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Source link: http://archive.mises.org/9196/why-congress-must-stop-the-feds-massive-pumping/

Why Congress Must Stop the Fed’s Massive Pumping

January 6, 2009 by

If it were possible to lift real economic growth by means of money pumping, world poverty would have been eradicated a long time ago. Real economic growth requires real savings to fund various activities that support and promote it. (Remember that money is just a medium of exchange and cannot grow anything. Money is employed to exchange goods of one wealth generator for the goods of another wealth generator.) FULL ARTICLE

{ 46 comments }

Mark M January 6, 2009 at 6:16 am

An excellent article.

Sorry to be a Keynesian for a moment but can’t money at least give economic activity a gentle nudge to get it going? If banks stop lending (as they have done) and the fall in aggregate demand is such that businesses fear to invest incase there is no market for what they produce (which is arguably happening or at least starting to happen), then why can’t an increase in the money supply encourgae an increase in the level of consumer expenditure and thereby stimulate production and set us on the road to recovery?

Steve January 6, 2009 at 7:05 am

I only recently came across Austrian Economics and for the first time in my life I feel that I can grasp Economics in a common sense way.My first feeling was ‘oh,that’s how it works’! the second:’+$%^&*,what a pile of nonsense the man in the street has been forced to swallow for decades’! It has also provided me with a great,comedic treat (if it all weren’t so serious). Bernanke is a Priest.Gordon Brown is a Clown.I seriously do fear that America is burying itself and as an Englishman and a friend of America,I’m afraid I can’t help to prevent that.One thing you should do is make Murray N Rothbard’s ‘What has Government Done To Our Money’ a downloadable PDF document available from this website.EVERY AMERICAN (and the rest of us) needs access to the truth NOW.Please consider this request? and thank you beyond description for allowing me to discover the truth.

Tom Burger January 6, 2009 at 7:06 am

When I click on the FULL ARTICLE link I get taken to your jpg graphic, and nothing more. I haven’t found a way to access the article. What am I doing wrong?

John Tate January 6, 2009 at 7:20 am

http://mises.org/daily/3279

Full article can be found there. It appears an error has been made on this blog.

FarSide January 6, 2009 at 7:49 am

Steve – ‘What has Government Done To Our Money’ IS available, both as a pdf and HTML:
http://mises.org/money.asp

I am constantly amazed at how many publications are available for free on this site. Just incredible.

Bob January 6, 2009 at 9:22 am

Great article! However, in the first sentence of your conclusion I believe it should read ‘recipe’ for economic disaster, not “remedy”.

Tim Kern January 6, 2009 at 9:37 am

“Most commentators regard deflation as a terrible thing that must be countered as soon as possible. This is also the view of Federal Reserve policymakers, in particular Fed Chairman Ben Bernanke.”

This illustrates the largest blind spot among Austrian economists (but not among libertarians): the government is not concerned with the economy except as a tool to maintain or increase power.

If prices fell, savers and the frugal money managers would be able to get out of debt, removing power from creditors. The government is the ultimate “predator-creditor,” in that government (in general) operates as though all substantial assets were government rather than individuals’ property. Using property taxes as one example (and understanding that these are of greater concern to the states than the federal government), it is easy to see what could happen if valuations dropped: property tax collections would decline. Governments do not like to cut salaries or personnel, so things would get awkward in state capitals. Fewer people would be under direct governmental control, and the sphere of influence among government-worker families and substructures would contract.

The federal government corollary is that it taxes paper profits. When these lose value, the politicians’ power declines.

The Federal government also taxes productivity, through the income tax, and because of the progressive model of the confiscatory scheme, drops in nominal wages are magnified as the wage-earners drop down through the tax brackets. Declines in wages yield disproportionate declines in tax collection.

Near-government entities (banks and insurance companies, both of which operate as branches of government and enjoy special governmental privileges, subsidies, powers, and protections) would stand to lose even more, as their collateralized assets dropped in nominal value — and as the peasantry became more-able to afford them (due in part to the benefits of lower income tax bracketry and lower tax assessments), so these entities would also lose some of their grip on the throats of the masses and their hegemony over substantial assets.

So, why are the federalmasters not worried about printing an extra trillion dollars when they seem concerned about inflation? What we see in this seeming contradiction merely underlines the government’s motives: the government’s money pump is not designed to be used to the advantage of the people. That extra, low-cost and free money is intended for the exclusive use and benefit of the ruling class.

