06.30.2009 0

It’s the Government, Stupid

  • On: 07/06/2009 11:57:19
  • In: Monetary Policy
  • By Justin Williams

    With the nation gripped by financial crisis, the Obama Administration still treats the economy with an ostensible cure that’s worse than the disease. Barack Obama has created a commission to investigate what caused the bubbles—by further empowering the very people who caused this crisis: The Federal Reserve.

    If this were a play, the curtain would open on June 2001 when the economy was beginning to head into a recession. The Federal Reserve promptly lowered the federal funds rate to 3.75 percent—a .25 percent cut. This caused new home sales to go up 8.8 percent. And hence, the Federal Reserve had created a bubble.

    Lower interest rates cause businesses to invest in long-term projects because a lower interest rate in an uninhibited free market means that consumers are saving money to spend at a later date. This, then, is a good time for business owners to acquire loans to expand so that they will be prepared for the new future spending, and money is cheap.

    But it is not a good thing when the Federal Reserve artificially manipulates the rate of interest, thereby creating a false sense of economic well-being.

    Invariably, the next effect of the loose monetary policy is capital and labor are bid away from short-term projects and moved to long-term projects. These long-term projects, at this time, were in the form of new homes.

    Because of the high consumer confidence at this time, the labor from building the long-term projects (homes) create new consumption and raise short-term profits. With all of this, the rate of interest rose with the increase in spending.

    In the case of the most recent Fed-caused dislocation, the housing bubble was so big that The Economist in 2005 reported that since 2001, over two-fifths of all private sector jobs were in the housing sector. This includes the construction, real estate and mortgage brokering agents. Of course, when the bubble burst, it was all the worst for them.

    The pain comes from the market fixing the damage done by the Federal Reserve’s reckless policies. Now the short-term projects are bidding back the labor and capital from the long-term projects, putting the final touches on the interest rates, which are now arriving at their natural state.

    This is when massive layoffs occur. It is very hard for business owners and capital investors to switch back to short-term projects overnight, while their long-term investments are becoming unprofitable.

    Now this is where the government comes in with its boneheaded misdiagnosis of the problem. They see the problem as the pain, which is actually just the market reallocating the resources to their efficient uses. The real problem is, of course, the loose monetary policies that caused the boom in the first place.

    The Federal Reserve along with Congress panicked that the banks were going to restrict loans. But how could they do anything else when the Federal Reserve duped them into thinking that people were saving their money? Not to mention that when the interest rate is high, banks loan out less money in general.

    As Austrian Economist Ludwig von Mises said in Human Action, “The banks are faced with an increase in demand for loans. The banks believe that they have done all that is needed to stop ‘unsound’ speculation [which was a result of Fed policies] when they lend on more onerous terms.”

    But these “onerous terms” are exactly what the Federal Reserve seeks to prevent. Then, when, in response to Fed demands, the banks loosen loan terms, the Fed charges them with “unsound speculation” (the Fed’s own crime) in an attempt to cover up its own culpability.

    In short, the Fed tries to have its cake, by blaming the banks for “unsound speculation”—and eating it, too, by trying to get the banks to do the same thing all over again.

    Now the Fed is up to the same old tricks with the Federal Funds rate, which is targeted between 0 and ¼ percent. Obviously, the Federal Reserve is trying to create another unsustainable boom causing a much bigger bubble, ensuring that the next crisis will be even worse than this one.

    Once all is said and done, the American people should expect the same old blame game, with the politicians blaming capitalism and free markets for the ills Big Government itself, created.

    Justin Williams is a Contributing Editor of ALG News Bureau.

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