Bernanke is wrong – so says Milton Friedman from his grave. Milton Friedman (1912 – 2006) was a well-known American economist, and author who taught at the University of Chicago. He basically championed the macroeconomic policy known as “monetarism,” which largely (in my opinion) has been put aside in favor of “Keynesian” macroeconomic policy, championed more recently by Paul Krugman.
Clearly the Obama administration and more importantly the Fed under Ben Bernanke, are Keynesians. They believe that they can spend our way to prosperity with loose monetary (quantitative easing and near zero interest rate policies) and fiscal (deficit spending) policies. Friedman argued that Keynesians are naive. Who’s right and what is the impact on our markets on the outcome of this debate?
Keynesians believe that the government faces a trade-off between unemployment and inflation in the so-called Phillips curve. In this view the government could, by increasing the demand for goods and services, permanently reduce unemployment by accepting a higher inflation rate. Friedman argued that once people adjusted to the higher inflation rate, unemployment would just creep back up. To keep unemployment permanently lower, he said, would require not just a higher, but a permanently accelerating inflation rate.
Remember what the Fed is trying to do today – fight deflation, by pumping the economy with more and more money, until their target, unemployment, is met. If Friedman is correct, these continuing Keynesian policies, will require to be permanently accelerating. The Fed, has said however, they will exit gracefully at the right moment. But this point will never come according to Friedman – the Fed keeps extending the exit date, which is now 2016. We have seen some evidence that Friedman is correct. Each quantitative easing and fiscal stimulus has had a diminishing effect, as Friedman predicted.
The effect on the markets? Though of course we will have the ups and downs in both the markets and economic data, the end will never come, until we hit the Minsky moment, where the debt eventual consumes us. The solution is in fixing the fundamental economic structure to a fair and free market system where everyone participates democratically, as opposed to what our current politicians are doing – dinking with taxes, spending and/or spending cuts. This means the markets go up and up, until the crash. But as traders, we all know, timing is everything.
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