Home > Macro/Monetary Theory, Things to be Outraged by, Uncategorized > Why You Really Shouldn’t Like The Fed

Why You Really Shouldn’t Like The Fed

I want to try to say very simply, hopefully without too much economics, why I don’t support the current financial system despite noticing the flaws in the Austrian story.  To get the context watch Peter Schiff’s video blog from last week after the Fed announced “operation twist.”  There is a part of this that is right and a part that is wrong.  The wrong part is what I have been talking about already, namely that these policies will result in inflation (and higher gold and silver prices).  The right part is that the whole thing is to get people to borrow and spend more.  In fact this is the whole point of the entire financial system.  The whole mechanism by which money is created is basically a process of creating a shortage of loanable funds and filling it with new money (debt).  This is the peice that Austrians tend to overlook but it is the real reason why it is so terrible.

The system perpetually increases the degree to which our lives are leveraged.  They promise to stimulate the economy through monetary policy.  To do this, as I said, they create money by creating a shortage in the market for loanable funds which they fill with money by lending it out.  But this is not permanent money, it has to be paid back, and it has to be paid back with interest.  So this causes price inflation and increased economic activity.  But when the money has to be paid  back the money supply starts to shrink which causes prices to fall which causes another economic crisis.  To solve the crisis they have to expand the money supply by even more to replace the money they created before, plus the interest, plus enough to make the money supply even larger to keep prices rising.  This requires an even greater shortage in the market for loanable funds.  So they have to do something to either increase borrowing or decrease saving or usually both.  The most common method is to lower interest rates.  (Of course sometimes this just goes on smoothly for quite some time with no crisis but it’s the same process of increasing the money supply by creating increasing shortages in the loanable funds market and filling them with more and more debt.)

Ok so what’s the problem?  Well have you noticed how we don’t own anything any more?  There is a comercial on TV that starts out like this: “You’re proud of the fact that you support yourself and you don’t need to borrow money.”  And then they say “But did you know that if you _________, you actually are borrowing money.”  Guess what goes in the blank.  If you said “have a mortgage” then sorry, thanks for playing.  If you said “own stock in a company that is highly leveraged” then you’re way off but nobody said that because nobody thinks about that.  The answer is “carry a balance on your credit cards.”  America! Do we not know that carrying a balance on our credit cards is borrowing money now?  Hopefully most of us are not that far gone yet.  But look at the way we treat our houses.  If you have a mortgage you don’t own your house, the bank owns it.  This doesn’t mean you shouldn’t have a mortgage but we are in a place where practically nobody owns their house because even people who have paid off their house go and get a second mortgage and use it for consumption (or worse: investment….)  And that’s not the worst of it.  We don’t own our cars any more.  We take out loans to buy boats.  We buy stocks on margin.  We count on social security and public or private pensions to provide for our retirement and these are mostly hopelessly underfunded and counting on their ponzi-game (yes I said it!) structure to keep them going.

This is not an accident.  Our solution to every economic problem since the great depression (when our solution was to keep prices from falling by passing laws making it illegal) has been to try and get people to borrow and spend more.  And if you can do it, it works… for a while.  But eventually all those loans still have to be paid back and that means to keep it going we have to find more and more ways to borrow.  The real problem with this economy is that we are running out of stuff to hock for more credit.  And the Federal Reserve is doing their best to get the last hold-outs to take out another mortgage.  They are even forcing Fannie and Freddie to lend 25% more than a home’s value.

So why am I against this system?  First, because the contractionary nature of it is inescapable.  But more importantly because when we can’t put it off any longer and it collapses we will look around and realize we don’t really own anything.  When we can’t pay our mortgages the banks will take our houses.  When we can’t pay our car loans the banks will take our cars.  When our companies can’t pay their bonds the banks will take their capital.  In short we will “wake-up homeless on the continent our fathers conquered.”

And the cure may be worse than the disease–government spending.  Sure, it’s ture if we allow the government to run ever-expanding deficits without any end, they could fill the gap with this borrowed money and spend it on whatever they want.  But this puts ever-increasing control of the economy in the hands of the federal government.  This is not a recipe for either prosperity or liberty.  And in this manner we become more-and-more collectively in debt to the monetary authorities.  Isn’t that fantastic!  So even if you figure it out and do things right individually who do you think they will come after with the taxes to pay back the government debt once everyone else is broke?

