"Karl Marx (1818-1883) originated the idea that recurrent crises are inherent in the unhampered (free) market economy. Mises has shown that 'the trade cycle is... on the contrary, the inevitable effect of manipulation of the money market'"
- Percy L. Greaves Jr., Mises Made Easier
Occasionally I hear the odd guest on CNBC or Bloomberg Radio who lays blame for the crisis in exactly the right place - the Federal Reserve System in the U.S....or central banking more broadly.
These extremely influential institutions ostensibly exist to regulate prices, employment and interest rates by way of control over the money supply. They do this by inflating bank reserve credit, on which the banks can pyramid, thus essentially abrogating the role of interest rate determination by the market.
That is, the central bank tries to determine interest rates as far as it can. The rationale for this policy is to attain full employment and price stability, and to otherwise manage economic affairs.
Any economist whose lenses aren't blurred by the fatal errors of the neo-classical doctrines is immediately capable of spotting the problem with that policy foundation. Unemployment could scarcely exist on a free market, where the government did not interfere with the price of labor. Just like shortages of goods cannot really exist in a market where their price is free to adjust to the reality of existing conditions, there can be no excess labor unless the government intervenes to artificially boost its price. It's the same principle. It is a simple economic fact - free of political considerations. Labor is an economic good primarily because it is scarce.
Moreover, whether we are talking about labor legislation or the central bank trying to manage growth, prices and interest rates, it amounts to economic management, even planning.
The apparent effect of the policy is to bring about a boom in investment and consumption... the building up of bubble companies and uneconomic enterprises relying on the continued increases in the selling prices of the goods they deal in - be it widgets, homes or securities.
These price increases are afforded by regular money debasement, which is one of the economic consequences of an increase in the supply of money in particular. So it is illusory.
In reality, as Rothbard points out, the boom "is actually a period of wasteful misinvestment. It is the time when errors are made, due to bank credit's tampering with the free market".
So this policy, and the booms it engenders, crowds out real savings (by pushing rates below market), and investment comes to rely on the continued "stimulus" of money creation or from borrowing overseas.
Ultimately, it further lays the seeds of its own demise because the process invariably arrives at a point at which the central bank must desist if it does not want to prompt a run of confidence in its notes, leading to hyperinflation.
This is why we say the policy is "unsustainable."
Thus it tries to withdraw the stimulus or "tighten" money and credit - explaining that the overheated economy might produce inflation. The error in its thinking is that it is managing a delicate balance between price stability and growth...that it checks market failures, and can know the unknowable (the future).
In fact, almost all economists would agree, it cannot produce growth. It's like the analogy of pushing on a string.
The Fed's policy can only increase employment by decreasing the relative cost of labor through inflation (the expansion of money supply relative to demand). And as one of the largest of interventions conducted by government policy, it only produces more instability - i.e. the boom-bust cycle as well as interest rate and foreign exchange volatility eventually.
Technically, tampering with the rate of interest produces disequilibrium as a mismatch between consumer preferences and producers' investment plans - during the boom phases. Effectively, it taxes long run growth, and is but a massive redistribution of wealth from savers to borrowers and speculators.
The bust, which often begins with the onset of a financial crisis, brings much pain, and threatens job losses on a wide-scale. But this is because the artificially low rate of interest produced by the previous policy, which could not be sustained, produced waste, a "cluster of error" as Rothbard called it. This "malinvestment" or uneconomic activity is essentially exposed as the subsidy is withdrawn.
In his book, America's Great Depression, Rothbard posits the error in Marx's reasoning,
"In the purely free and unhampered market, there will be no cluster of errors, since trained entrepreneurs will not all make errors at the same time."
What you see then is basically the widespread failure of parasitic enterprises that could not survive on their own - without the handouts and support of the central bank. This is the empirical evidence that should indict any inflation policy. But, the bust still merely represents a return to natural market ratios.
"The 'depression' is actually the process by which the economy adjusts to the wastes and errors of the boom, and reestablishes efficient service of consumer desires. The adjustment process consists in rapid liquidation of the wasteful investments" (Rothbard)
It follows then, that "Attempts to interfere with free and flexible prices, wage and interest rates prevent recovery and prolong the depression period" (Mises Made Easier )
Efforts to stabilize the bust with even more inflation effectively prevent the liquidation of uneconomic enterprises necessary to return the economy to equilibrium, where markets reflect actual conditions.
Now, I'm not a policy maker. I don't want to suggest the best way to fix the world or argue why these theories are true. My chief concern is the future. And the evidence that most people would side with Marx on this (over Mises et al) is all I need to predict more inflation, war and higher gold prices.
Joe Public can't for the life of him figure out why it matters if interest rates are 1.5% or 1%.
He cannot connect the escalating price at the pump to the process of money creation required to bring about such a modest change in the interest rate. The tech bust was the fault of irrational speculators, and greedy investment bankers. The housing bust is blamed on Wall Street's larceny, his mortgage and real estate brokers, or the thrust toward deregulation. The painful increase in commodity prices is caused by too much growth. The growing trade deficit is caused by new competition from foreign countries. And so on.
For, Joe takes his cue not from Mises, but from the media and political classes under heavy influence by the progressive institutions.
