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Hank Paulson & Ben Bernanke: Tag teaming the economy
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Paulson with Bernanke - Shawn Thew/EPA file
Conventional wisdom is placing blame everywhere for economic problems other than where it ought to be. Blaming speculators, short-sellers, greedy businessmen, etc., seems to be very popular. Blaming the real cause, which is the Federal Reserve system, would threaten the source of power for both major parties.
Most problems that are hotly debated are but corollaries of the insolvency. These problems are symptoms. Symptoms do not cause symptoms. Foreclosures do not determine economic conditions; it is the other way around. Job losses do not determine economic conditions; it is the other way around. The government trying to fight the symptoms of its own doing, by doing more of the same, will only inflict more injury. The problem is the insolvency.
What is to blame? Not the free market. To find the cause one must understand that economic growth comes from increasing per capita investment, and investment can only come out of savings. Credit can't be extended beyond the real pool of savings. All the government can do, through its central bank, is trick people into believing they are more solvent than they really are. This is done through inflation (i.e., an expansion of the money supply by the Federal Reserve), which, in turn, causes people to use up savings without even knowing.
Prevailing economic orthodoxy teaches the exact opposite: i.e., that economic growth is hampered by an impaired credit system. Thus, reason the central planners, if the Federal Reserve can create enough liquidity, thus keeping interest rates artificially low and enabling banks to lend again, then the economy can recover. But it has been due to artificially low interest rates and too much liquidity and inflation which caused the insolvency in the first place. It is real, free market economic growth that gives rise to savings and credit, not the other way around.
Saying that low interest rates and more inflation is the "cure" is another way of saying that the problem all of these past years has been high interest rates and a lack of inflation. If one is to look at the real data, they would find that there has not been high interest rates, and there has been inflation; and that is the problem.
The Federal Reserve, through the Federal Open Market Committee, injects funds created-out-of-thin-air into the loan market. By increasing the supply of loanable funds, this sends misleading signals to the loan market. On paper, the loan market now looks wealthier and more solvent than it really is. Injecting funds into the loan market like that has a suppressive effect on nominal interest rates, leading to promiscuous lending that the market otherwise wouldn't allow. Inflating the money supply also lowers the real rate of interest by allowing debtors to pay back creditors with a devalued Dollar.
And then the loan market, itself, inflates the money supply through fractional-reserve banking. This inflationary credit expansion also lowers the real rate of interest. While the Bureau of Labor Statistics uses phony inflation statistics, nobody properly accounts for inflation. The entire time the housing price bubble was forming, inflation wasn't a real problem, pursuant to that thing the BLS calls the CPI. In my estimation, the real rate of interest had been below zero for several years before the housing price bubble began to pop. There is no right way for the loan market to run a real rate of interest below zero. It matters not how good the borrower is, nor how good and regulated the lender is, so long as interest rates are artificially low.
This cheap credit/cheap money policy generated malinvestment that the free market would have never allowed, because interest rates would have reflected true time preferences. Artificially low interest rates caused the loan market to use up scarce savings, becoming insolvent. The loan market's insolvency then brought a halt to continued inflationary credit expansion. No longer could the loan market inflate away its insolvency. While the problem transcends sub-prime, a symptom just began to manifest itself at the weakest link: i.e., sub-prime. If you can't pay your mortgage, you are, by definition, sub-prime. While the Federal Reserve helped create the crisis, it is the market, itself, that reverses this error. The natural consequence of extending credit beyond the true supply of savings is for the loan market to go bust. Good. Let the bust go bankrupt. The more we try to make the insolvent solvent, the worse the problem will become. For the economy to recover, we need to start saving again.
Interest is the discount rate of future goods as against present goods. Suppose you ask me to get you an apple to eat. I tell you I will have it to you in five minutes. You accept that. Then I change it to one hour. You hesitate, but agree. Then I change it to tomorrow. You become impatient and threaten to find somebody else. I then change it to next year, or ten years from now. You walk away to go find yourself an apple. Present goods are more valuable than are future goods. This is where interest comes into play. If one wants to forego eating an apple today, by saving, they should be able to get more than one apple in the future. By only getting less than an apple back in the future, this diminishes the desire to save today, speeding up consumption; that is what inflation causes. If a borrower borrows an apple today, he should have to pay back more than one apple in the future.
