Posts
Perhaps the most destructive premise of modern, mainstream economics is
that a central bank-induced monetary/credit expansion can cause an economy to
grow without adverse consequences. Let's be perfectly clear from the
start...this policy has been tried by many central banks many times and all
such attempts have led to economic disaster. The latest victims are the poor
citizens of Venezuela, a once prosperous nation. Furthermore, we Austrian
economists have sound economic science to explain why it must be so, despite the
fervently held wishes of mainstream economists, politicians, and the public at
large.
Born of Depression Era Keynesian economic theory which elevated "aggregate demand"
as the driving force of an economy, central banks have constructed a fallacious
model of how an economy works. Repeated failures of this model have served only
to embolden them to double down and double down again and again, driving
interest rates in some countries below zero in order to force the world to
conform to their religiously-held theory. The simplest explanation of this
theory is that counterfeiting money will cause people to spend and it is a
dearth of spending that holds back prosperity. If people won't spend enough
themselves, then it is incumbent upon government to do it for them by paying
people the equivalence of digging holes in the ground and filling them back up.
No, I am not making this up. Keynes himself said it! (Book 3, Chapter 10, Section 6 pg.129
"The General Theory..")
The theory of lack of aggregate demand fails to recognize two essential
facets of how an economy really works. The first is that production MUST
precede consumption. In other words, we cannot consume what we have not first
produced, and one's production constitutes one's demand either through direct
or indirect exchange. This is the essence of Say's Law, which
Keynes unsuccessfully attempted to refute in developing his theory of an
economy driven not by production but by aggregate demand. The second is that
the structure of production is determined by time
preference. Sounds complicated, doesn't it? Well, it is simplicity itself.
The structure of production is merely all the intermediate steps that
constitute production. There are fewer steps taking less overall time in an economy with a high
time preference, meaning that people wish to spend most of their production
borne income in the short term. Likewise there are more steps taking more
overall time in an economy with a low time preference, meaning that people wish
to save more of their current income in order to have more in the future.
A simple example is that one
must plant seeds in order to grow vegetables for current consumption. (Please
keep in mind that what I describe is applicable for all types and levels of
production.)The steps in this process are the saving of seed from previous
crops, the tilling of the soil, the planting of the seeds, the watering and
perhaps fertilizing of the seeds, the spraying or covering of the young plants
from the predations of birds, insects, and bacteria. You get the idea. The
"structure" is the steps and the amount of production that is
involved in each step. In a high time preference economy in which people wish
to consume almost all of their crop production, saving more seed is a waste of
resources. Likewise, producing more fertilizer than is necessary for the size
of the crop is also a waste of resources. Time preference is the underlying
guide. However, if people are more future oriented, they will save more from
current production in order to plant more crops; they will clear and till more
land with the extra seeds; they will buy more fertilizer, etc. The increase in
crop yields spurs a new level of production in the preservation of excess
production for future consumption. The refraining from current
consumption--i.e., savings--is what funds this increase in the new level of
production. The preservation process takes more time, but in the end there is
more to consume in the future, especially in cases of future crop failure.
Think of the children's story of the ant and the grasshopper.
Keynes thought that an economy could bypass the savings process and
substitute an increase in the medium of exchange for real savings. The obvious
flaw in this argument is that counterfeit money is not a substitute for saving
real, fungible production. Counterfeit money is simply a watered down medium of
exchange. Think of the old adage of watering down the soup when uninvited
guests show up for dinner. The cook can serve more bowls of soup, but the
nutritional value per bowl is less.
But monetary/credit expansion does more than just reduce the value of
each monetary unit. Because the counterfeit money appears no different than existing
money, entrepreneurs are fooled into believing that something real has been set
aside and that people have chosen a lower time preference. With a lower
interest rate level their plans for expansion appear to be achievable. Canning and/or
freeze-drying facilities, for example, are constructed over a longer period of
time in anticipation of an increase in sales of vegetables that may be consumed
much later. Eventually the entrepreneurs realize that no such longer-term
demand really exists. They have wasted time and capital, neither of which may
be recovered. The workers who left jobs in businesses that served the higher
time preference economy for higher paying jobs in the vegetable preservation
plants must find new work. This takes time, and the ranks of the unemployed
grow until the economy has once again achieved a structure of production more
in tune with the people's higher time preference. Businesses lose money; the
owners may even go bankrupt. Stock prices collapse. Banks may fail. Such a
transition is called the recession. It is inevitable and unavoidable.
Yet it is highly likely--in fact it is almost a certainty--that central
banks will fight the latest economic slowdown with the same old money printing
and lowering of the interest rate. This was the conclusion drawn by Thorsten
Polleit in his latest essay, published on Mises Wire: The
Fed Has No Choice But to Return to Ultra-Low Interest Rates. The Keynesians
at the Fed are baffled that the world won't conform to their religiously held
theory of aggregate demand. Their theory is a straightjacket from which they cannot
escape intellectually. Unfortunately we all will pay the price.
