The Law of Unintended Consequences: The Worst Mistake in Decades


U.S. Federal Reserve Chairman Ben Bernanke ignores the short term consequences of his QE initiative.

The law of unintended consequences has long existed dating back to at least Adam Smith but was popularized in the twentieth century by sociologist Robert K. Merton. In his theory, Merton stated that often unanticipated consequences or unforeseen consequences are outcomes that are not the outcomes intended by a purposeful action. In some cases, the law of unintended consequences could create a perverse effect contrary to what was originally intended and ultimately making the problem worse. 

 In the economic downturn of 2008, the central bank undertook a series of what they considered “positive initiatives” to stimulate the economy. Fed Chairman Ben Bernanke defended his position by saying that the policy of “quantitative easing” (bond purchasing), will “stimulate the economy and create jobs”.  In other words, stimulate the economy by printing massive amounts of money.  

 The unintended consequence of these initiatives will prove to be catastrophic in the long term. The cause of this unanticipated consequence is something Merton called the “relevance paradox”, where decision makers think they know their areas of ignorance regarding an issue, obtain the necessary information to fill that ignorance void but intentionally neglect other areas as its relevance is not obvious to them. This is exactly the case with our central bank.  

 To clarify, Ben Bernanke has intentionally ignored the short term consequence of his QE initiative through a justification of the potential long term positive effect.  In recent testimony before capitol hill, Bernanke stated, “while indicators on spending and production have been encouraging on balance, the job market has improved only slowly” adding, “it will be several years before the job rate is back to normal”, despite some positive signs that cropped up in January. Bernanke has chosen to ignore the negative “job market” consequences by stating that it will recover in a few years and focus on the minor positive. He continues to forge ahead while ignoring the relevance of negatives such as a surge in inflation in commodities, precious metals, and most importantly oil due to the systematic devaluation (destruction of the U S dollar) as well as the world wide chaos which has been ignited by inflation and rising food prices.  

 The unintended consequence of these Fed actions will result in the only economic condition worse than inflation, which is “stagflation”, in which the inflation rate is high and the economic growth rate is low. What will make this condition considerably adverse is the inverse relationship between the U S dollar and oil prices. Oil prices have historically increased as the value of the dollar decreases. Oil prices can exceed their 2008  high of $148 .00 per barrel  especially considering the fact that with oil prices at a historic high in 2008, the value of the U S dollar  was considerably higher. The unintended consequence of a weak dollar which is supposed to spur exports and stimulate our economy is more inflation and greater upside pressure on commodities and oil than we saw in 2008.  

 Merton believed that the ultimate flaw of mankind is hubris – our belief that we could fully control the world around us and that we put our immediate interest before our long term interests. Ben Bernanke and the central bank are guilty of “hubris”, as they continue to put their immediate interests before that of the nation’s long term interest. Their actions will force us to live with “unintended consequences” for decades to come.   

 To quote French novelist and Nobel Prize winner, Albert Camus, “the evil in the world almost always comes of ignorance, and good intentions may do as much harm as malevolence if they lack understanding”. In our financial lives it is imperative to invest with the foreknowledge that we may have to endure many “unintended consequences” inflicted on us by a “well intentioned” government to achieve our financial success.  

 Reason is our only defense. To quote Ayn Rand, “From the smallest necessity to the highest religious abstraction, from the wheel to the skyscraper, everything we have comes from one attribute of man … the function of his reasoning mind”.

Jeff discusses the concept of unintended consequences as it relates to decisions made by the Fed.