“I have really been meditating on your point, that a
boom is entirely unrelated to economic growth, and so the succession of booms
keeps destroying capital and impoverishing us.” LH
The statement above from a friendly personal email was about
the nicest Christmas present I could have hoped for in this time when people
and the media unthinkingly parrot the Wall Street fable that the economy is
recovering, thanks to the efforts of the Federal Reserve System…saving
capitalism from itself once again!
There is no denying that stocks have made record moves;
and that employment, GDP, profit, credit, and consumption are all expanding –
in the US – at least nominally. That is exactly why central
banks are under pressure everywhere to follow suit, or face the dreaded
deflation and government default of which gold bugs keep warning!
So then what’s happening here?
Why do I, and many others in our camp, insist that what
the media says is growth is actually the opposite? For one thing, Wall
Street has an interest in promoting the growth story for obvious financial
reasons while central planners and politicians have a vested interest as well
–both groups want to be reappointed and reelected, and the more money they
make for the financial district the better their odds.
I used to have an interest in this narrative by fault of
sheer ignorance, having bought the myth that I was working in a competitive
free market protected by a laissez faire government policy. I don’t
think it occurred to me until well past my fifth year as a broker that
central banks were, well, “central”…that they were there to centralize and
socialize the industry, not to provide some mythological perfectly engineered
currency or safety net. Even though they were called central banks, it
never occurred to me to think of them as anything other than symbols of free
market capitalism because they were so obviously necessary to make stock
markets go up. Right?
Only when certain things began to happen in the late
nineties that couldn’t be explained by economics as I learned it did I begin
to think and read about the monetary problem. Until then I thought
people like Casey were crackpots. I had not even heard of Mises yet,
back in the mid-nineties. Soros was still a role model. Like many
other libertarian-anarchists I grew up believing that Reagan and Thatcher
favored laissez faire. I had so much to learn. Eventually I found
what was wrong with the party line.
But you know what the most heart breaking part was?
I couldn’t save people from themselves – from their
determination to inflict pain on themselves through bad investment decisions
– even once I saw it for what it truly was. The reason the growth story
was so easy to sell is because that’s what people wanted to hear. It’s
an easy business if you bury your head in the sand, stay in the middle of the
crowd, and if you take a risk make sure you bet the farm.
It gets tougher if you try to tell people what they
really should do because they won’t want to hear it.
Among many things, the central bank policy incentivizes
reckless imprudent behavior by rewarding the high rollers while punishing the
prudent in the boom. It encourages excessive risk taking by rewarding
unsound bets. I was still naïve enough to think there was a demand for
prudent advisors back then.
I’m sorry to say, there’s a bear market in prudency; and
it starts every time the Fed creates a boom!
There’s The Rub
The thing is, a boom looks and feels like growth.
But it is by definition the opposite.
The boom-bust cycle is not inherent in free market
capitalism. Neither is unemployment. These are Marxist myths,
which everyone has unfortunately fallen for except for the Austrian
School. The cycle is caused by interest rate manipulation. That
is, government policy-intervention produces recessions.
Big surprise.
But the boom still is a good, isn’t it?
Some people think the boom times are so much fun they are
worthwhile despite the busts. After all, without the investment boom,
would we still have all the great technologies created in its midst??
This is a natural line of reasoning if you don’t quite
grasp what we’re trying to tell you. In truth, all the really good
stuff, the stuff that has the most urgent/real value to society, is the
result of the productive forces of free market capitalism. The boom
is not merely like growth on steroids. Nor is it produced by irrational
exuberance, not in the Austrian theory of the business cycle…not in our
framework.
As our emailer intimated, it is “entirely unrelated to
economic growth.”
In the Misesian framework, the definition of a boom is a
process incentivized by the policy of interest rate suppression affecting a
diversion of wealth from its creators to its ultimate wasters or consumers.
It is defined as a period of wasteful malinvestment, not
of lasting capital formation.
It is straight up hostile to the underlying process of
growth. It is its antithesis. It is the result of a policy that
aims at undermining the free market price mechanism necessary to have
sustainable growth.
The policy that manufactures it effectively stretches
scarce given resources, wastes capital, and taxes growth. It subsidizes
consumption at the expense of potential growth by discouraging real saving.
It is paid for with the bust…by the imposition of a cycle
of fits and starts supplanting otherwise more sustainable growth. Yet
the bust is just the market system trying to return to real prices.
The boom is a consumption binge on the one hand and a
redistribution of wealth on the other.
The reason it fools us is because it is based on fraud
and deceit. It is rooted in the unsound practice of fractional reserve
banking and employs deceit by fooling entrepreneurs into perceiving that more
savings are available for investment in the earlier stages of the capital
structure than truly exist.
The crux of the con is the interest rate mechanism.
Just like changes in prices are generally supposed to
contain and relay information that entrepreneurs use in their daily
deployment and organization of resources (and capital) interest fluctuations
do too.
The Price of Time
The difference is that money prices reflect exchange
terms for the present value of goods while the interest rate results
from an exchange between the present and future value of a monetary
good.
That is, interest is the price of credit, and is
basically determined by an interaction between the supply of savings (to the
loan market) and the demand for those savings (i.e., borrowing or investment
demand). It governs their demand and supply the same way that a price
governs the supply and demand for any old good –i.e., a freely fluctuating
price keeps supply and demand in balance.
The interest rate not only balances this, but also
governs the trade off between consuming and investing, which in turn affects
the supply and demand for credit. The main function of this regulation
by the free market is for the coordination of resources and scarce factors of
production along various inter-temporal stages of production. The more
savings there are the more can be invested in earlier stages like R&D,
exploration, massive development projects, and so on.