Divorcing politics from economics may make economics more “pure,” but it makes economics less useful and its understanding more opaque.

Politicians have no hesitation in contemplating all the practical parameters, be they economic, legal, or personal — into their calculations. That’s how they win. Too many economists continue to try to keep their studies “pure,” in the interest of practicing in the proper ceteris paribus scientific method, and they miss many big lessons that empirical evidence offers.

Our wealth is more-closely related to real life, with all its shortcomings and uncertainties, than it is to science, however valuable the scientific method is in other disciplines. In real life, there is no ceteris paribus, and there are no control groups.

Matt January 6, 2009 at 9:40 am

“Congress must stop the reckless policies of the Fed and the Treasury as soon as possible.”

Yes, Frank is right about that, however it must be remembered that Congress too is interested in Inflation of the money supply, it is the first recipient of that benefit and has been for decades in that of deficit spending and the taxing of fictitious profits. Congress and its cronies have a financial interest in inflation. The FED and Congress are in this scam together, don’t expect them to act otherwise.

Marshall McMahon January 6, 2009 at 10:18 am

Is there an error in this sentence: “In the week ending December 17, 2008 banks’ cash reserves jumped to $774.4 billion from $604.7 billion in November and $2.39 billion in December 2008″?

I Hate Taxes January 6, 2009 at 10:54 am

Mark M,

If you take 2 people, one produced a good, the other has nothing to exchange for it, then a turd person, pun intended, comes in and gives money to the second person that has nothing to exchange for the good produced by the first person.

The first person will not accept this phoney money because he will know that he will not be able to exchange it back for something the second person has because he has nothing.

The first person does not want to be stuck with worthless money which cannot be exchanged for nonexistant goods or services.

Real wealth is works and products.

No matter how much money you throw at the problem, it stays the same.

Chances are, the first producer will cling to his goods because he will see the value of money drop and therefore he will see the value of his goods increase over time.

Instead of referring to the cloudy macro-economics, you should always simplify the problem to 3 persons.

The turd person is of no use to the exchange between the person who produces and the person who consumes.

We could very well do without the turd person he is just getting in the way of free commerce.

Yeah, I know it’s spelled third, but I think TURD is more appropriate to describe government intervention in the economy.

I Don't Like Taxes January 6, 2009 at 10:55 am

Mark M,

If you take 2 people, one produced a good, the other has nothing to exchange for it, then a turd person, pun intended, comes in and gives money to the second person that has nothing to exchange for the good produced by the first person.

The first person will not accept this phoney money because he will know that he will not be able to exchange it back for something the second person has because he has nothing.

The first person does not want to be stuck with worthless money which cannot be exchanged for nonexistant goods or services.

Real wealth is works and products.

No matter how much money you throw at the problem, it stays the same.

Chances are, the first producer will cling to his goods because he will see the value of money drop and therefore he will see the value of his goods increase over time.

Instead of referring to the cloudy macro-economics, you should always simplify the problem to 3 persons.

The turd person is of no use to the exchange between the person who produces and the person who consumes.

We could very well do without the turd person he is just getting in the way of free commerce.

Yeah, I know it’s spelled third, but I think TURD is more appropriate to describe government intervention in the economy.

Ohhh Henry January 6, 2009 at 11:18 am

“If it were possible to lift real economic growth by means of money pumping, world poverty would have been eradicated a long time ago”

You have put your finger on it. But you haven’t answered why money pumping and the poverty it causes are such popular political strategies. The simple answer is that money pumping benefits the govt, as described by Tim Kern above, and increasing poverty also benefits the govt by creating an underclass whose discontent can be exploited in order to win elections and seize more power over spending and investment.

I see no conflict as such between Austrian economic and libertarian theories, in that the study of human action which underlies Austrian economics can perfectly explain the behavior of politicians in this case. However certain Austrian economists, and libertarians, are seemingly very naive in making assumptions about the good intentions and selflessness of politicians and bureaucrats.

B.L. Morrison January 6, 2009 at 11:37 am

Today’s economic mess can be laid directly at the feet of one Ronald Reagan. He made greed popular, by removing all the checks and balances put in place to keep the Wall Street “Carpetbaggers” from running our economy into the sewer. So Reagan de-regulated everything but my dog, and not to say he did not have help, Jimmy Carter started the ball rolling, but the Reagan administration took things much further. Alas, he could not have done so without the aid and assistance from the Congress, and the Senate, not to mention the Presidents who came after him.

