Financial Crisis and Recession

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The
severe financial crisis and resulting worldwide economic recession
we have been forecasting for years are finally unleashing their
fury. In fact, the reckless policy of artificial credit expansion
that central banks (led by the American Federal Reserve) have permitted
and orchestrated over the last fifteen years could not have ended
in any other way.

The expansionary cycle that has now come to a close was set in
motion when the American economy emerged from its last recession
in 1992 and the Federal Reserve embarked on a major artificial expansion
of credit and investment, an expansion unbacked by a parallel increase
in voluntary household saving. For many years, the money supply
in the form of banknotes and deposits (M3) has grown at an average
rate of over ten percent per year (which means that every six or
seven years the total volume of money circulating in the world has
doubled). The media of exchange originating from this severe fiduciary
inflation have been placed on the market by the banking system as
newly created loans granted at extremely low (and even negative
in real terms) interest rates. The above fueled a speculative bubble
in the shape of a substantial rise in the prices of capital goods,
real-estate assets, and the securities that represent them and are
exchanged on the stock market, where indexes soared.

Curiously, as in the "roaring" years prior to the Great
Depression of 1929, the shock of monetary growth has not significantly
influenced the prices of the subset of goods and services at the
final-consumer level of the production structure (approximately
only one third of all goods). The decade just past, like the 1920s,
has seen a remarkable increase in productivity as a result of the
introduction on a massive scale of new technologies and significant
entrepreneurial innovations which, were it not for the "money
and credit binge," would have given rise to a healthy and sustained
reduction in the unit price of the goods and services all citizens
consume. Moreover, the full incorporation of the economies of China
and India into the globalized market has gradually raised the real
productivity of consumer goods and services even further. The absence
of a healthy "deflation" in the prices of consumer goods
in a period of such considerable growth in productivity as that
of recent years provides the main evidence that the monetary shock
has seriously disturbed the economic process.

Economic theory teaches us that, unfortunately, artificial credit
expansion and the (fiduciary) inflation of media of exchange offer
no shortcut to stable and sustained economic development, no way
of avoiding the necessary sacrifice and discipline behind all voluntary
saving. (In fact, particularly in the United States, voluntary saving
has not only failed to increase, but in some years has even fallen
to a negative rate.)

Indeed, the artificial expansion of credit and money is never more
than a short-term solution, and often not even that. In fact, today
there is no doubt about the recessionary consequence that the monetary
shock always has in the long run: newly created loans (of money
citizens have not first saved) immediately provide entrepreneurs
with purchasing power they use in overly ambitious investment projects
(in recent years, especially in the building sector and real-estate
development). In other words, entrepreneurs act as if citizens had
increased their saving, when they have not actually done so.

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the rest of the article

October
8, 2008

Jess
Huerta de Soto, professor of economics at Rey Juan Carlos University
in Madrid, is Spain’s leading Austrian economist. As an author,
translator, publisher, and teacher, he also ranks among the world’s
most active ambassadors for classical liberalism. He is the author
of Money,
Bank Credit, and Economic Cycles
.

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