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The Economic Collapse Could Have Been Prevented

By: Steve Johnson

5/1/2009 - 44 Comments

The political leaders on both sides like to use the term ‘crisis’ and refer to how no one saw it coming or how it couldn’t have been prevented because they did everything they could to stop the current recession. 

None could be further from the truth.  All boom-and-bust cycles in the economy are created by government monetary policies and are therefore perfectly avoidable. 

To avoid the bust part of the cycle, the political leaders would have to forgo the boom part of the cycles that they so cherish.  But the ultimate responsibility lies with we the people who elected these leaders that set the policy to create the boom years, which we so cherished.

Thorsten Polleit, from the Austrian School of economics, explains it in his article, “Ending the Monetary Fiasco – Returning to Sound Money”.

“An increase in the fiat-money supply through what Mises called the expansion of circulation credit lowers — and necessarily so — the market interest rate below the natural rate, or people's time-preference rate. It is this artificial downward manipulation of the market interest rate that sets into motion the economically harmful and politically devastating boom-and-bust cycles.

The increase in the fiat-money supply via circulation credit is inflationary, and its consequence is prices for consumer or asset prices going up.

What is more, it leads to a false sense of real savings. The artificially lowered market interest rate induces investment projects that would not have been undertaken under an unchanged credit and money supply.
The artificially lowered market interest rate makes production more roundabout, that is, economic resources are increasingly diverted from the production of consumption (or lower-order) goods to investment (or higher-order) goods.
(this is why we over built houses, cars, furniture, etc.)

The lowered market interest rate reduces real savings and increases consumption and investment, making monetary demand overstretch the economy's real resources and diverting people's saving-consumption relation from their actually desired path. (this is exactly what happen as savings rates dropped to zero and consumption became 72% of the economy)

Sooner or later, however, people return to their favored savings-consumption ratio. When this happens, it becomes obvious that the economy has lived beyond its means, that is it has embarked upon an unsustainable path, and the credit-and-money-fuelled boom turns into bust.

But now comes the hard — the political-economic — part, of which Mises was so well aware. In view of an approaching depression, people start calling for the continuation of the very policies that have caused the malaise: even lower interest rates (which are now at zero percent) through a further increase in the supply of credit and money; more credit and money at the lowest possible interest rate are seen as a remedy rather than cause of the malaise.

Lower central-bank interest rates may prevent depression on some occasions, but this comes at a high price. A correction of the distortions in the production structure is prevented, and the artificially lowered interest rate encourages even more distortions in the economy's production structure.

As a result, a monetary policy that tries to fend off depression — the economically painful but necessary process of correcting malinvestment — merely postpones the inevitable crisis and, because it increases the amount of malinvestment, increases the costs of the final and inevitable bust. (a much bigger crash has been postponed into the future)

One may blame the public's economic illiteracy and its anticapitalist mentality for failing to come up with the right diagnosis of the causes of the crisis and to advocate an appropriate cure. This, however, would run the risk of underrating the disaster-causing role of government.

Governments and their sympathizers and beneficiaries have an existential interest in preserving and strengthening the fiat-money regime, marketing it in public — especially in state-funded schools and universities — as being in the best interest of the people, suggesting that there is no viable alternative.

But of course there is a viable alternative: free-market money.

But the majority of the people do not believe in free markets, as epitomized by the popular term international credit crisis.

To put it mildly, this is a misleading interpretation of what is really going on. What is called crisis is actually an inevitable process through which malinvestment — provoked by a relentless expansion of circulation credit and fiat money in the last decades — is corrected.”

In summary, the monetary actions that the government is pursuing today will result in a much bigger crash sometime in the future and the real problem and solution is to take away the power of money from the government. 

The Solution is Threefold

First to educate the public about economics so they once again realize how wealth is created and destroyed, through savings and production.

And second to elect new political leaders that also understand economics and do not make short term decisions that create a boom in economic growth only to be followed by a deep recession. 

And Third to face the recession, which cannot be avoided only delayed.

The good news is that the deepening recession will naturally do all of these.  The public will be forces to learn about economics and will eventually come to their senses and elect fiscally responsible leaders, who will drastically cut spending and lead the nation through the recession. 

But at this point, public opinion is willing to trust the current political leadership which is in the process of totally destroying of the value of the dollar by flooding the market with cheap money.  Because of generations of prosperity and little understanding about economics, the public and government counterpart are making the largest mistake in history - all the while, ignoring the history lesson of German’s hyperinflation of the 1920’s. 

The way to prevent history repeating itself is to change monetary policy - increase interest rates. The path to return to sound money, which is the only path to rebuild a sound economy, is to STOP expanding the money supply and STOP increasing the national debt. 

Banks should no longer be permitted to expand money by creating debt without 100% reserves and the Federal Reserve should no longer be permitted to manipulate the banking interest rates.  Then, the money supply should be linked to a fixed amount of gold so that no future government arm would be able to again increase the money supply.

I hope for the best, but its hard to ignore the direction that we are headed.

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The Case Against the Fed

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