America is likely entering its next great recession and pottential depression.
Ben Bernanke has chosen to undergo some of the most reckless Fed policies of the modern era, as today the Fed cut interest rates by .75 points - demonstrating to the whole world that it is in panic mode about the short-term future. Yesterday world markets dropped drastically as the rest of the world, still heavily tied to our currency and government, realized their mistakes as well.
Most people presume these cycles are completely natural fluctuations in the market - isn’t that why we have the Fed in the first place? To speed up and slow down the economy so we all have an easy ride? Or, even more ignorantly, isn’t this all just a result of corporate greed and vice?
It may be surprising, but the second one is partially right.
The Anatomy of a Crisis
The Federal Reserve has virtual monopoly control over interest rates and currency creation. When interest rates are low, more people can get their hands on large sums of money and use it to invest and consume, stimulating the economy. However, because the money is so easy to obtain, many people in all classes and professions (whom the market would never have permitted to acquire it) malinvest. Poor people buy houses they cannot afford, middle class people buy properties and start businesses and wealthy people invest in new (and riskier) ventures. And consumer spending skyrockets, making it all seem justified. It creates a massive economic party that everyone is invited to.
But the money was too easy, and those who obtained it for little cost went and did dumb things with it. The poorer people who extended themselves to their maximum debt to buy a house, are the quickest to topple. They lose their house, or have to make massive lifestyle reductions and can no longer spend gobs of money on the junk that the middle-classes were peddling to them. The middle-class businesses that the wealthy invested in fail, and massive amounts of money disappear into dust and ruin.
While these groups were obviously responsible for their bad decisions, it was the easy money that was initially created by the fed that is ultimately to blame.
Analogies to the Crisis
Like any party - the drinking, sex and revelry all feel good in the moment, but in the morning it brings sickness and regret at best, and at worst, you wake up next to the biggest mistake of your life. So too does the Fed, by the very practices which are intended to bring growth, actually sow the seeds of recession, depression and financial crisis.
Milton Friedman once wisely compared the easy money of Fed creation to a drug addict. To avoid becoming sober and dealing with the physical, emotional and psychological consequences of abuse, the user continues to get high - desperate to avoid reality and live in a fantasy world. The addict knows that when he goes off the drugs, he will have to face the accumulated consequences of his lifestyle. They may last years, even be permanent, but he will be better off in the end by sobering up.
If the market determined interest rates, then as soon as investments began to sour, the rate would be increased by private banks to ensure that they were not losing money. Corrections would be small, localized and manageable. With one institution, and one oligarchical board controlling the essential mechanism of the economy, we are merely passing time until a major collapse. Interest rates and currency management, like all goods, services and prices, cannot be controlled by even the wisest of men and must be left to the market to determine to avoid the poor driving of the Fed.
Here Come the Effects of Inflation
The Fed Rate cut has other drastic effects which hasten the coming of the bust period. Part of the mechanics of lowering the rate, is to liquidate debt. That is to move virtual dollars into physical ones. More dollars chasing the same amount of goods and services causes prices to rise and brings inflation. During the initial boom, this is great - everyone has more money to throw around. But soon the market realizes this and prices shoot up, causing a decrease in living standards and economic activity.
In other words, the inflation is not about to commence, but was started after 9/11, after the dot com bust and after the housing bust. Its effect has merely been staved off by even further inflation.
These most recent rate cuts are only going to heap more negative consequences on the economy. We’ve dealt with the last three busts (dot com, 9/11 and housing) by behaving this way - by taking another swig from the inflation bottle and toasting to our health. The consequences are compounding, growing and will soon bring this country to it’s knees. Do we have the courage to stop now, deal with the consequences, and return to a normal and prosperous economy?
I have no idea what that article was about. I have no education in national or global economics. (I could say something practical about personal economics, but that’s not the topic.) So I have nothing to say except two things:
1. Every night on the news when I hear all the blah, blah about the economy, I wonder–Don’t people have any common sense?
2. I’m glad that as believers our provision ultimately is in God’s hands, not the economy of any country or agency, etc.
Hi Colin,
Great article. Let’s say that interest rates were to be controlled by the free market. With the constant merger of banks that we’ve seen, what would you do if the banks got together and eliminated competition?
Excellent question, but it is not possible on a free market for banks to gain a coercive monopoly. Banks, in the terms we are describing them, are lending institutions and all that interest rates are is a price on lent money.
So Say all the banks merge and want to charge a 40% interest rate. Individuals or groups of individuals could easily beat that and make a crap load of money while offering a better product. Heck, I’d be part of a banking co-op that offered me a return on my money for lending it out.
The only way this doesn’t happen is if new entrants and/or substitutes are restricted through government actions (such as laws or licenses).
While I firmly agree that bad loans were the fault of banks and borrowers, I fail to understand this “magic value” you seem to import in the money supply. Money, like ALL things, has no inherent value. Its worth is EXCLUSIVELY in what people are willing to do or give you for it that you want. A federal currency is nothing more than a point system that a government uses to keep track of what kind of taxes you need to pay.
