ECONOMIC THINKERS NOBODY WANTS TO HEAR ABOUT
By James R. Cook
gloomdoom.com
Few economists would disagree that the expansion of money and credit leads to a business boom. That’s why in a slowing economy interest rates are lowered. A cut in interest rates generally leads to an expansion of money and credit. But these attempts to turbo-charge credit growth have an impressive list of critics.
The great classical economist of the Austrian School, Ludwig von Mises wrote, "Expansion of credit does lead to a boom at first, it is true, but sooner or later this boom is bound to crash and bring about a new depression. Only apparent and temporary relief can be won by tricks of banking and currency. In the long run they must land the nation in profounder catastrophe. For the damage such methods inflict on national well-being is all the heavier, the longer people have managed to deceive themselves with the illusion of prosperity which the continuous creation of credit has conjured up."
One of Mises foremost students, the late economics professor, Murray Rothbard (the other was the nobel prize winner, Freidrich Hayek) wrote about attempts to prolong the boom by manipulating interest rates. "Why do booms historically continue for several years? The answer is that as the boom begins to peter out from an injection of credit expansion, the banks inject a further dose. In short, the only way to avert the onset of the depression is to continue inflating money and credit. For only continual doses of new money on the credit market will keep the boom going and the new stages profitable. Furthermore, only ever increasing doses can step up the boom, can lower interest rates further, and expand the production structure, for as the prices rise, more and more money will be needed to perform the same amount of work. Once the credit expansion stops, the market ratios are re-established, and the seemingly glorious new investments turn out to be malinvestments, built on a foundation of sand. It is clear that prolonging the boom by ever larger doses of credit expansion will have only one result: to make the inevitably ensuing depression longer and more grueling."
The extent of the credit expansion in the U.S. drew these comments several years ago by economist Kurt Richebacher. "There is something unique and unprecedented about the present U.S. bubble: the phenomenal magnitude of the credit excesses. Credit creation is completely out of control in relation to economic activity and domestic savings." More recently he wrote, "The U.S. economy’s sharp downturn is basically a reaction to the unsustainable, preposterous credit and spending excesses that have accumulated during the boom."
Fear of a 1929-style depression heavily impacts current monetary policy along with the widely held view that the big mistake in the 1930’s was a lack of monetary easing. But analyst Douglas Noland strongly disagrees. "…. The depression was not, as the consensus believes, caused by the Federal Reserves’ failure to create bank reserves/liquidity (through the purchase of government securities) after the stock market crash. Instead, depressions are the unavoidable consequence of reckless boom-time money and credit excess, rampant speculation and the resulting severe structural and economic distortions. At some point, bank reserves and ‘liquidity’ become virtually irrelevant to the greater issue of intractable economic imbalances and maladjustments, and the instability of debt structures. This was the case after the ‘Roaring 20s,’ and it is once again the case today. Sure, there were some post-crash policy errors, but a severe downturn and major financial dislocation were not to be avoided."
Douglas Noland goes on to explain the difference with today’s credit expansion. "What we have experienced over the life of this long boom is a financial system and economy that has come to be dominated by inherently unstable monetary flows created overwhelmingly by financial sector leveraging. This is acutely unstable ….. the leveraged speculating community – has come to control the reins of our nation’s credit system…. The flow of extreme monetary excess is directed by securities firms, the GSEs, the hedge fund community, and the aggressive ‘growth’ lenders that finance their risky lending through the securitization marketplace. It should be clear that such a system specifically fosters rampant speculation, asset bubbles, reckless lending, and the creation of ballooning quantities of increasingly suspect financial claims."
Richebacher agrees, "Borrowing and lending in the past several years has massively shifted to credit channels outside of the banking system. The main sources of credit creation today are the securities markets and a plethora of non-bank financial intermediaries. With investment bankers and non-bank financial intermediaries now the kings of credit creation in the United States, the money supply data are a woefully inadequate indicator of monetary conditions."
Douglas Noland further explains. "Not only has the amount of credit creation been unprecedented, the quality of the lending has been exceptionally poor – the fundamental problem for the U.S. financial sector is that it has created too much leverage and too much paper of increasingly poor quality."
What are the consequences? Noland tells us one of them, "An explosion of money and credit is, by definition, highly inflationary. After all, the excessive creation of new financial claims – or new credit – fuels over spending and what should be recognized for its unmistakable inflationary effects." Much of this inflating fueled the dramatic rise in asset prices. Asset inflation dwarfed rising consumer prices.
Mises also stressed serious consequences. "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved." In other words, do we take our medicine now or do we continue to expand money and credit.
Mises warned, "The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly." He instructed that, "If the credit expansion is not stopped in time, the boom turns into the crackup boom; the flight into real values begins, and the whole monetary system founders." He concludes, "The final outcome of the credit expansion is general impoverishment."
There you have it; a litany of critics who see current monetary policy as a prescription for inflation, an economic bust and lower living standards. No wonder nobody wants to listen. |
