Aggravating the Agony


“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