Looser Money? Tighter Money? Everyone Misses The Point
Pundits from Reason to Forbes have been engaging in wholly misdirected discussion about what Ben Bernanke should do next. by Walt Thiessen
(libertarian)
Saturday, June 9, 2012
You may not have noticed it, but there is an absolutely absurd online discussion happening between Nick Gillespie of Reason and Timothy Lee of Forbes over an article by John Merline at Investors Business Daily. The crux of the discussion is this: do we need more money supply creation, and if so, how much?
Merline's article didn't actually discuss monetary creation, but Gillespie's reply and Lee's rejoinder definitely did. Gillespie is a Friedmanite, and as a good Friedmanite (is there such a thing?), he believes in steady money supply growth: not too fast, not too slow. Lee, on the other hand, is a huge supporter of flooding the financial system with newly created cash during what he, like so many others, perceives as a cash crunch.
Gillespie wrote, "I agree with the general historical argument (made by Friedman and Christina Romer, among others) that monetary stimulus was responsible for countering the effects of the Depression in the mid-'30s."
Lee responded, "But a lot of people have fallen into the trap Milton Friedman warned us about: of taking low interest rates as a sign of loose money. In reality, low interest rates can be a sign of extremely tight money, as with Japan over the last two decades."
Sadly, the one point that neither man is willing to acknowledge is that monetary expansion has never actually solved anything. All it has ever managed to do is to paper over deeper problems.
Monetary expansion during the 1920s created the Great Depression. Monetary expansion during the 1930s didn't resolve it.
Some critics will protest, "But the monetary base didn't expand at all during the 1920s! So how can you claim that monetary expansion created the Great Depression?"
Sure, the monetary base didn't expand during the 1920s, but very clearly the money supply as a whole DID increase substantially. Remember, bank accounts are not counted as part of the monetary base. Yet, it was monetary expansion via fractional reserve banking that flooded the stock market with newly created cash during this period and created the mass illusion known as the Roaring Twenties. Without that monetary expansion, the Twenties could not have (seemingly) Roared, and the inevitable Crash of 1929 that followed could not have occurred. As it turned out, the Roar was actually a Bite.
Sure, there was definitely a monetary contraction immediately after the Crash of '29, but that contraction didn't last for 12 years. In fact, monetary expansion, by all accounts, began in the early-to-mid-1930s.
So why did it take 7-8 years or more for all that newly created cash to, supposedly, work?
The answer is that it didn't work. The supposed connection between monetary expansion and recovery is an illusion.
Witness this quote from a blog entry in 2008 at Macro and Other Market Musings entitled, "Monetary Policy Ended the Great Depression..." which cites a paper by Christina Romer in which she wrote:
"The money supply grew rapidly in the mid- and late 1930s because of a huge unsterilized gold inflow to the United States. Although the later gold inflow was mainly due to political developments in Europe, the largest inflow occurred immediately following the revaluation of gold mandated by the Roosevelt administration in 1934. Thus, the gold inflow was due partly to historical accident and partly to policy. The decision to let the gold inflow swell the U.S. money supply was also, at least in part, an independent policy choice. The Roosevelt administration chose not to sterilize the gold inflow because it hoped that an increase in the monetary gold stock would stimulate the depressed economy."
So, by Romer's own estimate, monetary expansion began in earnest in 1934, yet the economy didn't turn around until after the U.S. entered World War II. The obvious question is: what the hell took so long? Bear in mind that this is the same personality type that believes that if inflation doesn't appear within a year or two, then it won't come. They also believe that monetary expansion will eventually fix everything, even if it takes a decade or more to happen. Talk about a double standard!
Anyway, let's get back to Romer's argument. As you can see, Romer supplied a graph to describe what she (and others) contend actually happened. The graph purports to show what real GNP was and what it would have been under "normal" monetary policy. Put her supposition about what "normally" would have happened aside and look for a moment at the "real" line. As she is presenting it, it is a rapidly expanding GNP with just a little dip in 1937. This is typically the way most economists present it. But is it true? Does it accurately depict the economy of the 1930s?