John Trudgian January 6, 2009 at 11:38 am

“It has not occurred to Bernanke that a massive amount of money cannot replace nonexistent real savings. If pushing money is going to fix the problem, why is a country like Zimbabwe in total ruin after doing just that? ”
The USA is not Zimbabwe, Frank, because the US prints the world’s money. It is highly likely that the US treasury will be able to call upon the massive savings in North Asia – ie. China, Japan, Korea and Taiwan – simply by printing money.
This alchemy is possible because of dollar hegemony. Exporting countries are highly sensitive to their dollar exchange rate. They must buy dollars in order to stop their currencies from rising and thus protect their competiveness. These dollars are then mostly recycled into US assets – especially US Government bonds.
Thus worthless dollars become legitimate through other countries export surpluses (ie. savings).
A further incentive to buy worthless dollars is that they can be exchanged for precious natural resources, especially oil and food.
It’s a fantastic scam that’s been running for many years now. If any reader would like to look into this matter further I recommend:
http://www.michael-hudson.com/books/superimperialism.pdf

I enjoy the Mises articles – keep up the good work.

Jack Green January 6, 2009 at 12:01 pm

Mr. Frank Shostak: A little history lesson – - – in 179l the states ratified the first 10 Amendments- for the next 122 years (until 1913) 1)we did not have a federal income tax – - -citzens could do with their money as they pleased even put it in a business!!!! 2) No federal Reserve Act – - – Thus no INSTANT INFLATION until 1913 3) The states appointed the U.S.Senators after 1913 would the New York Legis appoint JFK’s brother Bobby Kennedy from TAX achusetts to the U.S.Senate? of course not – - -the states lost what ever power they had after 1913 – - -We had the greatest growth in the history of the world during that 122 years we invented airplanes wire and wireless railroads going every where highways too the FES Free Enterprise System still works inspite of the government = the mess we are in could have been avoided if we did not make those three changes mentioned above The framers understood FES but our politicians are too busy helping themselves and their relatives to care
SINCERELY
JACK GREEN email jackgreen_99@yahoo.com

Mark Humphrey January 6, 2009 at 12:22 pm

To Mark M: I’d like to try briefly to answer your question. Inflating the money supply will not provide for the creation of additional wealth–which is what people mean by “recovery”. The production of additional wealth first requires the creation and accumulation of capital. Capital is necessary to pay wages, for example, and to provide for work-in-progress, equipment and machinery, buildings and stores, and so forth. In short, a sustainable recovery requires the creation of additional capital.

Dr. Shostak emphasizes the central importance of “real savings”–the goods and services that sustain workers, entrepreneurs, and capitalists–because those material goods are necessary to the process of production, which is necessary to the formation of additional capital. But printing additional money will not lead to the formation of additional real savings; it will undermine and destroy real savings.

When the Fed creates additional money, wealth consuming activities become temporarily profitable. This wealth consumption stems partly from mal-investments that are funded and promoted with infusions of new money, which bids scarce workers, materials, equipment away from authentic wealth producing enterprises. But this “boom” is unsustainable, because it mis-allocates scarce resources into the production of things that people don’t much need and–in the light of day–cannot afford. When the Fed slows money growth for a while, the wealth consuming enterprises lose funding and sales. This restores the economy to a sounder footing.

In summary, inflating destroys real wealth, and with it, real savings and capital. It does so through the promotion of wealth-consuming mal-investments. Inflating also encourages wealth consuming behavior among wage earners, who are easily misled by the wealth effect to spend as though there were no tomorrow and borrow to speculate on unsustainable rising asset prices, such as dot-coms and McMansions.

Eric January 6, 2009 at 12:45 pm

If the FED’s goal is to get us spending, and creating money out of thin air is good for us, then why not empower all of us to print money ourselves.

Why is counterfeiting illegal, unless done writ large by the FED? Wouldn’t it be much more efficiently done if we let everyone with photoshop and a printer do their own money creation?

But the more important question is this: Doesn’t anyone (except Austrians) see the problem with FED counterfeiting? How can an entire country not see the obvious truth here?

If we were playing a game of monopoly, and one player (say the banker) started printing more monopoly money and handing it out to his favorite players, wouldn’t the average couch sitting, football watching, (and presumably viagra, flowmax, and beer drinking) public realize he was being cheated? Are we so concerned with our little heads that we don’t use the big one?

