Somehow, someway, it always comes back to the central bank. With economic anxiety growing, trouble in Latin America, frustration at the length of the recession, suspicions that matters are going to get worse before they are better, and, above all, terror that stock prices could fall ever further, Alan Greenspan is letting it be known that rate cuts are not out of the question. One percent is the target being tossed around. The hint alone sent the financial markets soaring.
To inject more money and credit into the system at this stage is extremely dangerous. That point might seem obvious to those in the know. It was excess credit that created the boom of the late 1990s and led to the bust which caused the Nasdaq, for example, to fall by 80 percent. Is the bust over? Either it is, in which case loose Fed credit can only distort what might otherwise be a sound recovery, or it is not, in which case loose credit can only turn the bust into something worse than it is already.
What an illusion, to believe that more money is the answer! And yet this is precisely the prevailing ethos in financial markets and politics. If the market soars on the prospect of more Fed credit creation, it is seen as a vote of confidence in the Fed’s idea. The financial markets have become like crowds in Brave New World demanding more Soma, the calming, happiness pill distributed by the government. Everyone pretends there is no downside.
Yes, sometimes the risk of inflation or a lower dollar on international exchange is mentioned, but then immediately dismissed. After the Fed rumor on Tuesday, the dollar went up not down, on the belief that more credit will spur recovery. And so that slight risk is immediately dismissed. As for the possibility of inflation, radically higher prices are not a current threat, so that concern is waved away, too, never mind that cause and effect in monetary affairs are not simultaneous events.
In all the stories written on the possibility of a cut, only one strong point was made against the policy: that it would send a signal that the Fed believes the economy to be in worse shape than it has so far admitted. In other words, the downside is considered to be entirely psychological, as if injections of artificial credit have no effects on real factors. Even more absurd, no one seems to be able to offer a scenario under which looser credit will actually do the job.
The present federal funds rate is 1.75 percent, a 40-year low, and that hasn’t done the trick. During the 1990s, the Bank of Japan tried again and again to manufacture a recovery through absurdly low rates, but that didn’t work either. There is no evidence from either theory or history that pounding interest rates into the ground can create anything resembling a sustainable prosperity. And yet, people believe it, or want to believe, because it seems better than the alternative.
This entire affair underscores the awful underlying reality of American political and economic life: it always comes back to the state’s ability to create money and credit. All other powers of the government—regulatory, military, and even fiscal—pale in comparison to this one power. Further, the chairman of the Fed, though unelected and ultimately accountable to no one, is by far the most powerful man in American politics.
Despite this reality, the Fed is the least controversial institution in American political life. Apart from Ron Paul of Texas, no sitting politician understands how it works. When Greenspan comes before Congress to testify, he is deferred to like no other human being. If he is even treated with skepticism, it is only on grounds that he is not inflating enough, that he is somehow being stingy and not spreading the wealth. There is no influential constituency in politics pushing for tighter money, less credit, sounder finance.
The Mises Institute is in the midst of its annual program called the Mises University, where students from around the world come to a kind of economic theory that you won’t hear on the Nightly Business Report or on financial affairs programs on the radio. The students are taught about such classic works as Ludwig von Mises’s Theory of Money and Credit (which is also online), a treatise that explores the foundational issues that no one seems to want to talk about today.
Among the questions that Mises addresses: What is money, and where does it come from? Is it a product of the state, or the market? In what sense is it a good like any other, and in what sense is it special? Must the state be involved in its management, or can money and banking be managed by private markets within the legal system required by free enterprise? Most importantly for our purposes, Mises addresses the social, economic, and political consequences of the centralization of credit and its management by an institution like the Fed.
Mises distinguishes three varieties of inflationism, that is, the demand that the state work with the banking industry to flood the economy with credit. The first is naive inflationism that sees no real downside to monetary expansion, the second is inflationism that intends to reward debtors at the expense of creditors, and the third sees disadvantages to an expansionary policy but believes that the advantages outweigh them. Obviously, the US. is right now in the grip of the worst form: naive inflationism, which
“demands an increase in the quantity of money without suspecting that this will diminish the purchasing power of the money. It wants more money because in its eyes the mere abundance of money is wealth. Fiat money! Let the state ‘create’ money, and make the poor rich, and free them from the bonds of the capitalists! How foolish to forgo the opportunity of making everybody rich, and consequently happy, that the state’s right to create money gives it! How wrong to forgo it simply because this would run counter to the interests of the rich! How wicked of the economists to assert that it is not within the power of the state to create wealth by means of the printing press!—You statesmen want to build railways, and complain of the low state of the exchequer? Well, then, do not beg loans from the capitalists and anxiously calculate whether your railways will bring in enough to enable you to pay interest and amortization on your debt. Create money, and help yourselves.”
The students at the Mises University are learning what is wrong with this view--that it is contrary to long-term prosperity,that it generates more business cycles, not fewer, that it can lead to a banking crisis, and, if carried far enough, can destroy civilization itself. In times where the entire world seems completely oblivious to the downside--where the demands for monetary Soma are universal and unrelenting--it gives one hope to know that at least one segment of the next generation of economists is being shown the truth.
They and their future students will not join the crowds in Huxley’s novel who, after a brief interval when the prospect of Soma deprivation appeared, entered into mindless bliss when the state assured that the drug would continue to flow:
“[T]he soma vapour had produced their effect. In tears, the Deltas were kissing and hugging one another–half a dozen twins at a time in a comprehensive embrace. Even Helmholtz and the Savage were almost crying. A fresh supply of pill-boxes was brought in from the Bursary; a new distribution was hastily made and, to the sound of the Voice’s richly affectionate, baritone valedictions, the twins dispersed, blubbering as though their hearts would break. ‘Good-bye, my dearest, dearest friends, Ford keep you! Good-bye, my dearest, dearest friends, Ford keep you. Good-bye my dearest, dearest…’’
