A lot of people are wondering why the Federal Reserve plans to pump another extra $600Billion into the ailing US economy. Even the New World Order Commissars at the IMF and the World Bank are saying it's a bit crazy. So why are they doing it? Well, the Fed's claim is explained right here. To summarize:
1. The recession is supposedly leading to deflation.
2. Deflation is evil.
3. We must create illusory wealth to be lent out to stimulate new spending.
4. New spending will get the economy moving in an upward spiral again.
Okay, I honestly don't know how these people can fit so many fallacies into one policy. Now, let's be clear on this, I never took an economics class in my life. I am not an expert here. All I do is use common sense, a commodity largely undervalued in today's world. H.L. Mencken once wrote "I am strongly in favor of common sense, common honesty and common decency. This makes me forever ineligible to any public office of trust or profit in the Republic. But I do not repine, for I am a subject of it only by force of arms."
I know this inflation/deflation topic is a huge one, so I will try to limit it to basics and expand in some later post. After all, all four of the premises stated above (and in which our intellectuals believe) are false. So let's now use some common sense and apply it to the theories of those who "hold offices in the Republic"...
So what exactly happened over the course of the real estate bubble, while it was getting pumped by the government and the Fed? I previously touched on it here, but now I'll explain it using the example of one house belonging to one man.
Let's say Mr.Smith bought a house in the year 2000 (right after the Fed started subsidizing housing in the post tech-stock bubble era) for $200,000. Interest rates are at a low 4-5%. Money from the Fed is practically guaranteed to all banks who want it because of the low rates they would have to pay when getting it, so Mr.Smith easily gets a mortgage. He then realizes (miraculously!) that his house is appreciating in value because investment in the subsidized housing industry is growing so much. Mr.Smith then takes our all sorts of loans against the value of his house and lives off of them as if they were a salary. Heck, he might as well! The prices are doubling every year! But wait a second, if Mr.Smith started with $200,000 and he now has $400,000, what does this mean? It means one of two things, either (a) his house actually doubled in value, or (b) the liquidity frenzy and mania of malinvestment created the illusion of his house being worth so much money and it is actually still worth around $200,000. But he has already taken out another mortgage and so owes banks $400,000. He thinks the scenario (a) is true, and the bank is willing to gamble that it is so (after all, with money being so cheap because of the interest rate, it is only too easy to attempt this sort of investment in Mr.Smith's house). But, alas, 2008 has come around. Mr.Smith has by now taken out something like $600,000 on his property and lived happily until one day some guy somewhere realized that in reality Mr.Smith's house is only worth around $200,000. And hey, the bank still wants its money back from Mr.Smith. Scenario (b) was actually true! Now Mr.Smith cannot take out any more loans! And, what is more, it doesn't even occur to him to pay his current loans back. Why pay off the $600,000 to keep living in a house worth $200,000? So he simply stops making payments. Now the bank seizes Mr.Smith's house (he goes off to live in cheap rental housing) and must auction it off to reclaim some of its lost money. Sadly the house only fetches $150,000 at auction, so the bank just made a colossal loss of $450,000 (600-150=450)!
Let's go back to the Fed and their definition of deflation. They claim that this money which just disappeared off the markets (450,000 in asset value) is deflation of some kind. In reality, however, this value never existed! The "losses" of money supply are losses of people who made bad market decisions. Under a capitalist system this is perfectly acceptable.
Sadly Mr.Bernanke is not a capitalist...
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Monetary policy would essentially be determined by the rate of gold production. Fluctuations in the amount of gold that is mined could cause inflation if there is an increase, or deflation if there is a decrease. Gold fails to increase in much quantity in response to an increase in demand.
ReplyDeleteDeflation rewards savers and punishes debtors. Therefore, why borrow? Also, real debt burdens therefore rise, causing borrowers to cut spending to service their debts or to default. Lenders become wealthier, but may choose, as has been the case, to save some of their additional wealth rather than spend it all. Consumers may also do this- Some Austrian school economists say that this is unlikely, claiming that if you have always spent 90% of your income and saved 10%, you would not change your habit with your newly formed disposal income. However, individuals with new found large amounts of wealth tend to be more cautious then reckless, and their savings rate increases. If an individual wins the lottery of (after taxes) a million dollars, he is far more likely to retire at a younger age and save the money he has made to last for a long period of time rather then spend $900,000 in the first year, even if his disposable income spending rate per annual was 90%. The same can be said if that individual knows deflation will occur in the future. Why would that person want to spend his/her money now when he/she knows it will be worth double in ten years? Meanwhile, consumer spending falls and a heavily consumer society suffers from a recession. Overall amount of expenditure is likely to fall on a per annual basis until several market driven counterbalances work themselves out, which may take months or years. The purpose of the Fed, though disagreeable, is to minimize these prolonged periods. After the gold standard removal and after the fuel crisis of 1973 and 1979 and eventually after newly established deregulatory procedures, it did minimize periodic recessions from 1983 to 2005. Indeed the gdp growth of America in 1984 was 7.2%, one of the highest America experienced in the 20th century, thanks to a combination of sound monetary and fiscal policy
Historically, when gold left a nation, the ideal balancing effect would not occur immediately. Instead, recessions and unemployment would often occur. This was because nations with a balance of payments deficit often neglected to take appropriate measures to stimulate economic growth. Instead of altering tax rates or increasing expenditures - measures which should stimulate growth - governments opted to not interfere with their nations' economies. Thus, trade deficits would persist, resulting in chronic recessions and unemployment.
With the outbreak of the first world war in 1914, the international trading system broke down and nations valued their currencies by fiat instead, i.e. governments took their currencies off the gold standard and simply dictated the value of their money. Following the war, some nations attempted to reinstate the gold standard at pre-war rates, but drastic changes in the global economy made such attempts futile. Britain, which had previously been the world's financial leader, reinstated the pound at its pre-war gold value, but because its economy was much weaker, the pound was overvalued by approximately 10%. Consequently, gold swept out of Britain, and the public was left with valueless notes, creating a surge in unemployment. By the time of the second world war, the inherent problems of the gold standard became apparent to governments and economists alike.
Admittedly, the fed is not a capitalist institution, but it does have capitalist and socialist characteristics. The Fed has limited the growth rate of America tremendously over the years, but it has also limited (until 2008) the depths of the recessions. In other words it reduces the size of the bubbles and bursts for economic security at the expense of pure free market freedom. Yet, because the world is comprised of statist societies, taxes are no more free than the markets or the fed. I prefer the constitution to the articles of confederation. There were reasons why people were so bitterly opposed to the articles and not as much to the constitution. Unfortunately, I agree with Hamilton more than Jefferson on matters regarding a national bank.
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