Making Things Worse

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Typically, this is done under the guise of making things better. And yet, it never seems to work out that way. Although the Federal Reserve system was allegedly established to stabilize American currency, the value of the dollar has plummeted since the creation of the Fed. This is exactly the opposite of the promised policy results. And still we are burdened with the Fed.

Take the case of the economy. The US economy has entered a slump, and there are urgent calls for Congress and the president to do something — anything — to “fix” the economy.

The fixes which are being proposed demonstrate only that the Congress, the president and the journalist community have no idea what is really wrong with the economy.

To illustrate this problem, consider the case of Japan, which is also in an economic downturn. Allegedly as a way out of the troubles, the Japanese government has announced that it will, in effect, print more money. Or, as the International Herald Tribune headlined the Japanese government’s plans, “Japan’s Central Bank to Open the Cash Tap.”

An honest headline is a refreshing thing.

“Opening the cash tap” is the American approach to the economic downturn as well. And it is the wrong approach. Putting more money into circulation cannot cure malinvestment. It can only delay the liquidation of bad investments and the return to wise investments.

By artificially making it cheaper to borrow money, the Federal Reserve causes malinvestment. Investments that would not be attractive when borrowing is more costly — and hence must be done more cautiously — become more attractive when credit is cheap. This is the Austrian Business Cycle theory, developed by economists such as Ludwig von Mises, F.A. Hayek, and Murray Rothbard.

Do not assume, however, that merely because such artificially cheap credit causes malinvestment that politicians will avoid this strategy like the plague. Malinvestment (bad investments, that is to say, unwise investments) is a long-term consequence of such credit inflation.

When the Federal Reserve lowers rates, it takes time for banks to lower their own rates, for profit-seekers to scratch their heads, make decisions, and borrow money, and for people to spend the money. Perhaps the money will be spent on dot.com startup companies who promise merely possible future profits, and perhaps it will turn out that money invested in such companies will return only pennies on the dollar. How, then, will the loans be repaid? In many cases, they will not.

Which is where we are today. The credit expansion of the late 1990s fueled the bubble in the stock market, and fueled the dot.com mania. Now that the bubble has burst, what’s the remedy?

More of the same.

As John Cochran writes of the Austrian theory of the business cycle on Mises.org,

Rothbard’s answer is supported by the evidence provided in Vedder and Gallaway in Out of Work, as well as in Herbener’s “Japan Can’t Inflate Away Its Woes” and “The Rise and the Fall of the Japanese Miracle,” wherein Herbener shows how the analysis applies to Japan.

As for avoiding depressions, the remedy is simple: avoid inflations by stopping the Fed’s power to inflate.

If we are in a depression, as we are now [this is as applicable now as it was when it was written], the only proper course of action is to avoid governmental interference with the depression, and thereby allow the depression-adjustment process to complete itself as rapidly as possible and thus restore a healthy and prosperous economic system.

Before the massive government interventions of the 1930s, all recessions were short-lived. The severe depression of 1921 was over so rapidly, for example, that Secretary of Commerce Hoover, despite his interventionist inclinations, was not able to convince President Harding to intervene rapidly enough. By the time Harding was persuaded to intervene, the depression was already over, and prosperity had arrived.

When the stock market crashed in October 1929, then-President Herbert Hoover intervened so rapidly and so massively that the market adjustment process was paralyzed. Following this, the Hoover-Roosevelt New Deal policies managed to bring about a permanent and massive depression, from which we were only rescued by the advent of World War II. Laissez-faire — a strict policy of nonintervention of government by the government — is the only course of action that can assure a rapid recovery in any depression crisis. (Murray Rothbard, America’s Great Depression, pp. xxvii-xxix).

God save us from our supposed saviors in the government.

For further reading, see two classic works of Murray Rothbard: The Case Against the Fed and What Has Government Done to Our Money (the latter may be read online for free at Mises.org).

Mr. Dieteman [send him mail] is an attorney in Erie, Pennsylvania, and a PhD candidate in philosophy at The Catholic University of America.

© 2001 David Dieteman

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