How an Economy Grows and Why It Crashes

added a bunch of new graphics, and upgraded the paper stock from rough pulp to smooth and glossy. Basically, we switched to the storybook format that we always thought was consistent with the book's spirit. But that is just the packaging. We also added important content. The original book was written just about one year after the economy almost completely collapsed. Since that time, things have apparently turned around. We are no longer reporting negative GDP growth, the housing market has rebounded, with prices in some markets rising at record pace, the stock market is hitting record highs, inflation appears to be under control, and unemployment has drifted steadily downward. But at the same time, most Americans aren't feeling particularly good about the so-called recovery. Adjusted for inflation, median household income in August 2013 is lower than it was before the Great Recession began in 2008. More people are dropping out of the labor force, or taking only part-time jobs when they really want full-time work. And the full-time jobs that are being created are more likely to be low-paying retail or service sector jobs rather than the good middle-class jobs that are being lost. Today's college graduates are facing the bleakest employment prospects on record, even while they are leaving school with record amounts of debt. As a society, we are traveling and vacationing less and spending more of our take-home pay on the basic necessities of life, food and energy. It is no accident that the cars currently on American roads are the oldest fleet on record and that Detroit, a city that once represented the pinnacle of America's economic might, is now bankrupt. There is a clear disconnect between the recovering economy that we are told we have and the disappointing prospects that we are actually facing. That's because, in an effort to prevent further pain after the crash of 2008, the federal government began spending trillions of dollars that we didn't have, and the Federal Reserve began implementing a new policy called Quantitative Easing, QE. These policies have become a substitute for a real economy. A decade ago, hardly anyone outside of university economics departments had heard of the phrase Quantitative Easing. Today, this policy has become the most important driver of the economy. Investors and financial journalists follow the Fed's statements about QE as obsessively as 14-year-old schoolgirls follow the tweets of their favorite boy bands. It's as if Ben Bernanke has become Justin Bieber. But QE is just a fancy euphemism for printing money. Since 2010, the Fed has simply been creating trillions of dollars out of thin air and using them to buy assets like government and mortgage-backed bonds. These actions have helped to push up prices in those markets and to lower long-term interest rates. The Fed is using the power of the printing press to create the illusion of recovery. But the economy it has created is only as real as the printing press money propping it up. Beneath the thin facade of health lies an economy that's even sicker than it was before the Fed began administering its cure. For instance, at the time we are preparing this new edition of How an Economy Grows and Why it Crashes, the Fed is buying $45 billion per month of treasury debt, which is a majority of all the bonds that the government issues. This keeps long-term interest rates low, which then gooses the economy in a number of ways. It encourages business and individuals to borrow and discourages them from saving. Ultra-low interest rates are also a primary reason that the stock market has taken off in recent years. If the Fed were to stop buying bonds, interest rates would immediately spike upwards, stocks would fall, and our apparent economic health would disappear. QE has also made a direct impact on the housing renaissance. Through its purchases of $40 billion per month of mortgage-backed bonds, the Fed has essentially underwritten the housing market. And it is buying mortgages that private buyers, for good reason, don't need.