Expanding the money supply was a handy scam for central bankers and politicians. The economy slowed, they took action and the economy improved. What really happened was the economy getting a temporary jolt from the stimulus. By the time the jolt was wearing off, normal forces in the economy had healed the imbalances and the economy began to grow again on its own.

In the same sense as the rooster took credit for causing the sun to rise, government took credit for curing economic slowdowns. Government crowing enabled it to establish itself as necessary for the economic sun to keep rising. In doing so, they vastly increased government size and power over the economy.

One major difference between the rooster and the government is that the rooster never harmed the sun’s ability to provide light and warmth. Government’s belief and actions were not so benign. Each intervention obstructed the natural healing process of the economy. After five decades of such interventions the economy no longer functions properly as a result of the cumulative damage. These interventions served government’s desire to obtain power at the expense of a productive and growing economy.

As a result of such policies, massive imbalances exist in the economy. Each intervention represented an attempt to prevent these imbalances from correcting. Now we are at the point where massive liquidations of excess debt are necessary. So too is capital tied up in unproductive uses.

Politicians cannot afford to allow this to happen. It would destroy the myth that they have cultivated for the last half century. Unfortunately for them, they are or soon will be, powerless to stop the massive corrective forces which will break out in the form of another Great Depression.

Econophile explains monetary policy and why it no longer works:

If there is one thing we should have learned from recent data is that you can “juice” the economy by inserting more money into it because when the money works its way through the economy, certain economic data will become more positive.

This is not a difficult concept to grasp. For example, if in a hypothetical economy there is a $1 trillion money supply and then it is increased by, say, 10%, assuming that new money is spent in economic activities, GDP will ultimately rise more or less by 10% because GDP measures spending. More money equals more spending, thus higher GDP.

During this phase one might see manufacturing and consumption increase and even employment grow. This happened with QE1 and 2. However, one might ask, if money stimulus actually revives real economic growth, why did we need QE2? Of course this is the flaw in the above argument. It doesn’t work.

These naive monetary theories don’t work to create real growth, they just make the numbers go up … temporarily. QE 1 or 2 did nothing to cure underlying economic problems or create lasting real growth. If QE had worked the economists at the Fed wouldn’t be scratching their heads over the current negative economic data that has been pouring out recently.

The political class is both perplexed and panicked. They sense their economic charade is at an end. Unfortunately to right the economy from its cancerous condition requires major surgery, not by intervention but by allowing market forces to heal the damage done.

“Monty Pelerin” is a pseudonym derived from The Mont Pelerin Society. The writer has no connection with the Society (other than coincidence of philosophy). Nothing said by me should be considered to be representative of the views of the Mont Pelerin Society or any of its members. “Monty Pelerin”  blogs at Monty Pelerin’s World