Political leaders in Europe, meanwhile, are taking full advantage of Joe to wage a new war on capitalism from the left on grounds that American style capitalism is in dire need of more regulation.
This is the great evil of the inflation policy.
It is insidious. The great economists have all recognized this truth. It only produces the opposite of what it claims to accomplish. It also funds the growth of government and anti-capitalist sentiment, and other confused ideas that may lead, ultimately, to the general disintegration in the division of labor, the fabric of society. It promotes moral degradation and corruption, conflict, and finances wars. It is 80% of what's wrong with the world.
But for the most part, the voices of reason that point to this cause are trampled over by the rhetoric of the larger political class, which fear mongers people into clamoring for more money and credit.
This truth is evident in the Fed's actions. It has abandoned any remnants of conservatism, as have the other central banks worldwide. The helicopter blades are in full swing. So any enthusiasm about the world having reached this place where it is ready to turn a new leaf must be tempered by this fact.
The voices of reason, though on the beltway, are still only voices in the wilderness.
This alone suggests we are going to continue to see more inflation, taxes and government. The scary part is that this process is accelerating.
The next bubble may well be in gold.
Good trading,
Ed Bugos
for The Daily Reckoning Australia
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Comment by Coffee Addict on 20 November 2008:
The views of Marx and Mises are not mutually exclusive.
Marx and the "utilitarian liberals" and Labour Movements of the 19th Century were absolutely correct in pointing to the reality of market failures everywhere.
Mises was correct in believing "manipulation" of markets leads to misallocation of resources and trade cycle booms and busts.
Friedman and the monetarists accepted many classical views emphasising the futility of fiscal policy (in interconnected markets with free capital flows) and emphasise that tight monetary policy is needed to avoid excessive booms and busts.
Keynes' view that Governments could "kick start" an economy from a bust hold true in some circumstances only. I he assumed that governments sitting on mountains of gold and other reserves could do it at SOME points in the cycle. I doubt very much whether Keynes would agree that debt churning and political pork barrelling would do the job – although some of less able ascendants seem to think so. He would realise that losses first needed to be realised.
All four men were free thinkers who correctly analysed the circumstances of there respective times. All four would recognise the scope and limitations “defined” economic models. All four would be eclectic and innovative in their suggestions for dealing with the current crisis. None would suggest that there was a quick fix.
Comment by Ross Delaney on 20 November 2008:
I am heartened reading all the above. I also believe Friedman gets a bum wrap, especially from the point of view of his late revisionary work ignored by the pump primers. Luddites grab what they want and take radical positions.
In Australia from the mid 80's when the banks were let off the leash and the big red bodgy CPI interest rate lever became the only act in town we have had the exact "disequilibrium" and "malinvestment" referred to above. In those years we managed to produce that combination of high interest rates and high asset price inflation referred to.
Aside from holding up the govt surplus better than the UK & US, from the mid 90's on we joined the anglo-western party. But little does that matter when the CAD-to-GDP and household debt-to-income ratio is so much worse.
Comment by mike on 21 November 2008:
...storytime for baby bankers.....once upon a time a fly on the wall says to a grape on the vine.....look...at the dawn of the day, the banker's shadow is very big....there's much work to be done and mr.obolo the banker has a full vault of credit to lend....see...at mid-day the banker's shadow is little....productive capacity has reached it's zenith and the banker has an empty vault of credit to lend....observe....at the sunset of the day, the banker's shadow is very big again, except it's in the opposite direction and his vault is full of debt while there's no more work to be done...nighttime is a time of consolidation and rest not depression....or nightmares....tomorrow the tired wake up refreshed and debt wakes up as credit....BUT lo ....caraspita!!........ out in the moonlight comes mr. shadow banker...dancing naked all around with vaults full of notional credit to lend....and sirens of counterproduction around every corner...every one...smiling seductively invests...no no...at times like this, it's best to be snug as a bug in a rug...as pharoah says "find a secret safe location..it is here that (i) recline under my gold sleeping mask"...but now mr.obolo the day banker is afraid of his own shadow...as the earth reclines on her axis relative to the sun, day is so much shorter than night....at these times the shadow bankers run wild....poor mr. obolo, the sun is so low in the sky that his shadow stays so big all day long and it's difficult to know if it is the shadow of credit or debt that he sees on the ground....all the mr. obolos everywhere don't trust even each other to know the difference so they'll just have to "hang on" until the days become longer....viva dia is their motto...mr. dia obolo is not well liked by the shadow bankers who even make fun of his name....the moral of the story ; one must not paint all bankers with the same brush...
Comment by ralph hill on 21 November 2008:
Maybe I drank one bottle of scotch too many, but I'm fairly certain that Mises never wrote in HUMAN ACTION that markets are efficient, rather it is just way much better than centralized gov't planning.
So if you think what's become of Wall Street is bad, just wait till the gov't comes to save the day...
Comment by John L. Pehrson on 21 November 2008:
Speaking of government coming to save the day, I realize governments worldwide are attempting to re-inflate their economies by flooding the system with money. Everyone seems to assume they will be successful, and, after a recession, we will see a new round of inflation.
However, can this go on and on indefinitely? At some point doesn't the system collapse, as the public loses confidence in the system? Are we there yet?