|
 At the Federal
Reserve Bank of Kansas City's annual economic symposium, held in Jackson Hole , Wyoming on August 21, 2009, Ben Bernanke expressed satisfaction with the
action that his administration undertook to save the financial system. According
to Bernanke,
History is full of
examples in which the policy responses to financial crises have been slow and
inadequate, often resulting ultimately in greater economic damage and
increased fiscal costs. In this episode, by contrast, policymakers in the United States and around the globe responded with speed and force to arrest a rapidly
deteriorating and dangerous situation.
Furthermore, argues
Bernanke,
Without these speedy
and forceful actions, last October's panic would likely have continued to
intensify, more major financial firms would have failed, and the entire
global financial system would have been at serious risk. We cannot know for
sure what the economic effects of these events would have been, but what we
know about the effects of financial crises suggests that the resulting global
downturn could have been extraordinarily deep and protracted. Although we
have avoided the worst, difficult challenges still lie ahead.
As a result of all
the swift actions argues the Fed Chairman,
Critically, fears of
financial collapse have receded substantially. After contracting sharply over
the past year, economic activity appears to be leveling out, both in the United States and abroad, and the prospects for a return to growth in the near term appear
good. Notwithstanding this noteworthy progress, critical challenges remain:
Strains persist in many businesses and households continue to experience
considerable difficulty gaining access to credit. Because of these and other
factors, the economic recovery is likely to be relatively slow at first, with
unemployment declining only gradually from high levels.
Most commentators are
unanimous in their belief that Bernanke's Fed has prevented another Great
Depression through swift monetary pumping.
Since September of
last year, the yearly rate of growth of the Fed's balance sheet (the pace of
money pumping) has accelerated, climbing to 152.8% by December 2008 from 3.9%
in August of that year. The federal funds rate target was lowered almost to
zero from 5.25% in August 2007.
Figure 1
 
Can Money Pumping Stimulate
Economic Growth?
According to Bernanke
— and most economic experts — when an economy falls into a
recession, the central bank can pull it out of the slump by means of money
pumping. This way of thinking implies that money pumping can somehow grow the
economy.
Indeed, US historical evidence supposedly does show that loose money policy seems to work. For
instance, between 1960 and 2008 it took on average about nine months before
increases in money supply caused increases in the rate of growth of
industrial production (See Figure 2.)
Figure 2
The question is, how is this possible? After all, if
printing money can grow the economy, then why not to print plenty of it and
cause massive economic growth? By doing that, central banks could have by now
created an everlasting prosperity for every individual on the planet.
For most
commentators, the arrival of a recession is due to unexpected events such as
shocks that push the economy away from a trajectory of stable economic
growth. It is held that shocks weaken the economy, i.e., lower economic growth.
We suggest instead that, as a rule, a recession or an economic bust emerges
in response to a decline in the rate of growth of money supply.
Typically, this takes
place in response to a tighter stance of the central bank. As a result,
various activities that sprang up on the back of the previously strong rate
of monetary growth — usually these emerge on account of a loose
monetary policy by the central bank — come under pressure.
Note that these
activities cannot fund themselves independently. They survive on account of
the support that the increase in the money supply provides. The increase in
money diverts to them real savings from wealth-generating activities. Consequently,
this weakens wealth-generating activities.
A tighter stance by
the Fed and the consequent fall in the rate of growth of money undermines
various false activities. This precisely is what recession is all about.
Recession, then, is not a weakening in economic activity as such, but rather
is the liquidation of various non-productive activities that sprang up on the
back of an increase in the money supply.
Why the GDP Framework Presents a
Misleading Picture
Government
statisticians present economic growth in terms of monetary expenditure data,
such as gross domestic product (GDP) and industrial production. These
indicators are designed in line with Keynesian thinking that spending equates
to income — hence, more spending leads to a higher national income and
therefore to a higher economic growth.
On this logic, a
tighter monetary stance by the Fed leads to slower economic growth, while
increases in the money pumping produce higher economic growth. A stronger
rate of growth in the money supply leads to a stronger pace of expenditure,
and therefore an increase in national income. The increase in overall income
in the economy leads to a higher rate of growth in terms of GDP.
We suggest that in
reality the exact opposite
actually takes place. Printing more money weakens
the wealth generators' ability to grow the economy, while a decline in the
rate of growth of the money supply strengthens their ability to grow the
economy.
Once the central bank
raises the pace of money pumping in order to lift the economy from a
recession, it arrests the demise of various false activities. It also gives
rise to new false activities. An outcome of so-called economic
"growth" here is thus nothing more than the strengthening of wealth
consumers and a renewed pressure on wealth generators. All of this undermines
the process of wealth generation and weakens the true economic growth.
Real Savings Fund Economic
Activity
Irrespective of
whether an activity is productive or nonproductive, it must be funded. At any
point in time, the number and the size of activities that can be undertaken
is determined by the available amount of real savings. From this we can infer
that the overall rate of increase in productive and nonproductive activities
as a whole is set by the rate of expansion in the pool of real savings.
