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 of economics.
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, causing malinvestment.
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 prices.
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.[1]
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.
