This morning I received an email news letter from the Ludwig von Mises Institute linking to an article by Frank Shostak that describes his view that the Federal Reserve's pumping of cash into the economy is inflationary. His position is that the current decreases in commercial credit do not effect the overall money supply. On October 5, Elliot Wave International's Bill Fox wrote that the US in neither in a disinflationary nor an inflationary economy, but in a deflationary economy.
For those that are unaccustomed to economic terminology, or may have forgotten, Inflation is an overall increase in the total amount of money in the economy, disinflation occurs when the rate of inflation is decreased, and deflation occurs when the supply of money decreases. The effect of inflation is rising prices, while the effect of deflation is falling prices. reflation is an attempt by government to return the money supply to its previous levels once deflation has set in.
Normally, the folks at EWI and the folks at von Mises agree on inflationary and deflationary changes in the economy. In fact, EWI's Robert Prechter says in his book, At the Crest of the Tidal Wave, that the Austrian School of Economics (von Mises was a founder) is the only group of economists that understand credit's effects on the economy. Both analysts are looking at the same numbers, so what gives?
For what it's worth, here is my take. Shostak's view that decreases in lending rates doesn't directly reduce the money supply (other than credit extended on fractional reserves, which is money created from thin air) enough to counter balance the infusion cash pumped in by the Fed. This is correct as far as it goes, but if fails to take into consideration that banks (and consumers) are hoarding cash. The total supply of money may remain unchanged, but if that money is sitting idle because the banks won't lend it or the consumers won't spend it, then the amount of money available in the economy has decreased.
Fox, and EWI, believe that the contraction of commercial credit will result in less money available in the economy to consumers because the banks aren't lending it. If loans aren't available to finance leveraged assets, then demand for those assets will decrease, driving prices down. Prices of items, especially consumer items, usually purchased on credit will decline EWI's whole point, and it is a point they borrowed from von Mises, is that the "growth" in the economy over the last decade or so, has been false growth based on too-readily-available credit money.
The collapse of the sub-prime mortgage market (a market fueled by artificially low interest rates, resulting form the Fed's monetary policy) was a deflationary event. As the mortgages, and then the banks, etc. defaulted, the value of those loans (credit money) was removed from the economy. The Fed money pumping and the Government's deficit spending were attempts at reflation. The Austrians would consider the excessive sub-prime lending to be "malinvestment" brought about by "false signals" in the economy from the Fed's manipulation of interest rates.
The question now is did the "Great Recession," a correction in the business cycle recognized by the folks at von Mises and EWI, fully correct for all of the malinvestment? Or did it over do the reflation? Or is there more correction to come? Or, even more ominous, has the infusion of cash used to reflate the economy sent even more false signals to create even more malinvestment?
For those that are unaccustomed to economic terminology, or may have forgotten, Inflation is an overall increase in the total amount of money in the economy, disinflation occurs when the rate of inflation is decreased, and deflation occurs when the supply of money decreases. The effect of inflation is rising prices, while the effect of deflation is falling prices. reflation is an attempt by government to return the money supply to its previous levels once deflation has set in.
Normally, the folks at EWI and the folks at von Mises agree on inflationary and deflationary changes in the economy. In fact, EWI's Robert Prechter says in his book, At the Crest of the Tidal Wave, that the Austrian School of Economics (von Mises was a founder) is the only group of economists that understand credit's effects on the economy. Both analysts are looking at the same numbers, so what gives?
For what it's worth, here is my take. Shostak's view that decreases in lending rates doesn't directly reduce the money supply (other than credit extended on fractional reserves, which is money created from thin air) enough to counter balance the infusion cash pumped in by the Fed. This is correct as far as it goes, but if fails to take into consideration that banks (and consumers) are hoarding cash. The total supply of money may remain unchanged, but if that money is sitting idle because the banks won't lend it or the consumers won't spend it, then the amount of money available in the economy has decreased.
Fox, and EWI, believe that the contraction of commercial credit will result in less money available in the economy to consumers because the banks aren't lending it. If loans aren't available to finance leveraged assets, then demand for those assets will decrease, driving prices down. Prices of items, especially consumer items, usually purchased on credit will decline EWI's whole point, and it is a point they borrowed from von Mises, is that the "growth" in the economy over the last decade or so, has been false growth based on too-readily-available credit money.
The collapse of the sub-prime mortgage market (a market fueled by artificially low interest rates, resulting form the Fed's monetary policy) was a deflationary event. As the mortgages, and then the banks, etc. defaulted, the value of those loans (credit money) was removed from the economy. The Fed money pumping and the Government's deficit spending were attempts at reflation. The Austrians would consider the excessive sub-prime lending to be "malinvestment" brought about by "false signals" in the economy from the Fed's manipulation of interest rates.
The question now is did the "Great Recession," a correction in the business cycle recognized by the folks at von Mises and EWI, fully correct for all of the malinvestment? Or did it over do the reflation? Or is there more correction to come? Or, even more ominous, has the infusion of cash used to reflate the economy sent even more false signals to create even more malinvestment?
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