To the contrary, nurtured by loose-money, inflationary policies of the Fed, banks are encouraged to engage in promiscuous lending that the market can't sustain. People have been able to borrow the apple today, never have to pay it back, to then borrow two more apples in the future. I'm sorry, but this can't work forever. Only can the government use up savings, penalize savers, and suppress interest rates all in one motion. It does that through inflation.
We need to ask ourselves: Does the market know what it is doing when it revalues asset prices downwards, punishing bad and inefficient behavior? Does the market know what it is doing when it is cutting costs? I believe the answer to both of those questions is yes. The damage was done during the inflationary boom. The recession is the cure. The market is trying to punish inefficiency, while the government is busy punishing the market.
Inflationary spending by the government, coupled with inflationary credit expansion through the loan market, has made the country insolvent by wasting resources and generating malinvestment. The only thing worse than a recession is when politicians and central planners figure out that we are in one, and then want to try to fight the recession. In the process, they repeat the same errors of more inflation to try to "fix" a problem that was precipitated by inflation.
It is imperative that scarce resources are re-directed towards channels that will satisfy our most urgent needs and wants. When the government fights the recesssion, these scarce resources are siphoned away from the most important elements of the economy and go towards trying to keep malinvestment intact, delaying an economic recovery and prolonging the crisis. That is exactly how Hoover and FDR helped create the decade-long Great Depression.
Neo-economists (a.k.a., econometricians), going by neo-orthodoxy, apologize for the central bank's response to the recession by looking at the problem through the wrong end of the telescope. Rather than understanding that something in the past (e.g., the inflationary boom) must have caused the recession, econometricians pull out piles of data to examine. The data itself then becomes synonymous with the recession, as though nothing in the past helped cause the present circumstances. From that thought pattern, it then follows that to adjust the "markers" (e.g., falling asset prices) of the recession is to provide the "cure" for the recession. If more inflation is the cure, then why was the recession precipitated by inflation? Lest the econometricians forget that their data does not determine economic conditions. Economic conditions determines the data. Prices do not determine economic conditions. Economic conditions determine prices.
Pursuant to what Hank Paulson and Ben Bernanke are saying, one would think there is a problem with the economy that the government can fix. In fact, the recession is not a problem whatsoever. The recession is merely the phase where the market cleanses itself from Federal Reserve-induced malinvestment. The real problem was the inflationary boom, which generated malinvestment and gave sustenance to inefficiency.
There are three main ways out of the mess we are in: liquidate assets, be productive and do some real work (not government work, nor government contractor work), or inflate our way out of this inflationary generated debt. The latter is only a faux solution, which makes problems even worse. Bernanke and Paulson are going with the latter.
Once the Federal Reserve inflated the money supply, the recession was inevitable. The sooner the recession happens and is allowed to run its course, the better. Every policy advocated by Hank Paulson and Ben Bernanke goes farther away from the real problem, creating even more problems. Paulson and Bernanke are doing the exact opposite of what needs to be done to cure the problem. With the latest $1 trillion [read: $2 trillion or more] bailout scheme, we run the risk of going over the hyperinflationary edge. Where are they going to come up with the money? They are going to print it.
The real cure, then, is for the government to do nothing. Absolutely nothing other than get out of the way, by repealing cumbersome regulations, and curtailing spending across the board. It's time to end the empire. The Federal Reserve needs to STOP inflating and, if it does anything, try raising interest rates. I never thought I would ask: Where is Paul Volcker when we need him?
If we had sane leaders in government, this could be a day for rejoicing. What is unfolding before our very eyes is history in the making. We are witnessing almost a century of central economic planning coming undone. We have been suffering from a century of socialism. The solution to the crumbling of socialism is not to fight to keep socialism intact. Don't let the politicians mislead you into believing that the crumbling of the state is your problem; it is their problem. Fannie Mae and Freddie Mac were New Deal beasts. They failed, and the government stepped in to nationalize them, which was a bad move that will delay the recovery. However, think of the socialist state as a glacier that is coming undone. As the government tries desperately to keep one piece from breaking away, another one breaks away.
If you support free markets, you have much reason for hope. The only problem is that we are going to suffer a little longer, given Bernanke's, Paulson's, Congress', and Bush's response. Prepare yourself for the coming hyperinflation by getting some gold and silver while they are still on sale.
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