This whole affair seems about as logical as testing witches by seeing if they can float and only if they drown, are they found innocent.

I’m not surprised at all by what the FED and the rest of the federal government are doing, what I can’t understand is how the public has become so stupid. I guess they just don’t understand simple math. They must not have paid attention in algebra class when the subject was both positive and negative numbers. The must have just loved absolute numbers, though.

John Rolstead January 6, 2009 at 1:09 pm

Two points that the Fed press release mentioned that need further analysis:

1. “The Board also established interest rates on required and excess reserve balances of 1/4 percent.”
- This will allow the Fed to increase the reserve amounts without the bank actually borrowing from the Fed. The money base can now grow at a controlled rate, the rate to be set by the Fed. But the banks still have to be induced to make loans. How can the Fed force the banks to loan the reserves? Maybe they buy shares in the bank, and gain control that way? Not possible? The Treasury just did that! Now the government can force the loans. He who controls who gets loans, controls the economy.

2. “Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.”
- So the Fed is going to bypass the banks that don’t want to loan money. The Fed becomes a bank for the masses. And you thought Fannie Mae and Freddie Mac were evil!

Wade A. Mitchell January 6, 2009 at 2:13 pm

The notion that banks are reluctant to lend is a difficult pill for me to swallow. Banks love to lend money. This is how they generate income. The way I see it, fewer businesses and individuals are willing to borrow because of these uncertain times. If a credit worthy entity wanted to borrow money, I’m sure any bank would jump at the chance.

The Congress neglected to pass legislation requiring people to borrow the money they gave to the banks. Maybe they should read Henry Hazlitt.

Ben January 6, 2009 at 2:47 pm

Wade, very good points. As Robert Higgs and others have argued, it is not as if creditworthy individuals cannot receive loans. It seems that it is really the shakier larger corporations who are subject to far more onerous interest rates.

Fundamentally though, as to the issue of pump-priming, dollars are just a means of exchange. As I have addressed here: http://socialistsatthegate.blogspot.com/2008/12/dollars-are-no-panacea.html, money does nothing to make us more productive or to help stimulate true productive economic activity according to the Austrian school tenets of savings and capital accumulation. It is all false prosperity.

socialistsatthegate.blogspot.com

Michael A. Clem January 6, 2009 at 2:49 pm

…why can’t an increase in the money supply encourage an increase in the level of consumer expenditure and thereby stimulate production and set us on the road to recovery?
Well, for one thing, the increased money supply is largely going to businesses, not consumers, thus consumers have no extra money with which to increase their expenditure.
Second, as someone else already explained, without real capital savings, many of those business projects started with the new money are infeasible, and will have to be cut back or abandoned. Plus, they don’t tell businesses if consumers will, in fact, want to buy into the new production or not, since consumers aren’t saving their money for that purpose, but are simply continuing to spend as they did before.

Sally Copperwaite January 6, 2009 at 3:10 pm

Good article. I just e-mailed a friend who works for GE Capital to ask her how she felt about becoming a government employee. I am outraged that GE Capital is issuing $10 billion of government backed debt under the terms of the so-called Temporary Liquidity Guarantee Program. I know Bank of America recently did the same thing but either way it is outrageous! Talk about creating an unlevel playing field for businesses! To me it is no different to President Putin giving his bankrupt friend Deripaska a $4.5 billion loan! What happened to free markets in America?

Lucas M. Engelhardt January 6, 2009 at 3:21 pm

One quibble:

It’s not entirely clear what, precisely, is meant by “false” activities. Madoff’s scheme was, naturally, one form of “false” activity. He was actually committing fraud. But, many boom activities are not false in that sense. The entrepreneurs truly (but erroneously) believe they will make a profit.

It seems to me that a more general term would be “wasteful activities” or “malinvestments”.

Mark M January 6, 2009 at 3:32 pm

Thanks very much to those who answered the query I had.

Vincent Cook January 6, 2009 at 3:41 pm

Mr. Kern:

Mr. Shostak has no “blind spot” in assuming that Bernanke is a sincere advocate of helicopter money; such views are consistent with Bernanke’s academic output over many years.

From a predatory ruling class perspective, wouldn’t it make sense to install someone as Fed chairman who honestly believes in the public benefits of inflationism and has expressed interest in innovating ways to spur inflation even in a zero interest rate environment?

