Why rate cuts are failing

An interview with Frank Shostak six years ago provides some answers. At that time the Fed had just lowered the Federal Funds rate to 1.25 percent. This week, the Fed cut the same rate to 1 percent.

Shostak:

While the Fed is going to do its best to inflate the money, it can happen that money supply won’t increase - depending on the behavior of banks. If banks stop lending, due to tighter credit standards or fewer borrowers, the money supply will not respond. This is what happened in the 1930s.

And why doesn't the Fed reduce rates to zero? Shostak:

The worry is that this would produce panic. It would underscore the reality that the Fed is incapable of producing wealth from its printing press. It would show that the Fed is completely powerless, except to produce mis-signals that generate malinvestment. The only thing that might temporarily move is the stock market.

Yet some people say the Fed chairman is the most powerful man in the world. Isn't he supposed to have the ability to get the economy growing again? Shostak:

. . . this reminds us that this powerful man only has one tool at his disposal: printing money. And this tool only creates an illusion. One cannot create real wealth by printing money. If printing money could create wealth, there would not be poverty in the world today. Every third world country could print money and become rich. There would never be a recession. We would have perennial wealth creation with no effort.

You can pump all the money you want but it does not create anything; it only destroys. It creates a misallocation of resources, consumes capital, and makes everything much worse.

If the Fed is creating more money with its interest rates cuts, why haven't we seen a more dramatic rise in prices? Shostak:

Prices have not responded because businesses do not have pricing power. The reason is that people don’t have as much real income as they used to have. If you don’t have the means to spend, it is hard for business to raise prices.

There would be price inflation if people were spending at the same level as they used to. When production is falling, those who produce have less means of payment. We are looking at a snowball of downward pressure.

Where has Bernanke gone wrong?

Where? "In the area of fundamental economics. Bernanke does not understand what money is. He and his countless watchers in the financial press talk about “liquidity,” not money. Bernanke can create all the “liquidity” he wants, but he will not create one cent of real money. He can’t because real money emerges on the market, not from FOMC policy decisions.

"To be sure, what comes out of the Fed’s powwows is something that functions like money, and therein lies a big error. For at least the last three centuries economists have had ample evidence that fiat money -- another name for the paper government orders us to use in exchange for real goods and services -- has a short lifespan."

From my article, "Bernanke and the Holy Grail."

True or false?

“The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system.” Says who?

This day in history

Recommended reading for the crisis

The government, led by the Fed and Treasury, is intervening massively to avoid a necessary correction. The implicit premise of its actions is that a correction would ruin us economically. It wouldn't. It would be painful for awhile, but market mechanisms would put the economy on a path to a sound recovery. Interventionism invariably begets more interventionism until the economy becomes a completely state-run bureacracy.

The fundamental issues of the financial crisis are money and banking. And the best primer I know of for understanding these issues is Murray Rothbard's What Has Government Done to Our Money?



In addition, permit me to recommend my own work, The Flight of the Barbarous Relic, which treats the issues in fictional form.

Headlines tell the story

These headlines from CNNMoney struck me as revealing. The standard line is we are a capitalist country. Not true. Under capitalism, there is no central bank, and Wall Street would only be waiting for trading to begin rather than the latest Fed announcement. Under capitalism, there is no such thing as a firm, or three firms, or ten firms, too powerful not to save. The powerful can fall as well as the weak. Not letting the market work hurts our well-being. But letting the market work is capitalism.

We are not a capitalist economy. Corporatism, crony capitalism, state capitalism, neo-mercantilism, interventionism -- one of these terms is more fitting for the kind of economy we have. The state rules, not the market. The state doesn't rule absolutely, not yet, but that's the end-game.

Nazi parallel

Thomas J. DiLorenzo has this post today:

"The most serious financial problem for the Nazi State is not the danger of a breakdown of the currency and banking system, but the growing illiquidity of banks, insurance companies, saving institutions, etc. . . . Germany's financial organizations are again in a situation where their assets which should be kept liquid have become 'frozen'. . . . But the totalitarian State can tighten its control over the whole financial system and appropriate for itself all private funds which are essential for the further existence of a private economy. Yet the institutions which still exist as private enterprises are not allowed to go bankrupt. For an artificial belief in credits and financial obligations has to be maintained in open conflict with realities."

From Gunter Reimann, The Vampire Economy: Doing Business Under Fascism (1939), p. 174, about German economic policy under Hitler.

We must remember, though, that FDR was a proponent of economic fascism, as are his many admirers in the seats of power today.

Market bounces, Iceland raises, Fed inflates

According to Reuters, stocks have jumped 4 percent in early trading today, following Japan's rally where stocks closed at 6.4 percent higher - after hitting a 26-year low. But as at least one strategist remarked, "the fundamental weakness is still there," so even if you're a-theoretical don't expect this to be a sign of a lasting recovery. According to an Oct. 9th commentary in The Economist,

This is a time to put dogma and politics to one side and concentrate on pragmatic answers. That means more government intervention and co-operation in the short term than taxpayers, politicians or indeed free-market newspapers would normally like.

FDR's Brain Trust couldn't have said it better. If you understand Austrian economics, which is virtually ignored in the MSM, you know that "more government intervention" merely augments the policies that brought us to this point. The Federal Reserve boosted Total Fed Credit by another $245.4 billion last week, while increasing the Monetary Base to $984.717 billion, up from $911.454 billion the previous week. The Fed and ECB are expected to cut rates to provide even more liquidity, while Iceland, taking the opposite approach, has pushed interest rates up to 18 pecent.

We continue to be reminded of Captain Bernanke's immortal words, as he guides the U.S. economic ship ever downward: "But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost."

New posts on BRC

There have been some outstanding articles written about the current market debacle, some of which I've posted on Barbarous-relic.com. In particular, you'll find one on the welcome page and about two dozen more under the What's New heading. Since BRC is devoted to monetary and banking issues, all of the articles and videos should be helpful.