I. Monetary Expansion Is Kept Going
In monetary analyses, the balance
sheet of the commercial banking sector is typically kept separate from the
balance sheet of the US Federal Reserve (Fed). However, combining the two
balance sheets might be much more informative.
First, adding up the business
volumes of commercial banks and the Fed provides a (much) better insight into
the expansion of the monetary sector as a whole over time — especially
so in times of the financial and economic "crisis."
Second, such an aggregation reveals
that in times of crisis the central bank unmistakably puts the interest of
the banking industry first, with its policy aimed at "restoring the
banking sector back to health."
The expansion of the Fed's balance
sheet as from the end of 2008 onwards has not only helped prevent the banking
industry from shrinking; it has kept the expansion of the monetary system
going, as shown by the chart below.
The Fed has expanded its balance
sheet through providing additional credit to the commercial-banking system
and purchasing (government and mortgage) bonds from banks and nonbanks. As a
result, the combined balance sheet of commercial banks and the Fed rose to a
record high of close to 115 percent of GDP in Q4 2011.
II. The Increase in the Stock of Payments
The expansion of the aggregated
balance sheet of commercial banks and the Fed has been accompanied by a rise
in the stock of payments in the form of M1. It has increased by 58 percent
from August 2008 to February 2012.
Within M1, demand deposits went up
from $314 billion to $772 billion, a rise of 146 percent. The increase in the
means of payment may be in part due to the extraordinarily low interest rates
(that is, the extraordinarily low opportunity costs of money holdings).
However, it may also be due to the
Fed's purchases of bonds from so-called nonbanks (for instance, private
households, pension funds, and insurance companies). Under such operations
the Fed increases the means of payments directly; it is a policy of
increasing money by actually circumventing bank credit expansion.
The marked increase in the stock of
payments in recent years is an unmistakable sign of what can be called,
economically speaking, inflation, a view held by the Austrian School
A rise in the money stock leads,
and necessarily so, to a decline in the purchasing power of a money unit
— when compared with a situation in which there had not been a change
in the money stock.
Most important, a rise in the money
stock actually prevents a rise in the purchasing power of money — which
would have occurred had the Fed not ramped up the means of payments in the
hands of commercial banks and nonbanks.
The rise in the money stock can be
expected to translate into higher prices — be it prices for consumer
goods (via, for instance, higher commodity prices) or prices for assets (such
as stocks and real estate).
Rising prices erode the purchasing
power of money and do great harm to the (coordination) function of market
prices, thereby provoking misinformed decision making of market agents,
Such a policy is by no means neutral.
The winners of the Fed's policy are, for instance, the holders of goods and
assets that are prevented from declining in prices, while the losers of the
Fed policy are money holders: they have been prevented from buying at lower
III. The Boom That Must End in Depression
The ongoing expansion of the money
supply — a monetary policy of going well beyond measures of just
keeping the money stock from shrinking — is indicative of attempts to
keep the boom, caused by bank circulation credit expansion, going.
However, such a policy will not
cure the economic and political malaise brought about by bank-circulation
credit expansion in the first place. In fact, such a monetary policy will
make things much worse going forward.
It will not only pave the way
toward a deep depression, through which the economy will finally be brought
back to equilibrium; it will also ruin the currency. Ludwig von Mises (1881–1973), in Interventionism:
An Economic Analysis (1940), noted,
The boom cannot continue
indefinitely. There are two alternatives. Either the banks continue the
credit expansion without restriction and thus cause constantly mounting price
increases and an ever-growing orgy of speculation, which, as in all other
cases of unlimited inflation, ends in a "crack-up boom" and in a
collapse of the money and credit system. Or the banks stop before this point
is reached, voluntarily renounce further credit expansion and thus bring
about the crisis. The depression follows in both instances.
Against this backdrop, the
conclusion is that the monetary policy of continuing to expand the money
supply through bank-circulation credit provided at artificially lowered
interest rates is actually the worst of all monetary policies.