Darius January 6, 2009 at 4:11 pm

In the context of money pumping and “helicopter money”, one thing on the Fed’s website doesn’t sound nicely:

“In addition, the Federal Reserve and the Treasury Department are consulting with market participants on ways to provide additional support for term unsecured funding markets.”

It is getting a bit to the dark side, because, at first, the Fed decide to lend below the Discount Rate with it’s Term Auction Facility, and now they want to give money without any collateral. Obama’s thoughts about tax credit also go to the cheap money territory.I think it is time to start understanding the difference between reality and Utopia – and, also, the proper ways to reach it, if it is possible.

Dianne January 6, 2009 at 4:32 pm

John: “Thus worthless dollars become legitimate through other countries export surpluses (ie. savings).”

I believe that this is called money laundering in third world countries.

newson January 6, 2009 at 8:51 pm

bl morrison:
“So Reagan de-regulated everything but my dog…”

this is a popular myth, similar to bush “the free trader”. reagan oversaw a massive increase in public sector spending and recruitment, despite the soaring laissez-faire rhetoric.

truman was the last to preside over a cut in the public sector. if you’re interested, here’s a decent article showing what effect a real cut in public spending can have (http://mises.org/journals/rae/pdf/RAE5_2_1.pdf).

Robert Meyer January 6, 2009 at 9:35 pm

Frank,

You article is quite logical. However, you ended with this statement. “To prevent a further destruction of the American economy, Congress must stop the reckless policies of the Fed and the Treasury as soon as possible.”

Do you honestly believe most of the menbers of Congress possess any incentive to embark on the recommended course of action you recommend? I believe it is more likely that they fervently endorse the reckless policies of the Fed and the Treasury for the following reason I presented in an article of mine.

The ascendancy of faulty economics has resulted in establishment economists reversing cause and effect. They now define deflation as falling prices and inflation as prices rising. These are effects—the results of deflation and inflation. Remember deflation is a decrease in the quantity of money. Inflation is an increase in the quantity of money. Of course, these days most people accept the faulty definitions.

There are obvious reasons why the establishment prefers that you believe in falsehoods. Ask yourself these questions: Who is in control of our money? It is the Federal Reserve System. Who directs where the newly created money goes? It is the government and the Federal Reserve System working together to make sure the “right people” receive the inflationary money.

The reason the establishment wants you to believe the faulty definitions of deflation and inflation is so they can divert blame from the creators our economic crisis to some imagined “culprits.” This way they can blame greedy capitalists, speculators, short-sellers, consumers spending too little, consumers spending too much, people saving too much money, people not saving enough money, ad infinitum, ad infinitum.

Since the Federal Reserve System controls our currency and along with the government determines where the newly created (fiat) money goes—who is responsible for our current economic crisis? Do I really have to answer this question?

Apparently these evil political games are “Last Man Standing Matches.” As the old song says “One tin soldier rides away.”

It might be in your best interest to discover the course set for Bernanke’s helicopters.

Bennet Cecil January 6, 2009 at 11:29 pm

If 11 trillion dollars are in circulation and the government prints another trillion or two it dilutes the purchasing power of the dollar. Printing more dollars is simply a tax just like income, sales or property taxes. It is a very democratic and flat tax unlike the income and estate taxes.

You can resist the politicians’ plans by holding real assets instead of paper assets. We cannot control what the government does since we are a very small minority, but we can blunt the bad effects of their bad choices. Only after economic collapse, will the American people elect better politicians. The fact is that it must get worse. The dollar must collapse. When inflation and unemployment are 15% we will see economic and political change.

Brian Gladish January 7, 2009 at 12:40 am

Bennet,

In 1933 Germany got economic and political change. Don’t bet on the electorate ever figuring out that the lack of free markets was the problem.

Gil January 7, 2009 at 6:03 am

I’m initiallly stumped at the ‘counterfeiting’ notion. If the Fed has authoritah to print more dollars then they’re aren’t counterfeiting – they’re creating more money to go with the existing money. The only meaning to the term is ‘counterfeiting’ I can think of that would be proper is the government fiat that paper money is just as good as the real money – gold and silver coinage.