To look at “wealth growth” over the last hundred years, I think it is useful to look at this chart:
Far more reliable than the price of gold has been the price of stocks. Why is this? Because stocks have REAL meaning. They represent the ownership of companies that are producing goods and services, and increase in value over time because the amount of goods and services they can produce for any given commodity (including gold or federal currencies) has consistently improved over time. It is foolish to store your wealth in metal OR currencies stuffed in a mattress. Neither of these allows your assets to produce wealth.
In the US, we don’t normally store our wealth in treasury notes, but rather in “insured loans” and “capital investments” that are used to produce further wealth. Viewing a currency as a “magic system” with power over economies is foolish. However fast inflation moves in value, productive investments in the US have ALWAYS moved faster. Keeping any more worth than needed in a stockpile doesn’t make sense unless you have significant reason to believe that availability of that stockpile will significantly decline. I have NEVER seen reason to suppose that the supply of treasury notes will decline, making them a very foolish resource to stockpile.
Stock Market decade decline (as compared to dollars):
1930 20.67 15.34 164.58
1940 34.5 10.58 131.13
Gold Market decade declines (as compared to dollars):
1950 40.25 20.41 235.42
1960 36.5 58.11 615.89
1980 641.2 135.76 963.99
1990 423.8 330.22 2633.66
1990 423.8 330.22 2633.66
2000 272.15 1320.28 10786.85
Which is a more stable form of wealth storage: Gold or stock index shares? Woe be to the nation that was on a gold standard in the 90’s… (Though it HAS done incredibly well the last few years!)
It is true that stock value can represent the value of real goods and services, in that sence they are, at best, equal to gold. However, the objective valuation of goods and services (such as companies, labor and gold) is either in a barter from other other goods, or through a common barter item(s). I am not suggesting that gold somehow increases in value, as it does not - it actually decreases as more of it is found. My point is that the Fed’s idea of valuation (in fake units called “dollars”) is not based on good and services at all. If we traded around stock notes instead of barter, I would be fine with your suggestion, but we don’t. We trade dollars - which, when the supply is increased arbitrarily, lose value against the goods and services that have not been produced.
This is not a complete picture. The goods and services “catching up” with inflation is merely in spite of the inflation, and not a cooperative or related function. Without the inflationary measures of producing more dollars, those goods and services are more objectively valued (since the dollar has no inherent value, and is merely used in monetist theory to objectively value subjective goods and services). Inflation makes it harder to produce goods and services because it distorts prices (in terms of itself, aka dollars) and causes bubbles and busts in the market by means of under and over valuation. Thus, currency does have power over economies ion the most fundamental sense, as the articulation of objective value in any particular moment in time as values fluctuate with the subjective values human place on good and services. Without a stable price system (and worse, an inflationary currency), the market will at least be proportionally inefficient, and eventually crumble back to barter.
But doesn’t this happen with ANY “point system”? If we measure “true value” against gold, the values of other commodities jump around constantly based on new gold findings, usages, and stockpiles. In fact, over the short term Gold was a more unstable currency than a unbacked notes have been in the US. Look at the kind of massive inflation that the Gold Rush caused. There is NO “objective valuation of goods and services”, and even if there was those valuations would be different for every individual at every moment in time. Economics MUST deal with constant shifts of relative values, or it is irrelevant to reality. Again, the only relevance of “federal reserve notes” is that they are the primary form in which taxes can be paid, and most loaning organizations index their loans against predicted inflation models.
The “stability” of the currencies value is entirely in the hands of the government, which may or may not make it more stable than any given commodity. Look at the value of gold vs the value of the stock indexes over the last 27 years. Gold dropped 57% between 1980 and 2000, then went up almost 200% in the next 7 years. Arguably it could be the dollar that was unstable, but then look at the stock indexes. Consistent growth, even considering the tech bust and housing bust.
Tying your “objective valuation” to something that bounces around constantly would definitely add complications. There IS no objective valuation, and the better people understand this the less surprised they will be by situations like this. Our current problems are based on some specific bad business decisions by specific large corporations. The current monetary policy might not be ideal, but there is no clear evidence that it is worse (or better) than anything we’ve seen before either. As in most things, the best idea is to diversify so a crash doesn’t wipe you out.
This is all subject to how one defines “unstable.” If you mean “fluctuate” than gold, like every commodity, fluctuates. However, if you mean “unreliable” then you mean the dollar, which loses value against other goods and services, not based on market phenomenon (like every other commodity, good or service), but because it is controlled by men.
In fact, we agree on the subjective nature of valuation, but, whereas gold (or any commodity money) operates congruent with these laws, fiat money is a-market in nature and fails drastically because it is incapable of offering objective valuation (which is inherent in the ideology of planning).
Stock indexes are merely an indicator of growth. They represent the inherent move towards equilibrium in the aggregate market. And as I have said, some kind of currency note tied to aggregate value would be a beautiful thing. However, the dollar or any fiat money is not such a solution.
