no third solution

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Engineering a Depression: Monetary Policy 101

January 6th, 2009

(Minor updates to text @ 11:20 PM PST – 6-Jan-2009)

I said it before: Their idea of “fixing” the economy is not the same as yours.

In a recent article in the Financial Times, Samuel Brittan opines about the peculiar nature of the current economic doom and gloom. Interestingly enough, is at least partially correct in diagnosing the problem:

[I]t is … a logical absurdity that there should exist unsatisfied wants side by side with idle workers willing to supply them. The natural condition of mankind is one of scarcity, and conflicts are often about the allocation of scarce resources. You cannot usually have endless amounts of both guns and butter.

Perplexing, indeed! Brittan is correct: we didn’t suddenly and collectively become less productive. We didn’t suddenly enter an age of abundance (in which case nobody would need to work, and it wouldn’t matter one bit!).  How in the world did we lose 80,000 jobs? It’s not a novel question, and it’s one that’s plagued economists and policy-makers alike.  Whenever resources are idle and needs are unsatisfied, there is something fundamentally wrong.

What happened — what is happening, is a necessary consequence of government and central bank manipulation of the money supply and the macro-economy.

The proximate cause of our current suffering is not simply “overinvestment” or “underconsumption”, (Paul Krugman’s favorite straw men) or overutilization of the scarce economic resources, for which we all compete, in order to satisfy our limitless desires. The cause of our current suffering is Malinvestment, brought about by expansionary monetary policy. And these malinvestments must be liquidated or reallocated. The economy eventually needs to restructure from the shock, in order to satisfy actual consumer demand, not the contrived demand of inflation.

Brittan notes that he has no qualms with the Schumpeterian theory of “creative destruction”, but since Schumpeter’s theory is more about economic progress and evolution than it is about business cycles, the comparison demonstrates that he doesn’t fully comprehend the problem:

A different kind of objection is that recessions are said to have a purpose. They accelerate the destruction of misplaced activities and overspeculative investment. … But this does not justify the secondary and tertiary destruction of perfectly viable activities because purchasing power has fallen throughout the economy.

Well of course it does! Those activities, those economic endeavors that to Mr. Brittan seem so “perfectly viable” were only “perfectly viable” under the fog of inflationary credit expansion. As long as the more money is printed, debts are repaid and new debts incurred. For someone apparently familiar with the works of F.A. Hayek, the failure to acknowledge the nature of business cycles is alarming. Hayek and Mises before him, essentially argued that this phantom “viability” could only persist, as long as the rate of monetary expansion continually increased.

They also noted (and this is the salient point) that this continual increase in the rate of inflation would inevitably lead to a severe bust, as the monetary unit would eventually fall into disrepute, and lose its status as a medium of exchange.

So it is, that the booms and busts of State-capitalism are coordinated. They may not be coordinated in the sense that a bureaucrat or central banker actively seeks to destroy a particular business or industry, but they are coordinated in the sense that, failure to coordinate them results in the complete dissolution of State capitalism’s power structure. Business Cycles then, are not so much engineered by policy makers, as they are tolerated as a necessary evil.

I’ll say it again: Their idea of “fixing” the economy is not the same as yours.


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no third solution

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