is it important?
7. “Zero Hedge”; Charting The Fed's Across The Board Fail; “Tyler Durden”; October 18, 2013.
8. “Zero Hedge”; Lacy Hunt Warns Federal Reserve Policy Failures Are Mounting; October 18, 2013.
9. “Zero Hedge”; Things That Make You Go Hmmm...Like the Freaking Fed; “Tyler Durden”; October 18, 2013.
10. “Zero Hedge”; Ron Paul Knows The Longer QE Lasts, The Worse It Will End; “Tyler Durden”; October 19,
2013.
11. “Department of Commerce”; GDP data; Bureau of Economic Analysis
12. “CATO Institute”; Greenspan's Monetary Policy In Retrospect, Discretion Or Rules?; David R. Henderson and
Jeffry Rogers Hummel.
13. “Business Insider”: Central Bankers Have Gone Wild, And The World Is In Code Red; John Mauldin; October 27,
2013.
14. “Federal Reserve Board”; Does the Fed get audited?
15. “Bloomberg”; Fed Bubble Agonistes Persists As Zero Rates Prompt Debate; Craig Torres and Caroline Salas Gage
October 28, 2013.
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Schools, July 25, 2012.
17. “Zero Hedge”; Fromer Fed Quantiative Easer Confesses, Apologizes: “I Can Only Say: I Am Sorry, America”;
Andrew Huszar; October 12, 2013.
18. “Zero Hedge”; You Are Here; “Tyler Durden; November 11, 2013.
19. “Moneycation”; What the Federal Reserve Bank's Debt Monetization Means For You; “A.W. Berry”; September
13, 2012.
20. “Stockhouse”; U.S. Federal Reserve Official Apologizes. Goldman Sees More Downside For Gold; Clif Droke;

9. November 15, 2013.
21. “Option Queen”: Archive For October 2013; J.A. Schwartz-Market Analytics.
22. Federal Reserve Board”; Does Monetary Policy Affect Stock Prices And Treasury Yields? An Error Correction And
Simultaneous Equation Approach J. Benson Durham; Division Of Monetary Affairs; Board Of Governors Of The
Federal Reserve System.
23. “GMO LLC Quarterly Letter”; Ignoble Prizes And Appointments; Jeremy Grantham; November 2013.
24. “New York Times”; Volcker Rule On Bank Risk Approaches Its Final Edits; Ben Protess; December 3. 2013.

10. November 15, 2013.
21. “Option Queen”: Archive For October 2013; J.A. Schwartz-Market Analytics.
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Simultaneous Equation Approach J. Benson Durham; Division Of Monetary Affairs; Board Of Governors Of The
Federal Reserve System.
23. “GMO LLC Quarterly Letter”; Ignoble Prizes And Appointments; Jeremy Grantham; November 2013.
24. “New York Times”; Volcker Rule On Bank Risk Approaches Its Final Edits; Ben Protess; December 3. 2013.