Stanley Pinchak January 7, 2009 at 7:29 am

Bennet Cecil,

have you ever heard of Cantillion Effects? No, the inflation tax is not flat, it is not uniform, and it is more pernicious than an overt tax, for it robs the layman of wealth through deceit. Furthermore, like all governmental interventions, the uncertainty and time preference impacts foster a climate where the incentives for the accumulation of capital are diminished. Combined with capital gains taxation, many businesses with durable goods find that they overstated their profits, and the after tax, savings are insufficient to replace their capital at its increasingly higher costs. No, inflation is a terrible way to tax a people, it is, however, politically expedient.

Michael A. Clem January 7, 2009 at 8:17 am

Who are these people who think that Frank Shostak is stupid and that the evil, conspiratorial politicians and bureaucrats are smart? It makes sense to say that they are deliberately doing what they intend to do, but given the complex nature of economics and the economy, it’s much more likely that, as Bastiat and Hazlitt warned, they are only aware of the immediate effects of their actions, and not the long-term, unseen consequences. The only smart thing about their actions is that they know they can get away with it.

joebhed January 7, 2009 at 7:07 pm

The FED is involved in the supra-money game written about earlier as The Legalized Crime of Banking.
All of the FED members are part of that cartel.
All of the private banker member’s of the FED in this country are the real culprits here.
It is not the government.
To the contrary, they are the monied elite, loved on these pages.
Their tool is the fractional reserve banking system by which ALL MONEY IS CREATED AS A DEBT.
The money to pay that debt is created as a debt.
And the money to pay the interest on that debt is created as a debt.
et cetera.
ALL money.
If we want to do anything about the burden of the FED’s debt-money yoke on our society, then we need to institute a new monetary system that is based on a debt-free money.
All else is rhetoric and deception.
Friedman had it exactly right.
100 percent reserve banking and government-issue of anti-inflationary amounts of debt-free money.
See monetary.org for the monetary reform legislation that is well overdue to restore our national economy.
It’s OUR money.

sam robbins January 7, 2009 at 9:21 pm

I always love your aticles. please keep preaching the truth.mayb someday the pols will listen when it is then of course too late. But even so, keep preaching.

Tony Immarco January 9, 2009 at 12:54 pm

An excellent article as usual. But, when does hyper-inflation start? Or has it already. It seems to be inevitable to me given that the notion of fiducial responsibility and being a member of congress (most members) are incompatible. Perhaps we citizens should insist that a tour of Zimbabwe should be mandatory for every member of congress.

Adam Odorizzi January 10, 2009 at 3:04 pm

Superb. Nothing to add here and no way to add it in a more eloquent and well-reasoned way than Mr. Shostak did in the article.

Steven Grycel January 10, 2009 at 5:55 pm

A well written article. I guess the gist of it is that Obama’s plans to stimulate the economy will in fact only cause a temporary “employment bubble” that will burst when the Government ceases to further fund these projects. Then unemployment, which will be continuously worse in the private sector, be added to by all of the laid off construction workers, making the problem of unemployment a nightmare. Add to this the watered down buying power of the dollar through inflation as the Fed prints more and more to lend the Government and what we have is another Zimbabwe, big time. The only good thing to come of that might be no more foriegn aid, no more police state, no more welfare, no more social security, and best of all, no more TSA at the airports!

Jake Peachey January 11, 2009 at 6:17 pm

Western schools of economic thought accepts that mother-of -all Ponzi scheme: that archaic and historical fractional reserve banking practice — which is behind the historical economic cycles. And this is getting repetitiously monotonous. It’s the same old story when Nickolai Kondratieff predicted extensive economic troubles for capitalism and the Bolsheviks awarded honors. But when Kondratieff predicted recovery, based on historical credit cycles, the Bolsheviks awarded him the gulag where he perished.

This mother-of -all Ponzi schemes multiplies money and builds value during credit expansion and then does the exact opposite during credit contraction, with a velocity of money factor playing an enormous but secondary follow-up role on both sides of the cycle. During credit contraction phase, both money and value literally disappear into thin air. And then what’s left behind is a lot of non-performing debt that will seriously threaten the financial system and subsequent economic performance.

And with all schools of Western economic thought, the assumption seems to be that this system of managing money supply is unchangeably fixed by the stars. The Austrians would allow deflationary destruction of the economy (by doing nothing) to save it from destruction by hypothetical future inflation. Once you have a generation like the 30s whose economic confidence is badly scarred –they will spend only what is necessary (which is vastly below the productive capacity of the economy) and if they have money, they will not invest for more productive capacity. Unlike a mere recession, the depression economy stays comatose, like it did in the 30s — until the massive deficit spending of World War II and a rising generation with the natural optimism of youth started changing things.