Well, as most people who lived through the Great Depression can tell you, it certainly wasn't true in their experience. Of course, the members of that generation are either quite elderly now or have passed on, but their joint message is clear. The 1930s right up until WWII was, economically speaking, a horrible time to live. It was not a time of an exciting, expanding economy. It was a time of hardship and difficulty to make ends meet.
How, then, can we reconcile this general, widespread perception of difficulty, trials, and tribulations with Romer's optimistic graph of GNP growth during this time period? We cannot, and herein lies a pointer to a major flaw in monetarist thinking.
Today, we experience the same flaw in action. Monetary expansion grew astronomically after the financial crisis of 2008, to the point where the monetary base is now roughly 3.5 times larger than it was. That's a monetary expansion that dwarfs what happened in the 1930s. Yet, like the 1930s, we experienced no economic growth as a result of it.
A seemingly unrelated tiff has simultaneously taken place between Paul Krugman, the Keynesian economist and New York Times blogger, and the country of Estonia. I say that it is "seemingly unrelated" because most people do not, in fact, consider them to be the same discussion at all. Yet, as you are about the see, they are precisely the same discussion.
It seems that Estonia, one of the 17 nations in the European Union, is (in Krugman's words) being presented to the world as, "the poster child for austerity defenders." He mocks this view by presenting a graph of the Estonian economy since 2007 as measured in GDP. Here it is:
Krugman follows this graph with a derisive rejoinder: "So, a terrible — Depression-level — slump, followed by a significant but still incomplete recovery. Better than no recovery at all, obviously — but this is what passes for economic triumph?"
Now, let's compare this graph to, say, a similar graph representing the American economy during the same period. Ah, here is one from Krugman himself, published at quantstocktrader.blogspot.com:
Krugman says, "It is a good chart to show how fiscal stimulus works with a austerity country as benchmark."
Now, fiscal stimulus, of course, means having the government increase overall spending by over a trillion dollars since 2008, thereby adding roughly 7-8% to the GDP, since government spending is counted as a part of the GDP. And what do we see? We see that U.S. GDP is roughly 7-8 points higher than UK GDP. In other words, since GDP includes government spending, and since government spending accounts for all of the increase in GDP, therefore government spending counts when measuring economic growth.
The illogic of this should be obvious to everyone. One cannot justifiably count fiscal spending as a cause of recovery when the spending itself accounts for all of the recovery! It's supposed to be a stimulus, remember? Recovery of an economy is supposed to be reflected in private enterprise growth. If that doesn't happen, then the "recovery" is nothing but an illusion.
Indeed, anyone other than an ivory tower economist like Krugman can attest to this fact. Four years after the event, no one but the wealthy are experiencing any great economic revival in the U.S. To the contrary, unemployment continues to be high, worse even than the horrible numbers put out by the Bureau of Labor Statistics would suggest. Wall Street continues to react negatively to job reports. Entrepreneurs and small business owners will uniformly tell you that their businesses are not generally expanding. The economy, by all accounts (except for the likes of Krugman) continues to stagnate and contract, and people are now fearfully looking at Europe as being on the path toward causing even greater economic devastation.
Monetary manipulation cannot create prosperity. It can only take prosperity away and replace prosperity with illusions and magic tricks. It's long past time that people like Krugman, Lee, and Gillespie learn this fact of life. Unfortunately, they're all so steeped in their own illusions that they cannot see reality anymore.
Congressman Ron Paul of Texas will, sadly, not win the Republican nomination. He is flawed on a number of issues, but there is no doubt in my mind that he is among the very few who understands the true nature of monetary manipulation. So we are going to have to find some other route toward getting off the fiat money, elastic money supply horror ride. I still wonder when that debate will finally take place. I hope we do not wait until the last minute.
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