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 We live in an age of grave economic ignorance, if
central-bank policy is an indication of prevailing economic theory. It is
apparent that we've learned nothing from several millennia of monetary
destruction. The persistent demonstration that capital, not paper, is the
basis for prosperity has fallen on deaf ears. Daily, we face the sad
spectacle of government officials, pundits, and even Nobel laureates telling
us that printing money is the answer to an economic downturn.
Consider that
since the eruption of the financial credit crisis in the second half of 2007, all major central banks have embraced an
irresponsibly loose interest-rate stance.
For instance, the
policy rate of the Bank of England (BOE) was lowered from 5.75% in November
2007 to the current level of 1%. The sharp decline in the BOE policy interest
rate is in line with policies of other central banks.
The US central
bank (the Fed) has lowered its policy rate (the federal-funds rate target)
from 5.25% in August 2007 to around zero at present.
Also, the
relatively "conservative" European Central Bank (ECB) has been
aggressively lowering its policy interest rate. The rate was lowered from
4.25% in September last year to the present target of 2%.
Similarly, the
Bank of Japan (BOJ) has visibly eased its interest rate stance. The policy
rate was reduced from 0.5% in September 2008 to the current level of 0.1%.
Given that, so
far, already extremely low interest rates have failed to revive economic
activity, central bankers are now considering another approach.
Last Wednesday,
February 11, the governor of the Bank of England said that the UK central
bank is going to embrace a quantitative easing policy to revive the economy.
The idea here is to flood the economy with money by buying government bonds.
US central-bank policy makers are currently contemplating a simliar idea.
We shouldn't
overlook the fact that, since embracing the aggressive lowering of rates,
central banks have been aggressively pushing money into the banking system
without succeeding in reviving economic activity. So why should aggressive
money pumping work now?
The yearly rate
of growth of the US central-bank balance sheet (money pumping) jumped from
3.9% in August last year to 152.8% in December 2008 before falling to 127.5%
in January. The yearly rate of growth of the balance sheet of the Bank of
England jumped from negative 7.2% in May 2007 to positive 179.4% by October
2008 before easing to 157.6% in November last year and 129% in January.
The growth
momentum of the European Central Bank balance sheet has accelerated in
January. Year on year, the rate of growth jumped from 7% in July 2007 to
45.5% in December and to 56.5% in January.
Also, the yearly
rate of growth of the BOJ balance sheet follows a visible uptrend. The rate
of growth climbed from negative 0.8% in August last year to 10.3% in December
before easing to 5.7% in January.
What permits real
economic growth is an improvement in the investment infrastructure of the
production process. What makes the improvement
possible is real savings. It is real savings that fund the enhancement of
infrastructure through various tools and machinery, i.e., capital goods. With
better tools and machinery, a better quality and a greater quantity of goods
and services can be produced.
In a free,
unhampered market economy the established infrastructure is in accordance
with the tendency toward harmony between various activities. This means that
the flow of real savings is sufficient to fund various lines of production
without any disruption.
On this Murray
Rothbard, paraphrasing Ludwig Lachmann, wrote,
Capital is an
intricate, delicate, interweaving structure
of capital goods. All of the delicate strands of this structure have to fit,
and fit precisely, or else malinvestment occurs. The free market is almost an
automatic mechanism for such fitting; … with its price system and
profit-and-loss criteria, [it] adjusts the output and variety of the different
strands of production, preventing any one from getting long out of alignment.[1]
As a result of
the artificial lowering of interest rates and massive money pumping, an
additional demand for various goods and services emerges. This leads to an
attempt to expand the infrastructure.
This attempt is
bound to fail since the flow of real savings is not large enough to support
the expansion of the capital structure. Consequently, the attempt to expand the
infrastructure leads to the diversion of real funding from various activities
that make the present flow of real savings possible. Thus, the flow of real
savings comes under pressure and the rate of real economic growth follows
suit.
Neither an
artificial lowering of interest rates nor monetary pumping by central banks
has direct input in the production of capital goods and the production of
goods and services that are required to promote and maintain human life and
well-being.
The artificial
lowering of interest rates and monetary pumping only give rise to various
false activities by diverting a portion of the flow of real savings to these
activities. The more false activities that emerge on the back of the
artificial lowering of interest rates and monetary pumping, the less real
savings will be available for wealth-generating activities.
The fact that
economic conditions have continued to deteriorate despite the aggressive
lowering of interest rates and massive money pumping by central banks raises
the likelihood that the flow of real savings is in trouble.
Note again that
monetary pumping and the artificial lowering of interest rates can't replace
nonexistent real savings. Without additional real savings, it is not possible
to undertake various new projects without weakening the existent structure of
production.
Remember that the
interest rate is just an indicator of the state of demand and supply for real
savings. The falsification of this indicator cannot expand the flow of real
savings.
Likewise money is
just a medium of exchange. Its function is to permit the exchange of the
products of one specialist for the products of another specialist. More money
cannot generate more real savings or real economic growth.
On the contrary,
a further planned expansion in monetary pumping by central banks can only
weaken the flow of real savings and undermine prospects for a sustained
economic revival.
Frank Shostak
Frank
Shostak is a former professor of economics and M. F. Global's chief economist.
Notes
[1] Murray N. Rothbard, Man, Economy, and State with Power
and Market
(Auburn, Ala.: Mises Institute, 2004), p. 967.
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