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QE3 Would Ruin the Economy

Central bankers increasingly resemble Soviet-era planners. Their tinkering will do more harm than good...

IMAGINE a world where we don't talk about central bankers every other day. It's coming...just not quite yet, writes Greg Canavan for the Daily Reckoning Australia.

First, the central bankers need to disgrace themselves and prove to the world their theories are wrong. That will happen - actually it is in the process of happening now. But unfortunately it will cause untold economic damage in the meantime.

The next phase of the disgracing process is already underway. That's the part where the Fed governors climb the rostrum to prepare the markets for the next monetary injection.

Bernanke kicked things off at the Jackson Hole symposium – then Chicago governor Charles Evans followed up a few days later. Then, Minneapolis governor Narayana Kocherlakota, a dissenting voter at the last meeting, came out yesterday and said he's back on the dove's team and won't be dissenting in the future.

That just leaves Dallas governor Richard Fisher and Charles Plosser of Philadelphia as the two remaining opponents of more QE. That's two 'against' and eight 'for' in the next vote on how to distort and ruin the global economy in new and more twisted ways.

So with the markets now giddy again on the prospects of QE3, we enter the bizarre world where ugly economic news equals a sharp market rally - because bad news is actually good news.

Only the fully invested and desperate, or brainwashed Keynesians (or both) can honestly think more QE will have anything other than a temporary effect on markets. Here's why...

The problem with the global economy is a lack of real savings in the economic system. Our economic lever pullers constantly talk about the need for spending. They think an economy grows if you simply spend more.

But the key to economic growth is saving. It is saving that produces future spending. Saving is derided because for some reason people believe money saved is 'hoarded' under the mattress, or it sits lifeless in a bank vault.

When you save money and put it in a bank, the bank only sets aside a very small portion of your money as a 'reserve'. It lends the rest out. These savings are invested, which, if done efficiently, can create jobs and increase productivity.

In a real free market, the interest rate would determine the level of savings a society makes. High interest rates encourage savings and thrift, which in turn builds a large pool of funds available for investment. Then, when demand for investment funds begins to wane, interest rates fall to encourage borrowing and discourage saving.

But of course we have nothing like a free market in interest rates. The Fed has kept its boot on the throat of interest rates for so long in the US that the system is devoid of any real savings. By maintaining low interest rates though, the Fed gives the impression that savings are plentiful.

In fact, the savings are completely phony. The Fed simply created them by buying assets with money it doesn't have. And it puts this new money in the commercial banking system in the hope they will lend it out.

But the economy knows the savings are false.

Why? Because the economy didn't do the saving! Prolonged low interest rates have encouraged spending instead. Now, there is no appetite to borrow so the phony savings sit idle and the Fed morons sit scratching their heads and come up with a brilliant plan to do more of the same.

So QE3, whatever its guise, will simply be an attempt to convince the economy (i.e. the people who have no savings) into thinking there are plentiful savings about, when in fact there are none and the US economy is actually consuming capital because of the dearth of savings.

This is the big picture story behind prolonged low interest rates and QE insanity. On a day-to-day basis, it holds out hope for market speculators but under the surface the structure of the economy continues to deteriorate.

So enjoy the equity market pop while it lasts. We have a feeling the market won't party for as long this time around. Bernanke will have to do something big, like bail out the housing market, to really get an inflationary surge happening.

If you think about the economy from this perspective, Australia's interest rate structure is quite healthy from a longer-term perspective. Australians are saving and deferring their consumption. More accurately, Australians are saving after over-consuming for so long, These savings will form the basis of future consumption...at some point.

This is how an economy should function. It's just that we've been led to believe by conniving, power hungry politicians: that recessions don't have to occur (not on their watch, anyway) and we can live in perpetual good times.

It's all about savings. As for the individual, savings are the bedrock of a society and make for a structurally sound economy. Unfortunately, Keynesianism and a docile, state-led education system have twisted this reality around.

Savings aren't bad, but they can be invested poorly. Take China. Its government is using its citizens' savings to lend to the largest bankrupt nation in the world. That's not too smart. Of course, China is doing so for its own strategic purposes. It lends to the US so it can keep its currency competitive.

But by doing so it robs its household sector of purchasing power. It keeps import prices expensive and denies the country's savers the ability to purchase foreign goods at a more favorable price.

In economics, every action has a reaction. Trying to make things better in one place will make them worse in another. The more the system is tinkered with, the greater the distortions become. That's why the Soviet Union eventually collapsed. Too much tinkering...

It should be a lesson for US central planners. But it won't be. They know better.

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Greg Canavan is editor and publisher of Sound Money, Sound Investments, a weekly financial report devoted to unearthing great value investments amid today's "money illusion" of fiat currency. Formerly editor of Australia's market-leading finance newsletter, Greg has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as LewRockwell.com and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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