BEST OF MOGAMBO GURU
April 28, 2003
- Frank Shostak, an adjunct scholar at the Mises Institute, is one of those guys who make you scratch your head and say to yourself, "There are some really bright degreed guys around who really understand this stuff. So why aren't any of THEM in charge of the Federal Reserve?" Anyway, he writes, in his new Mises.com essay, "Does a Falling Money Stock Cause Economic Depression?" Well, cracking wise, I say that, personally, I have never experienced a falling money stock that DIDN'T cause me economic depression.
He writes, "Most economists …are of the view that the policy makers of the Fed have learned the lesson of the Great Depression and know how to avoid a major economic slump." And what is that, you ask? Well, since the only tools they have is interest rates and money supply, then it follows as night follows day that their solution lies in more interest-rate bashing and money-supply expanding.
Let's apply those lessons to the busy mother of today. Problem: the toddler is drawing on the wall with his crayons. Old solution: take away the crayons and clean the wall. New Fed Solution: give the kid more crayons.
"Needless to say that such massive monetary pumping amounted to a massive exchange of nothing for something and to a severe depletion of the pool of real funding, that is, the essential source of current and future capital needed to sustain growth. When things start declining for whatever reason, banks get nervous" he says. "In response to this, banks curtail their lending activities and this in turn sets in motion a decline in the money stock."
Now, the Big Question is "How is it possible that lenders can generate credit out 'of thin air' which, in turn, can lead to the disappearance of money?" The answer is surprisingly simple. When I borrow money from you and subsequently pay you back with interest, the M1 money is all still there, and has traveled full circle back to where it came from.
On the other hand, since the Fed created the money out of thin air to start with, when the money comes back, there is no original owner of money, and so it disappears! He notes that right after the stock market crash in 1929, M1 dropped and kept dropping for years.
Then I took a look at our M1 with renewed interest. And it looks kinda peaked.
But this is just the start of the gloomy outlook that we seem to share. He continues, "Again, note that contrary to popular thinking, depressions are not caused by tight monetary policies, but are rather the result of previous loose monetary policies. On the contrary, a tighter monetary stance arrests the depletion of the pool of real funding and thereby lays the foundations for economic recovery. Furthermore, the tighter stance reveals the damage that was done to the capital structure by previous monetary policies."
One of the complaints I have about this article is that the growth of Fed credit is shown as a logarithmic graph. So, when you look at it, the line goes up at about a forty-five degree angle, and in a straight line. It doesn't look too bad, as it looks like the chart of everything for the last few decades.
But, had the graph had been nominal-dollar arithmetic, which is how things are in the REAL world, the graph would appear entirely different. Out here on the tail of that graphed line, which is where we are, representing as it does the up-to-the-minute here and now, that line of Fed credit would be zooming almost straight up. With the logarithmic scale, it seems to be merely increasing at a constant rate.
And what does this have to do with anything? Well, my little buckeroo, this represents the dark side of the Miracle of Compound Interest. When the Miracle of Compound Interest is working FOR you, then it truly is miraculous. But when it is working AGAINST you, then one is forced to come up with an antonym for "miracle" that is appropriate in degree.
Richard Daughty, writer/publisher of the Mogambo Guru economic newsletter, is general partner and C.O.O. for Smith Consultant Group. |
