Rough Times Ahead, Part II: An ‘Austrian’ View of the Great Depression
Economic Cycles & The Money Supply
According to proponents of the Austrian School of Economics, boom and bust cycles are caused by inflationary monetary policy; that central banks “create the business cycle by inflating the supply of money in a fiat monetary system.” They argue that policy expanding the supply of money ultimately lowers the cost of borrowing and results in speculative investments and a misallocation of resources. “A correction—commonly called a ‘recession‘ or ‘bust’ — occurs when resources are reallocated to their best uses.” Furthermore, government policies to minimize the impact of a correction only delay and exacerbate the inevitable bust. Austrian economists Hayek and Murray Rothbard, for example, blame the Federal Reserves’ inflationary policies during the Roaring Twenties for the Great Depression. If you follow this school of thought, the current housing and financial crisis should come as no surprise - we are, as they would say, paying the price for Greenspan’s reckless reduction of interest rates. The M3 money supply, which the government now refuses to publish, literally doubled from approximately $5 trillion to $10 trillion between 1998 and 2006, and if the slope of the line remains unchanged, should be well over $11 trillion today. The only ways to correct the imbalances are to either (1) allow deflation to occur, or (2) continue providing cheap credit to stay one step ahead of deflationary pressures and as a consequence, continue expanding fiat money supplies.
United States Money Supply (Graph from Wikipedia)
Excerpt From “America’s Great Depression”
http://www.mises.org/rothbard/agd/contents.asp
“Since it clearly takes very little time for the new money to filter down from business to factors of production, why don’t all booms come quickly to an end? The reason is that the banks come to the rescue. Seeing factors bid away from them by consumer goods industries, finding their costs rising and themselves short of funds, the borrowing firms turn once again to the banks. If the banks expand credit further, they can again keep the borrowers afloat. The new money again pours into business, and they can again bid factors away from the consumer goods industries. In short, continually expanded bank credit can keep the borrowers one step ahead of consumer retribution. For this, we have seen, is what the crisis and depression are: the restoration by consumers of an efficient economy, and the ending of the distortions of the boom. Clearly, the greater the credit expansion and the longer it lasts, the longer will the boom last. The boom will end when bank credit expansion finally stops. Evidently, the longer the boom goes on the more wasteful the errors committed, and the longer and more severe will be the necessary depression readjustment.
…
What, specifically, are the essential features of the depression-recovery phase? Wasteful projects, as we have said, must either be abandoned or used as best they can be. Inefficient firms, buoyed up by the artificial boom, must be liquidated or have their debts scaled down or be turned over to their creditors. Prices of producers’ goods must fall, particularly in the higher orders of production—this includes capital goods, lands, and wage rates. Just as the boom was marked by a fall in the rate of interest, i.e., of price differentials between stages of production (the “natural rate” or going rate of profit) as well as the loan rate, so the depression-recovery consists of a rise in this interest differential. In practice, this means a fall in the prices of the higher-order goods relative to prices in the consumer goods industries. Not only prices of particular machines must fall, but also the prices of whole aggregates of capital, e.g., stock market and real estate values. In fact, these values must fall more than the earnings from the assets, through reflecting the general rise in the rate of interest return.
Since factors must shift from the higher to the lower orders of production, there is inevitable “frictional” unemployment in a depression, but it need not be greater than unemployment attending any other large shift in production. In practice, unemployment will be aggravated by the numerous bankruptcies, and the large errors revealed, but it still need only be temporary. The speedier the adjustment, the more fleeting will the unemployment be. Unemployment will progress beyond the “frictional” stage and become really severe and lasting only if wage rates are kept artificially high and are prevented from falling. If wage rates are kept above the free-market level that clears the demand for and supply of labor, laborers will remain permanently unemployed. The greater the degree of discrepancy, the more severe will the unemployment be.“
Municipalities & Asset Deflation
Housing pricing across the nation continue to decline, and according to reports issued by some of the bulge-bracket investment banks, will decline further between 2008 and 2010. Unfortunately, the asset deflation is not limited to residential real estate. Yesterday, the Wall Street Journal, citing research conducted by Goldman Sachs, reported that commercial real estate values are projected to decline by “21%-26% in the next two years.” These declines, in conjunction with those expected from a further deterioration of the housing market, mean banks will suffer additional multi-billion dollar write-downs, and as a result, tighten credit even more. Banks are not the only victim of asset deflation. Indeed municipalities facing budget deficits from higher financing costs and lower property tax revenues will **have** to curtail spending or file for bankruptcy. Sacramento, CA / Vallejo, CA / and the state of Arizona are already feeling the pain.
General Outlook
Despite what the perpetually bullish folks on CNBC will have you believe, things don’t look all that good. Consumers are restraining spending. Local governments will be restraining spending. Foreign economies are starting to feel the effects of the United States led slow down (the Bank of Canada recently cut rates to stimulate their economy). The only question is how bad will it get?
Comments
-
About
My name is Arpan and this is my blog! I'll be writing about things I find interesting, and hopefully some stuff that you might too. Some posts are intentionally controversial and are intended to provoke discussion. Don't be shy!
-
Blogroll
Subscribe -or- Save
