Last year I explained that there would no recovery and that manufacturing was heading for a slowdown. Both of these predictions came to pass. I am forever stressing that the boom-bust cycle is caused by monetary expansion largely consisting of phony bank deposits. In plain English, we call this credit expansion.
In our world the central banks are supposed to determine the extent to which the banking system can expand credit. They are, according to academic folklore, the guardians of monetary unit's integrity. Unfortunately, putting this lot in charge of the money supply makes as much sense as putting an unrepentant madam in charge of a girls' school. Instead of protecting the virtue of their currencies they have spent decades debauching them. The result was the "global financial crisis" for which capitalism -- as predicted -- got the blame. Rare indeed is the economist who points out that the crisis was the result of a severe monetary disorder created by the central banks' criminally loose monetary policies.
Now we have the spectacle of Federal Reserve Chairman Ben Bernanke announcing that the Fed is prepared to boost the economy by buying bonds. (This is a desperate move by a man equally desperate to salvage his reputation.) The criticism is straightforward and has already been made. By buying bonds Bernanke hopes to drive down interest rates and spur spending. But just how low does he think interest rates can fall? They are basically zero already. He, and those who think like him, should bear in mind the British economist Dennis Robertson's observation that
while there is always some rate of money interest which will check an eager borrower, there may be no rate of money interest in excess of zero which will stimulate an unwilling one. (D. H. Robertson, Banking Policy and the Price Level, Augustus M. Kelley, 1989, p. 81, first published 1926).
The reader might wonder how trying to force down rates even further will simulate the economy given the failure of Fed's a low rates policy. Well, Brian Sack, Vice President of the Federal Reserve in New York, has the answer to that one. According to this genius -- another Keynesian I might add -- having the Fed buy US treasuries would stimulate the wealth effect. This is really, really bad stuff.
According to this fallacy the more wealthy people feel the more they will spend, and the more they spend the faster the economy will grow. (I think of this as magic pudding economics.)What the likes of Sack fail to grasp is that it is savings -- indirect spending -- that fuels growth. This is why growth is sometimes referred to as forgone consumption. Increasing consumption at the expense of savings will slowdown the rate of capital accumulation. Taken too far and it will lead to capital consumption. Unfortunately, this garbage about consumption driving growth is supported by the great majority of economists. (No wonder the world is in a sorry economic mess.)
Moreover, Sack must know that in order for the so-called 'wealth effect' to kick in inflation must be high enough to cause asset prices to start rising. The reasoning here is that the nominal rise in asset values deceives people into thinking they are getting richer. As a result, they will start eating their seed corn by borrowing against their nominal wealth. (And this is what the likes of Krugman, Sack and Bernanke call sound economic policy.) Not only is it a wicked swindle it also endangers the economy. It is in fact the same policy that got America into its current mess. Even if it did manage to lift up the economy, it would only be for a short time before the Fed felt the need to apply the monetary brakes.
In the macro-world that Keynesians blissfully inhabit there is no discoordination problem, no disproportionalities, as the classical economists called them: there are only aggregates that can be neatly manipulated according to economic policy, not to mention these economists' beloved models. But a closer look at Bernanke's inflationary policy reveals a very different picture. By continuing to force interest rates down below their market rates the flow of real savings is reduced (this result follows whether one believes interest rates are a monetary phenomenon or a pure time preference phenomenon) because pricing any good or service below its market rate always creates a shortage.
In these circumstance the reduction in the flow of real savings tends to be overlooked because the increase in credit expansion makes it appear as if 'real investments' are now being made while falling unemployment and rising consumer demand give the impression that the economy is expanding. It's all smoke and mirrors -- and completely unsustainable. What really happened is that inflation reduced the cost of labour relative to its product. This increased the demand for labour and raised nominal incomes. It also created malinvestments (meaning it discoordinated the structure of relative prices) that will have to be liquidated when the central bank is once again forced to apply the monetary brakes.
Far from being a cure for the boom-bust cycle it is in fact the cause.
Not everyone at the Fed is oblivious to the danger or thinks the possibility of galloping inflation is worth the risk. Janet Yellen, the vice chairman of the Fed and a Keynesian, recently fired a shot across Bernanke's bow when she warned that a policy of loose money and low interest rates "could provide tinder for a buildup of leverage and excessive risk-taking in the financial system." (At least she appears to be half-awake.)
There are numerous other problems with Bernanke's ultra-low interest rate policy. Uncertain conditions in the world are laying a curse on the US by enabling the Obama administration to borrow money by the container load despite the low interest rates. A clear case of spend now, pay later -- if you can. Moreover, Bernanke's monetary shenanigans must eventually alarm foreign lenders who will then demand a premium. When this happens bond prices will fall and rates will soar. The US got a taste of this last Thursday when the 30-year yield rose above 4 percent, the largest weekly jump since August 2009. This suggests that inflation is being factored into rates.
That's the good news. The bad news is that rising rates means more borrowing and higher taxes to pay off the loans. This can only be done by reducing domestic consumption and the flow of investment funds for industry. (Talk about a double whammy.) The easy way out is for the Fed to monetise the debt. In simple English, this means paying off creditors with newly printed greenbacks. Economists call this inflation. Creditors will call it fraud. In other words, the government will resort to the printing press in order to default on its loans.
Of course, the America people could wake up in time and take their medicine now, while they still can, rather than have Obama and his merry band of lefty wreckers finish off the capitalist system that they hate with a passion.