Observe that this
runs contrary to the GDP framework, where the pace of monetary expenditure
— i.e., money pumping — sets the pace of so-called economic
growth. This common line of thinking, however, doesn't make much sense. After
all, individuals (whether engaged in productive or nonproductive activities)
must have access to real savings in order to sustain their life and well
being.
Money as such cannot
sustain individuals; it can only fulfill the role of the medium of exchange. According
to Rothbard,
Money, per se, cannot be consumed and cannot
be used directly as a producers' good in the productive process. Money per se is therefore unproductive; it
is dead stock and produces nothing.[1]
As long as wealth
producers can generate enough real wealth to support productive and
nonproductive activities, loose-money policies will appear to be successful. (Observe
that loose fiscal policies are similar to money policy, since they also
impoverish wealth generators.)
Over time, a
situation may emerge where — as a result of persistent loose monetary
and fiscal policies — there are not enough wealth generators left, as
they have been badly damaged by loose policies. Consequently, generated real
savings are not large enough to support an increase in economic activity. Once
this happens, the illusion of loose monetary policy is shattered , and real
economic growth must come under pressure.
(Under such
conditions, it would be difficult to show economic growth even in terms of
GDP. The only reason why GDP might "grow" in such an event would be
through the employment of misleading price deflators.)
The government
attempt to boost the rate of growth of GDP by raising its expenditure must
also fail if the supply of real savings is dwindling. After all, government
activities also require real savings. (Remember, every activity, irrespective of whether it is productive
or nonproductive, must be funded).
If the government
persists with its aggressive stance, it will only make things much worse, as
it continues to deprive funding from wealth-generating activities. Likewise,
if the Fed accelerates its monetary pumping while the pool of real savings is
declining, it runs the risk of severely damaging the pool of real savings
even further.
It is clear, then,
that those commentators who subscribe to the view that the acceleration of
money pumping can fix things hold that something can be created out of
nothing.
From all of this, we
can deduce that there is no such thing as stimulatory policies that can grow
the economy. Neither the Fed nor the government can grow the economy. All
that stimulatory policies can do is to redistribute real savings from wealth
producers to nonproductive activities. And these policies encourage
consumption that is not supported by useful production.
The Fed's Loose Monetary
Policies Have Weakened Wealth Producers
As a result of all
the massive pumping by the Fed, the yearly rate of growth of our monetary
measure AMS jumped from 0.7% in May 2007 to 14% by July.
Yet, despite all of
this pumping, the growth momentum of industrial production remains in free
fall. (Note the massive gap between the growth momentum of AMS and the growth
momentum of industrial production in Figure 3.)
Figure 3
This very large gap
raises the likelihood that the pool of real savings could be in trouble. If
what we are saying is valid, then true, real economic growth is likely to
struggle in the months ahead. (Remember, without a growing pool of real
savings no economic growth is possible.)
As a rule, monetary
pumping "works" through the commercial bank expansion of credit. The
increase in commercial bank reserves on account of the Fed's pumping gets
amplified by means of credit expansion. At present, banks are finding it more
attractive to sit on the massive pile of cash reserves rather than lend them
out. So far in August, bank excess reserves stood at around $700 billion
— against $1.9 billion in August last year.
The banks are still
in the process of trying to fix their balance sheets. They are also having
trouble finding viable borrowers — i.e., wealth generators. All of this
raises the likelihood that the process of wealth formation is itself in
trouble.
Figure 4
Observe that if the
pace of wealth generation had been rising, banks would have been very active
in securing for themselves a growing slice of the expanding real wealth.
Obviously, banks
could become very active by pushing lending to non-wealth-generating
activities. However, this is not likely to happen soon, given that banks have
already accumulated a massive amount of bad-quality assets. The latest data
indicates that banks are still very tight. Year-on-year commercial bank
lending has fallen by 2.8% so far in August after declining by 2.7% in July. (See
Figure 5.) This was the fourth consecutive monthly decline.
Figure 5
Conclusions
At the Kansas City
Fed's annual economic symposium, the chairman of the Federal Reserve
expressed his satisfaction with the action that his administration undertook
to save the financial system. Historical evidence supposedly supports the
view that loose monetary policy can pull the US economy out of recession.
However, we suggest
that so-called economic growth in response to loose policy, as reflected in
terms of data such as GDP and industrial production, simply mirrors the
monetary expenditure rate of growth — and not true, real economic
growth. Since these indicators reflect monetary expenditure, the more that
money is pumped by the Fed, the larger the so-called economic growth is going
to be.
Over time, a
situation can emerge where, as a result of persistent loose monetary and
fiscal policies, there are not enough wealth generators left. Consequently,
generated real savings are not large enough to support an increase in
economic activity. In this situation, neither loose monetary policy nor loose
fiscal policy can "work." We suspect that such a situation may be
developing now.
Frank Shostak
Frank Shostak is a former professor of
economics and M. F. Global's chief
economist.
Also
by Frank Shostak
| 
