Fed Up With the Federal Reserve

Money, money, money.

Why do we have money to begin with? Remember trading pigs for goods and services? And writing all your IOUs on a little piece of paper? Well, I suppose you personally may not remember, but you catch my drift. Money is supposed to make these types of things easier. Louis Carabini, fellow of the Ludwig von Mises Institute, eloquently states in his book Inclined to Liberty,

In a society without money, each producer would have to find
a complementary producer with whom to exchange goods and
services directly. With money as an intermediary, a producer
needs only to find someone who wants his goods or services. The
time devoted to searching for a person with a coincidence of
wants in a barter market can now, with money, be devoted
instead to the production of more goods and services. (35)

That’s why coins were so great. If someone wanted A and had B, and you just wanted B, you could “trade” him or her an amount of money with intrinsic value (meaning that it has value regardless of being considered money, like gold) for B. That person could then go buy A with the money you just supplied.

But what happens when “money” does not have intrinsic value– when what is exchanged is actually a promise to pay later, an IOU of sorts? This is definitely just as effective as supplying a coin or a bar of gold and these can be exchanged more easily, without having to break your back lugging around heavy precious metals.

Does this sound familiar? In the real world, these aren’t called IOUs, they’re called fiat money by economists, and American dollars by the global community.

ss-money

These fiat dollars are only effective as long as their value remains constant. This is critical– who would want to accept a dollar as payment if it was depreciating in value each day? Money in general must maintain a steady value, granting the owner of the money a fixed purchasing power. If so, people can save their dollars and not have to worry about those savings losing their value over time.

These savings are important because contrary to popular belief, spending does not grow the economy. This is what many associated with the Occupy Wall St. crowd keep saying– that the consumers have the ultimate power because their purchases and spending fuel businesses to continue. That is partially true, but in essence, it’s putting the cart before the horse. Consumers need money to spend and where do they get that money? They get it from their jobs. You don’t need consumers to have business, you need business to have consumers.

In any case, it’s actually savings that can be used for capital investments, job creation, etc. Purchasing power stems from efficiency and production. Worker productivity is enhanced by capital, equipment and training, etc. which all available due to savings.

Savings also impact interest rates. Think of an interest rate as a price, dictated (as any other price) by supply and demand. The savings are the supply and the demand is the people wanting to borrow money. Therefore, if there are a lot of savings, interest rates go down because the supply is high. This signals to the free market that the majority of people prefer future consumption to present consumption.

The economy reacts, and people can borrow at low interest rates and make investments based on the assumption that consumption is deferred to tomorrow. On the other hand, when people are not saving their money, interest rates go up because supply is low. In the end, this reaches an equilibrium between saving and borrowing.

The problem comes in when the Federal Reserve can easily print more American dollars. As one can guess, this increase in the monetary supply sends out the false economic signal that there are more savings than actually exist. Interest rates plummet and as Peter Schiff, CEO of Euro Pacific Capital, says in his article The Fix Is In,

…ultra-low interest rates are among the biggest impediments currently preventing genuine economic growth in the US economy. By committing to keep them near zero for the next two years, the Fed has actually lengthened the time Americans will now have to wait before a real recovery begins. Low rates are the root cause of the misallocation of resources that define the modern American economy. As a direct result, Americans borrow, consume, and speculate too much, while we save, produce, and invest too little.

QE-comic

These booms are inevitably followed by busts, where all of these mistakes and “misallocations of resources” are corrected to balance the economy. However, the Federal Reserve urges the government to pass stimulus packages to avoid a recession. Some, like myself, believe that the recession (bust) is the cure to this perpetual disease. It’s like going to rehab and the rehab center giving its patients more drugs as its method of treatment. In the end, nobody gets better but still believes they are being cured.

If you have a  few minutes, check out this video.  Educational and fun!

Thanks for reading!

About these ads

3 thoughts on “Fed Up With the Federal Reserve

  1. I agree that printing more money is not a solution to the recession. Also, I really like your simile comparing the Federal reserve’s actions to rehab. However, I’m still confused on what your solution would be to a downturn in the economy. Do you believe that the Federal Reserve should do nothing at all and let the economy bounce back on its own?

  2. I thought this was a really enjoyable post to read, Peter. I also feel like adding more money is the last route we should take in hopes of resolving this recession. But at the same time, I still can’t come up with solve-all solution. Do you have any thoughts or insights on the route we should take? I’m interested to hear your advice on the topic

  3. Thanks for the comments, guys.

    I really don’t think there is a “solve-all” solution, unfortunately. To me, it really comes down to doing what is *least devastating* to the people– letting the country, which is addicted to the printing press, go into “withdrawal,” if you will, to really be cured.

    The problem is this: the government has responded by doing more of the same policies that caused the original problem: more central planning, more deficit spending, etc. — and it will continue to do this, as long as the Fed keeps printing cheap money.

    If they keep printing money, the dollar will inevitably crash. We’re really stuck between a rock and a hard place– the government and the Fed will have choose between deflating the bubble and ultimately destroying the dollar.

    Political figures always talk about how important it is to discuss solutions and policies, no matter how drastic, to combat global warming “for the sake of future generations.” This looming dollar crisis should be just as alarming, and it will take a solution nothing short of drastic to stop it.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s