If You Prop Up An Artificial Economy Long Enough, Does It Become Real?

Does carefully nurturing a facade of health actually lead to health? No; all it does is perpetuate a destructive illusion.

The policy of the Status Quo since 2008 boils down to this assumption: if we prop up an artificial economy long enough, it will magically become real. This is an extraordinary assumption: that the process of artifice will result in artifice becoming real.

This is the equivalent of a dysfunctional family presenting an artificial facade of happiness to the external world and expecting that fraud to conjure up real happiness. We all know it doesn't work that way; rather, the dysfunctional family that expends its resources supporting a phony facade is living a lie that only increases its instability.

The U.S. economy is artificial in three important ways:

1. The Federal Reserve has distorted the market for borrowing capital by reducing interest rates to zero. Those holding capital (savings) receive essentially zero interest income while favored borrowers (banks and large corporations) can pursue marginal-return speculations for free (when measured in real terms), creating systemic moral hazard of the most pernicious sort.

2. The Federal Reserve's monetizing of Federal borrowing via the purchase of Treasury bonds has given the government a "free" hand to spend $1.3 trillion more than it collects in tax revenues, feeding inflation (The Source of High Inflation: Government Spending [17]) and the moral hazard created by having essentially free money to dispense to cronies and to buy voter complicity.

In a real market economy, the cost of Federal borrowing would rise as bondholders would demand a premium for taking on the risk that interest rates would eventually rise under the relentless accumulation of stupendous debt. That mechanism has been frozen by the Fed's monetiziation of Federal borrowing.

3. The housing market has essentially been socialized, with the taxpayers now funding the entire mortgage market (98% of mortgages are backed by Federal agencies) and endless subsidies of marginal buyers (3% down payment loans, etc.) The Federal Reserve has committed itself to taking trillions of dollars of impaired or dodgy mortgages off the balance sheets of banks and burying them in its own opaque balance sheet, while also maintaining near-zero interest rates (when adjusted for inflation) to incentivize refinancing and home buying--both of which generate billions of dollars in fat fees for banks.

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