Just so that I am not misunderstood let me say that I don’t mean to point the finger at your hometown banker.  When things fall apart, they are hit as hard as anyone because all of their loans are stacked on top of an account with the Fed.  And the Fed has the power to come in and decide whether or not they are “solvent” and if they decide in the negative, to seize their assets and distribute them however they wish among the other banks.  Ever notice how Goldman Sachs and J.P. Morgan Chase always come out of these things just fine?  There is nothing wrong with banking per se.  The problem is when you create a centralized authority with special government powers (powers of coercion) to control a whole industry, set prices, and manipulate the currency.

When precious metals took a dive last week I couldn’t help but wonder how many vehement supporters of individual liberty have bought gold on the advice of Peter Schiff and the Austrians while meanwhile they have a mortgage on their home and a balance on their credit cards…

  1. September 28, 2011 at 7:08 am

    Wow. This was really powerful. I liked the quote from Thomas Jefferson. I think you should follow this article up with an article on how to “cure the problem” because you mentioned the cure could be worse than the disease. Also, how would you recommend escaping “waking up homeless on the continent our fathers conquered”?

  2. September 28, 2011 at 7:13 am

    And, what do you think is going to happen when the Fed can’t do this process any longer?

  3. September 28, 2011 at 7:21 am

    Also, you don’t think the price of gold will go ever higher as people lose more confidence in the economy? Gold is a protection against inflation, and extremely BAD scenarios, right? So, if we have deflation (which you predict), the value of gold will go down. However, if the economy collapses then wouldn’t the price of gold skyrocket?

  4. Free Radical
    September 28, 2011 at 3:28 pm

    By “the cure” I meant the traditional cure which is government deficit spending. And basically what I think is going to happen is what I was saying there. There will be deflation and defaults, bankruptcies, bank failures, etc. The recessions we have been having are foreshadowing but we have had enough slack left to wriggle out of them, eventually we won’t and it will be the same thing but much worse. Then what happens is anybody’s guess. Up to this point gold will go down because people will be scrambling for dollars. This is what Austrians don’t get. People will need those dollars to pay their loans. We can’t just “lose faith” in the dollar. When it gets bad enough what happens is anybody’s guess. I expect the powers that be will use it as justification for enhanced government powers and most likely try to create a centralized financial authority on a global scale. This would be a disaster and I just hope we can realize what is going on before we let that happen. Of course if the whole system collapses entirely then gold may be better to have than dollars. It’s not a bad idea to have a little on hand just in case of a doomsday scenario. But that would take a pretty serious paradigm shift.

  5. steve618
    September 28, 2011 at 4:43 pm

    Does anyone really ever “own” their home? (Try not paying property tax and it will be sold right out from under you). Property tax makes us all renters in the long run.

    For those fearing inflation: If the Fed planned to inflate endlessly, thereby destroying the value of the currency, why did they recently bother to spend lots of money to redesign the $100 FRN with added security features and on upgrades to their printing machines?

    How many people are aware that there are over one trillion dollars worth of Japanese Yen paper currency in existence (compared to less than $1 trillion of US FRNs) yet Japan still experienced deflation (despite a higher debt to GDP ratio as well)?.

  6. Free Radical
    September 29, 2011 at 4:47 pm

    Yeah I mentioned the tax thing in there, but I don’t know what are you gonna do just throw up your hands and say it’s over who cares?

    Interesting fact about Japan.

  7. W. Knowlton
    October 2, 2011 at 6:36 am

    Carry a balance on a credit card – what if you pay it off monthly?

  8. Free Radical
    October 3, 2011 at 7:25 pm

    Then you’re borrowing but only for a very short period. I do this every month I wouldn’t worry about it, most prices (like wages) are sticky enough that this isn’t long enough to screw you most likely. Plus, for what it’s worth, most credit cards have no collateral attached. I’m not exactly sure what the bank can do to you if you default on them. But the bigger point remains. Our economy is fueled by debt and the debt is hanging over our property to a staggering degree.

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