Had Austrian thought prevailed when Lehman Brothers failed, the global financial system would have completely frozen up. International trade would have collapsed with massive destruction of domestic financial system and the economy. The political party responsible for this would then be almost completely turned out of office with the electorate now willing to elect avowed socialists. This would then deliver the dynamic, entrepreneurial American economy into the tar pits of Euro-sclerosis — from which there seems to be no escape. This is the Austrian dead end.

The Achilles’ heel in economics for the Conservatives is the Austrian “closed system” perspective and its uncritical acceptance of the archaic and unstable fractional reserve banking practice.

“Closed system” explanation
http://economics102.blogspot.com/

newson January 12, 2009 at 2:03 am

to jake peachey:
the political party presiding over lehman bros’ demise has been turfed out. and the incoming administration is charting an european course for the american economy. so schlerosis is what the usa is going to be inflicting on itself.

you’ll failed to make a convincing argument as to why pain that is drawn out, that increases over years, and that doesn’t cure the ill, is better than a sharp, effective treatment. consider japan.

and last, how can you accuse the austrians of being sympathetic to frb? (selgin and sechrest would be the minority in favour of frb in the context of absolutely no state involvement in money).

David Michael Myers January 12, 2009 at 10:33 am

Excellent article, except for one thing.

FRNs (Federal Reserve Notes) ain’t money.

Real, true money is a market-determined commodity. For the last 5,000 years or so, “money” has meant: coins or bullion made of “precious” metals. Their value or purchasing power is usually determined solely by the weight of the pure metal.

Why do economists, especially Austrian-School economists, “conflate” money and currency?

FRNs are money-substitutes, currency.

Anything other than “precious-metal” coins or bullion is a money-substitute or currency.

How in the world are we ever going to clear up confusion in the minds of non-specialists and the general public?

So-called “economists” call the price increases caused by inflation, “inflation.” In my readings of the subject, inflation means an increase in currency (usually “fiat” currency) that is not backed by real, true (precious-metal) money.

So-called “economists” call the price-decreases caused by deflation, “deflation.” In my reading of the subject, deflation means a decrease in currency that is not backed by real, true (precious-metal) money.

When given careful thought, the above definitions reveal that credit and debt are not money, they are “money-substitutes” after a fashion.

Let’s define our terms and stick to them.

newson January 15, 2009 at 9:30 pm

to dm myers:
well, in a world of fiat currencies, gold/silver etc are not monies. once legal tender laws are repealed, one presumes they will be reinstated as the generally accepted means of exchange.

David Michael Myers January 22, 2009 at 9:48 am

To: Newson

In a world of fiat currencies, gold/silver, etc. are actually still money, they are just not authorized currency because of the “Legal-Tender Statutes” and because of the Prohibition of Gold Denominated Contracts by the Feds (US Federal Govt.)

If and when the Feds resume their prime duties of protecting life, liberty, and property (including legitimate contracts) we can begin using precious metals for money.

All that other stuff is still money-substitutes. No getting around it.

Our currency problems are caused by the Feds’ refusal to use money for currency.

Of course, they’d have to stop inflating at the drop of a ballot box.
DMM

Gerry Flaychy January 23, 2009 at 8:39 pm

Nowadays, what we call money, the definition that it is used, it is what serve as a general medium of exchange, and what serve the most as a general medium of exchange is checking account money, wich is a substitute of money if by money we now mean federal bank notes and species, wich too serve as a medium of exchange !

Gold as it, and silver as it, actually in the USA, doesn’t serve as a general medium of exchange, so they are not called money, and thus they are not counted in the diverse aggregates of the money supply.

Rhys Swanberg January 26, 2009 at 5:12 pm

I have a question in regards to the end of the great depression. Was it government spending during the war that ended the depression, or was it the forced savings? If I understand the Austrian perspective, then it was the forced savings by the government that created the prosperity after the war. The general population saved every last penny they had and bought war bonds. Some of the money from those war bonds (it would be interesting to know how much) then went into capital goods. We built more factories for guns, bullets, tanks, and battleships. After the war, those factories changed over to producing domestic goods. This is what ended the depression. Is my reasoning off or are there articles that look at this very subject? I would appreciate any feedback.

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