Aggravating the Agony

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“The history
of government intervention is the correcting of the ill effects
from its earlier interventions.”

~
Ludwig von Mises

It began with
Adam Smith telling us in 1776 that the sole end of productive activity
is consumption, followed by Jean Baptiste Say telling us in 1803
that the great producing nations are the great consuming nations.
But it took until 1936 for John Maynard Keynes to turn effect into
cause by declaring that “consumption is the key to prosperity.”

Today that
fallacious belief is deeply ingrained in “macro-economic theory,”
another fallacious concept which is utterly useless to an understanding
of economics. The consequence, as mainstream economists accepted
these dual economic fallacies as valid truths, has been to inflict
much economic harm. Their misguided actions make the Mises comment
above seem ever more pertinent.

Austrian economic
theory explains fully why the manipulation of fiat money and fiduciary
credit by government intervention is the sole cause of a general
business cycle leading to “booms and busts.” Further, it explains
how an unhampered market is continually self-correcting as entrepreneurs
respond to the vacillating signals of the market generated by the
behavior of guiding consumers. It's only when these market signals,
prices and interest rates, are distorted by government manipulation
of money and credit that entrepreneurial errors get magnified and
concentrated, resulting in significant mal-investments of scarce
economic resources which brings forth the inevitable “government-sponsored”economic
bust.

Money serves
a single economic function in the market. It's the medium of exchange
which establishes scarce resource prices and makes reliable economic
calculation possible for everyone. Money prices determine how consumers
act and how entrepreneurs respond to those actions. Consequently
any government interference with, or disruption of, money's exchange
value disrupts the economic behavior of the entire economy.

It's an economic
tragedy of our time that manipulation of money and credit by government
is considered an essential and necessary role to be performed by
a monopoly monetary authority. Critically ignored is the economic
truth that any manipulation of the money supply, up or down,
generates an economic disutility resulting in resource pricing
errors and, thus, future mal-investment of scarce resources. This
government-imposed monetary manipulation, alone, is the singular
cause which leads to the generalized phenomenon in an economy which
is called an “economic boom.”

The certain
consequence which the government-generated economic boom creates
for the monetary manipulators is that ultimately it must lead to
an economic bust. Of course the monetary manipulators can delay
the economic bust by pursuing a continually progressive rate of
monetary expansion. But such a rising rate of monetary inflation,
undertaken to avoid the inevitable economic bust, will inevitably
lead to the ultimate destruction of the purchasing power of money
itself. Since an economic boom can be only momentarily sustained
by an unanticipated inflation of the money, any linear expansion
of the money supply by the monetary manipulators simply delays and
aggravates the inevitable bust which the earlier inflation has created.

This is precisely
the situation which our economy faces today. The Federal Reserve
Banking System has created today's economic and financial disruptions
by its past actions of artificially lowering bank lending rates
below market rates, and expanding fiduciary credit through monetization
of government debt. Since the Federal Reserve's Board of Governors
are unwilling to progressively expand the money supply further,
which they know will lead to hyper-inflation, they are now confronting
the inevitable economic bust stemming from their past actions. They
have brought upon themselves a day of reckoning which can no longer
be avoided.

The horrible
irony is that the monetary authority, the Federal Reserve Bank,
which generated today's developing crisis is now viewed as the only
entity which can resolve the crisis…without question a case of
the fox protecting the hen house. Even worse, the economic error
(monetary manipulation) which has led to today's economic crisis
is about to be compounded with the additional economic error that
“consumption is the key to prosperity.” Sadly, the cost of acting
on an economic error, especially when it's compounded with another
economic error, will be exceedingly high as this country is about
to learn.

Obviously the
proper behavior toward past mistakes is to stop making them. Thus,
the correct course for monetary policy now is simply to do nothing.
If the Federal Reserve Bank truly wanted to achieve a successful,
long-term market response for its past blunders, it would simply
stop meeting and go home! Of course that is not going to happen.
Nor will the Federal Reserve respond with a policy of higher interest
rates and monetary deflation, even though such an unwise policy
would abruptly end the economic boom with economic agony of another
magnitude. Mises used to say that responding to past inflation with
future deflation makes no more sense than backing over a person
who has just been run over by a truck. The proper solution to inflation
is always to simply stop doing it!

With the markets
now facing credit default swaps threatening counter-party solvencies,
collapsing leverage among hedge funds, defaulting loans consuming
bank capital, rising home mortgage foreclosures, and most importantly,
debt-burdened consumers forced to reduce future spending, the inevitable
economic bust is now rapidly developing. We know if the market process
were left unhampered it would correct the economic problems which
the government's earlier monetary manipulation had generated, and
after markets once resolved those economic problems, the market
process would once again restore a viable economic recovery. Even
if the market is hampered further by additional government intervention,
the power of the market process can still lead to an eventual recovery,
with the caveat that it will take longer, resulting in more unnecessary
economic agony imposed by government along the way.

Unfortunately,
government intervention imposes a heavy hand on all of us. The erroneous
interventionist policies which are advanced now to “stimulate the
economy” assure a long and painful economic period ahead. The fallacious
Keynesian belief that “consumption is the key to prosperity” is
about to cost our economy dearly…again! Government efforts to
encourage consumption, which are mistakenly pursued to forestall
the inevitable economic bust, will prove no more effective than
pouring fuel on a fire to put it out. Seeking to solve a problem
without first determining what caused the problem is always an exercise
in futility, as we are soon to learn.

Toward such
hopeless ends the Federal Reserve is now lowering interest rates
in a futile effort to resolve the harm which their earlier inflation
has caused. In addition, the politicians are about to forcibly transfer
money from tax victims to tax beneficiaries through “rebate checks,”
a destructive act they call “fiscal stimulus.” Economic destruction
inflicted by government manipulation of the market is painful to
watch!

Shakespeare
had it right, “Tis a tale told by an idiot.” For, after all, is
not the sign of an idiot someone who keeps making the same mistake
over and over and looking always for a different result? What's
so difficult about understanding that the government cannot transfer
money to anyone without first acquiring it from somewhere else,
whether through direct taxation, borrowing, or its printing of new
money (inflation)? Even more absurd is thinking that artificially
lowering bank lending rates, which is what has caused today's problems
and can only aggravate and postpone a future economic recovery,
will somehow work this time around.

The notion
that the government should proceed further with more intervention
into the economy, to continue with more of the same past policies
of monetary manipulation and government edicts, is a remedy for
nothing. Rather, more manipulation will only assure a deepening
and lengthening of today's economic and financial disorder…it
will aggravate the agony.

It's utterly
astounding that a government policy of encouraging consumption through
“rebates,” an action which when the rebates are consumed can cause
only further wealth destruction, cannot be seen as a means to further
impoverish the economy. An economic understanding of wealth creation
should cause us to know that only increased savings and the productive
employment of those savings can raise an economy's real material
standard of living. As Jean Baptiste Say told us over two centuries
ago, “In the aggregate production and consumption are one and the
same. To consume we must first produce.” It's merely fantasy thinking
to believe that government, the seizer and plunderer of wealth,
can somehow enhance the economic well-being of its citizens by forcibly
transferring wealth from one person to another through rebate checks.

Pursuing economic
fallacies always leads to harmful economic consequences. And clearly
that is what is happening today. Consequently, the outlook for our
economic welfare ahead is indeed bleak, and will remain so until
either the agony caused by these erroneous ideas, or new economic
enlightenment, lets the freedom of the market process once again
restore prosperity and the higher material standard of living which
it always brings forth.

January
28, 2008

Robert
Anderson [send him mail]
taught economics at Hillsdale Collage and was executive secretary
of FEE.

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