Deflation or Inflation: which one does the future hold? We are like the
legendary suitor in Frank Stockton’s story standing in the arena looking at two
doors knowing behind one is a beautiful lady and the other a savage tiger.
Obviously, the choice is critical.
Everyone who has taken the time to do the research knows what causes economic
booms and busts. Booms are caused by the Federal Reserve increasing the money
supply which nowadays is implemented through the expansion of bank credit.
Booms are impossible without an expansion of money and credit and, in other
words, impossible without government intervention.
Depression/recessions/busts are caused by a contraction of the money supply or
contraction of credit. The “Great Depression” in the 1930s that followed the
booming “Roaring Twenties” was in large part due to the Federal Reserve
contracting by 1/3 the money supply. In short, easy loans and below market
interest rates cause real estate and stock market bubbles. A subsequent
increase in interest rates and loan qualifications, cause prices to tumble.
It may be counterintuitive but Ludwig von Mises discusses the cause of cycles in
his economic tour de force,
Human Action.
According to von Mises the boom part of the business cycle is retrogression
and the subsequent depression is actually progress. The boom creates an
allocation of resources that is not sustainable by consumer demand, and the
underutilized resources become idle. The unavoidable recession or depression
following a boom is progress in the long run because it directs the factors of
production back towards full utilization and full employment where they are best
employed for the satisfaction of consumers.
Credit expansion with below market interest rates makes investments that would
have been unfeasible at market rates magically appear profitable during a boom.
Think about downtown condos: built at first to meet the number of buyers in the
market but then overbuilding occurs because money is cheap and values are
distorted. When the market collapses during a recession many are unoccupied,
resulting in unemployed construction workers because building stops when the
number of units exceed the market for them. Financing is tied up in unsold
properties, leaving less money available for other things consumers would prefer
to buy. After prices deflate and wages decrease, supply/demand equilibrium is
restored and additional production and rehiring once again commence.
The downtown boom and bust came about because developers discovered a rising
demand for downtown living. Proposed projects quickly sold out before
completion yielding above normal profits. Expecting the trend to continue,
developers were motivated to pay higher prices for additional land. Banks
with excess reserves (made possible by the Federal Reserve) then loaned
additional money at artificially low interest rates which made additional
construction appear profitable. This additional development was more
driven by low interest rates and lax credit standards – than genuine homebuyer
demand. The low interest rates/low carrying cost also lead to speculators
buying to flip thus creating an illusion of increased demand. This process is
the reason there is presently a surfeit of condos that need to be liquidated at
reduced prices to clear the market.
The government is currently proposing to stimulate the economy a second time and
wants to re-inflate the housing bubble by redistributing wealth from high income
earners to low income people, "when you spread the wealth around it's
good for everybody."
What politicians fail to understand, as explained by von Mises, is that
“Inequality of incomes and wealth is an inherent feature of the market economy.
Their elimination would entirely destroy the market economy.” All attempts at
redistributing wealth are counterproductive.
People who demand greater income equality always want an increase in their own
purchasing power. How often do you hear them say they want to share their
own income with less fortunate Americans, or share with the 80% of the earth’s
population living on less than $10 a day? (A $50,000 annual income puts you in
the top 1% worldwide.)
See: cache:http://www.//globalrichlist.com
Inequality of income leads to savings (capital), which lead to investments,
which lead to more equipment per capita, making workers more productive per hour
worked. An increase in productivity per worker is the only way possible there
can be a “general” increase in living standards for those eager to work.
Countries with the highest living standards inevitably have more capital
invested per worker making their workers more productive, more competitive and
higher paid than low wage workers ($10 a day) in countries that are capital
poor. Taxing the savings (capital) of the rich inescapably makes poor people
poorer. Bangladesh is poor not because the U.S. is rich but because it has
negligible savings, negligible investment, and negligible productivity.
The question of income inequality should not be about whether income inequality
is fair but whether it results in higher incomes for all who are willing to
work. A policy that purports to be “fair” but results in more people unemployed
with no money makes “fair” meaningless. Profits and losses are the only device
for enabling businessmen to expand and to know what consumers want most
urgently. Imposing higher taxes takes away the working capital and cash saved
that are needed to maintain and expand payrolls and production. Profits and
aggregate savings to an economy are like seeds to a farmer – without them you
cannot have growth.
When government taxes or borrows to fund its activities it abolishes as many
jobs on one hand as it creates on the other. Alternatively, if the government
simply prints money - inflates the money supply – the ultimate result is an
increase in prices which in essence is a regressive tax on everyone. A July
Federal Reserve report states, “Recent increases in the monetary base are far
greater than any previously in American history, surely a ‘noble experiment...”
The present quandary is that the government is spending trillions of dollars
while the banks are rebuilding reserves in a near panic to cover future defaults
from malinvestments instead of lending out the money. Whether we next see
“Inflation” or “Deflation” hangs in the balance.
http://stlouisfed.org/publications/re/2009/c/pages/monetary_base.cfm
Adjusted Monetary Base has doubled
source: federal reserve
bank of st. louis fred (base)