I have no idea how this conversation moved to gold, but let me be clear that I am not a proponent of a gold standard, but a more generalized commodity standard. If gold won out in our modern economy, then fine - but my guess is that it would not.
I agree that all value is subjective. My point was merely that if you could press “pause” for a moment in any market, you would see objective values in terms of a commodity (NEVER in terms of human valuation, which is based on subjective prioritisation, not objective values. On this note, the current economic language of “utility” bothers me greatly. As if people actually go around objectively valuing things in “utils”).
ALL valuations are controlled by men though. The only reason Gold (for example) holds its value so high is because of vast stockpiles worldwide. If the US government desired to devalue gold, all they’d have to do is sell off some of the reserves it holds. As you indicated, Gold as a resource will continually DROP in value as more of it is found in the world.
The ability to predict future value and ease of carrying are the ONLY elements meaningful in a currency, whose sole importance is to allow you to exchange one type of good or service for another at a later point in time. There is no other reason for currency. If all we are looking for in a currency is a predictable value, then why would a unique product like a currency be a bad standard? We don’t have to worry about a new source of US dollars being discovered, only the US government can make them. If you trust them to hold the creation rate somewhat constant, you can reliably predict their future value. If that value is expected to drop at a consistent rate, you want to hold wealth in currency for as short a time as possible. The reliability of value in a currency over the course of decades is FAR less important than its reliability over the course of a day or week. I am aware of few major intra-day or intra-week fluctuations of the value of a US dollar, making it a perfectly adequate currency.
At that same point in time, you can also see “objective values” in terms of any currency. A currency is simply a resource created by men. Just as diamonds are artificially valuable due to controls by the DeBeers cartel, currencies are artificially valuable do to controls by governments. So long as these controls are maintained though, the commodity retains its value. Sure, a currency becomes worthless when the government starts recklessly printing money, but a commodity always drops in value when the supply increases. That is the risk of using any commodity as a currency (a small relatively valuable object accepted by most people in exchanging goods and services).
Not really, at least not in the methods that I was taught. “Utils” were advertised to me as a kind of psychic objective currency - I value pepsi 3 utils, and coke 4 utils. But even if it is all you say it is, which I’ll take your word for, it is completely meaningless at this juncture. We have no means to probe it or understand it - only through it’s articulation in the market through currency use. Which brings us back to what kind of currency system best enables and demonstrates this.
Perhaps my context wasn’t clear. This wasn’t a general stand-alone statement - by “men” I mean the socialistic sense - a group of elected or oligarchical planners who think they know better than the market. They think their mathematic equations about the market can give them expert knowledge on how to increase the money supply to preserve stability. In this respect, commodity currencies do not have this feature.
This is not true, and rather short-sighted. Further essential elements in a currency are divisibility, recognizability and (I would argue) actual market value. Locke makes this case (Works, Book I):
You are looking at currency, essentially, as an abstract math problem. But money comes off the chalk-board and enters the market and behaves like money always does, as a commodity. This is what money is and where it came from on the market. The experts cannot change this fact. Perhaps we will move to this point in the future, but we are not there yet.
If your point about the government monopoly on currency was a good one, then there would have been no need to ban competing currencies from 1933 to the seventies. Even still, gold is highly restricted as a competitor. If the dollar is somehow “above” all of this market money junk, then it should have no problem competing.
It is also ridiculous to think that long-term viability of a currency is not as important as short term. Combine this with the reckless behavior of democracies and other “public” governments to only consider the short term interest in funding wars and other government spending, you will have consistent long term instability. It will appear as though the government can fund increases without initial cost. It is the same kind of principle that encourages massive debt by both nations and individuals. It is the principle of Keynes when he proclaimed: “‘Long run’ is a misleading guide to current affairs. In the long run we are all dead.” I understand that short-term stability is critical, but capital (essential for production, and thus for increasing standards of living) is generated by long-term stability of prices, currency and markets. If a currency is losing value over the long term, then it will not be used. The wealth in that society will fail along with the currency.
This is the crux here. First of all, you are simply trusting that men with monopoly power won’t abuse it. I hope you can see the ridiculousness of this idea. Second, you equate this inevitable monopoly abuse with legitimate market loses of value - which is probably more silly. This is because a market naturally moves toward equilibrium: the loses in value of one good (even if it is a currency) are compensated by increased values of other goods. The loses in value on a monopoly fiat currency are not compensated for, and (if they are used in the way you suggest [and this is the way they are used now] - to represent aggregate market value) then the whole market is negatively effect (albeit not equally, some actually make money on the inflation, and some lose more than average). Do you see this? Loses of value of a commodity are built into a market, whereas loses of value in a fiat currency have no mechanism to bring the market back towards equilibrium. The offset is permanent and is only made up at the cost of new production (which you pointed out in your first post). Thus, your argument boils down to glorifying the broken window fallacy.
Also, for the stock market infallibility, this guy (who predicted the crash in 1987) has some charts that show the value of the stock market non-relative to itself (which is part of your argument):