The dominant financial economic dogma (Keynesianism), on
the other hand, denies a link between saving and investment, and it denies
the trade off between consumption and investment.
In their view, saving is a bad because it is a drain,
while investment is cyclical because it is driven by manic animal
spirits. Due to these market failures, they have to step in to ensure a
constant flow of investment, without anyone having to sacrifice an iota of
consumption, else face economic depression.
Policy Aims at Inflating Financial Returns
Effectively, Keynesians aim at replacing voluntary
saving with forced saving, and they view the rate of interest
erroneously in the framework of the productivity theory of interest rather
than time preference.
In English, one of the ways they can purport to be
succeeding in their goal is by inflating the money value of earnings to show
their policy is improving the return on capital, and that therefore capital
must be forming by implication of all the money one can make in the business
of churning out capital goods regardless of their kind. Aside from
falsifying earnings, there are two other problems with this policy.
Work for the Sake of Work is Still Not Growth
In this view it doesn’t matter what kind of capital goods
are being produced because to the Keynesians (and Chicago schoolers as well)
capital is just a giant homogenous blob. It only grows or doesn’t.
They don’t care if what is being produced is needed by
society. You could go out breaking windows, or waging massive wars, and
in their framework you would just be stimulating more economic growth.
But this is why: they measure in terms of money; and
government fiat money of course can be printed up. Goods can’t.
More money chasing a given quantity of goods is bound to produce an illusion.
Not only do they define growth in terms of the money they
throw at the economy. They equate it with consumption rather than
investment (even though saving and investment is the source of growth) and
fail to differentiate between growth in consumption funded by sustainable
investment (and increased wealth) and that consumption financed by
unsustainable investment (inflation) –i.e., at the expense of wealth.
Why Sustainable Growth Requires Actual Saving
Their world is two-dimensional: GDP expands or it does
not, and they can make it expand by printing money. They can make
stocks and other asset values go up by printing money. They can inflate
the money value of earnings and wages and create the illusion of
prosperity. They can even create jobs, at least temporarily. For,
the second problem, in addition to the first (i.e., wasting capital on goods
that society does not urgently need), is that the interference of
policymakers in aiming for a central interest rate is the source of the cluster
of errors that leads to malinvestment, and ultimately a business cycle.
The cause of the business cycle is the malinvestment and
the shortfall of real saving that builds into an imbalance between saving and
investment. By creating money and unsound credit the fractional reserve
banks essentially print up duplicate receipts (i.e., money) to an existing
pool of savings and inject them into the loan/credit markets, thereby
lowering the rate of interest charged on those loans.
This supply of forced or
falsified saving displaces, supplants or crowds
out voluntary or real saving, which is effectively discouraged by the low
interest rate(s). This has an added side benefit that the planners
like. It puts control of investment in the hands of their wall street
cronies, and government.
At the same time, the lower rate of interest sends a
signal to entrepreneurs and capitalists’ telling them it has become
profitable to re-arrange (economize on) the given resources along the capital
structure.
It suggests that resources previously devoted to
producing consumer goods have just become free for redeployment to earlier
stages of the structure of production –further out from the consumer.
In other words, if there was a general decline in the
consumption of flat screen tv’s because people decided it was better to save
and invest for the long term, some future shop employees might become
available for hire in tree planting activities or in construction…maybe they
have been going to school to study engineering and can be part of an R&D
enterprise devoted to building higher order capital.
This saving would reflect in a lower interest
rate and some entrepreneur might hire this employee for a new venture that
was not previously economic at the higher interest rate but is now at the
lower rate.
But in the case where the savings are forced
consumers did not actually abstain; and the resources continue to be employed
in the lower order stages of production serving the stimulated
consumer.
The artificially lowered interest rate discourages any
abstention from consuming.
But it encourages investment (borrowing) demand
nevertheless.
You Mean Another Imbalance?
As a result, you get an imbalance between investment and
saving. That is, you get a shortage of saving; or in other words you
get a shortage in credit that is backed by actual hard earned savings.
As long as the central bank continues to supplant this
shortage of saving with duplicate receipts to the existing pool of savings it
is not obvious that it is effectively putting the command of the given
capital and scarce resources of the economy at the disposal of imprudent high
rollers who destroy wealth.
Rising asset prices, incomes, gdp and a falling
unemployment rate is proof enough of growth for most.
The Bust
The farce (or savings shortfall) is revealed either when,
- The central bank stops printing money
(and interest rates return to normal), and/or
- The extra money fuels a bidding war for
the scarce factors revealing the false economies
Basically by tinkering with interest rates the central
bank is unwittingly tinkering with a complex three dimensional but rationally
organized heterogeneous structure of capital that it knows nothing about.
As a result, it produces the business cycle…and reduces
growth to fits and starts.
This is because the Fed (or government) cannot produce or
create or stimulate growth.
Only rational and prudent investment in capital formation
sustains economic growth while the Fed’s intervention impairs the signals
that entrepreneurs and other economic actors rely on to make rational
decisions. Not only does the policy fool them about the availability of
savings for investment in earlier stages of the structure, it fools them into
consuming some of their present capital (by falsifying profits).
All this private capital wasted and abused by a policy
intent on inflating the money value of wealth and consumption just in order
to help powerful elites get re-elected and Wall Street to fleece the public.
If the policy continues to be abused eventually there
will be no capital, and no growth.
Unfortunately, due to the state of government finance,
everywhere, the policy will likely be abused for the foreseeable future, and
we are doomed to continued attacks on the capital foundation.
The booms will last for as long as the planners can
falsify the factors and get away with all this.
But they are costly distractions from growth, and not
growth on steroids.
What you are seeing played out is an enormously dishonest
recovery story. Don’t buy into it.
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