Greenspan’s monetary fling

St. Louis Fed Money Aggregates

With the news Wednesday of the Federal Reserve’s one-half percent cut in its discount rate, the stock markets went ballistic. The Dow Jones Industrial Average increased by just under 400 points, and even the recently anemic NASDAQ index ended the day above 2,000 points.  By the time you have finished reading this article, it is likely that the markets will be giving back some of their one-day gains.

While investors enjoyed the rally, the larger question that persists regarding Alan Greenspan’s move is whether or not the Fed’s actions make any sense at all.  For that matter, has the Fed been making sense with its policies for the last several years?  The very fact that I ask this question leads me to believe that Greenspan has simply been creating the very boom-and-bust cycle that he has said he wants to avoid.

While most readers of this page are familiar with the Austrian Business Cycle Theory, it bears repeating, especially in the face of the confusing rhetoric that comes from the media and economists.  As Ludwig von Mises, F.A. Hayek, and Murray N. Rothbard have noted in their writings, whenever monetary authorities artificially increase credit – as the Federal Reserve has done repeatedly – much of the new money is malinvested in capital goods.

Unfortunately for the investors, the purchasing habits of consumers will not permit many of those investments to be profitable.  Ultimately, a crisis occurs in which the investments are no longer sustainable, which means they must either be converted to other uses or be liquidated.  This liquidation period is better known as a recession.

The Austrian theory differs greatly from the popular Keynesian theories, which stress that recessions occur because of sudden declines in “aggregate demand.”  In the view of Keynesians, a recession can be quickly ended or avoided altogether if government, either through increasing spending or increasing the money supply, can trigger a surge in aggregate demand, which will allow goods to be sold and production of capital and consumer goods to be sustained at their current levels.

Austrians counter that this is a very crude theory at best, since it is near nonsense to think that one can lump the billions of daily transactions of our economy into one straight line and label it “aggregate demand.”  The theory also fails to differentiate between capital and consumer goods, and it operates on the assumption that recessions are felt evenly throughout the economy when, in truth, they tend to be concentrated in certain areas like capital goods and agriculture.  Granted, secondary effects of the economic downturns are felt in consumer goods (although not as intensely) and the banking sector.  If the recession results in a number of bank failures, as was the case in the Great Depression, the overall effects are much more severe.

In short, Keynesianism, while easy to teach (just draw an “X” using aggregate demand and aggregate supply functions), has zero explanatory power.  However, this ridiculous theory has captivated Greenspan’s mind, as he seeks to increase “aggregate demand” by forcing down interest rates.

The problem for Greenspan is that whatever “good” effects occurred when the Fed lowered interest rates in the past are not likely to be repeated in the near future.  In reality, those “good” effects were in large part the result of money pouring into malinvestments and the stock-market bubbles.  Many investment “opportunities” that seemed so promising just a couple of years ago have turned sour and will not come back even if the Fed lowers interest rates to near zero.

In the long term, the monetary system of this country needs a major overhaul – if we actually wish to rid ourselves of these boom-and-bust cycles.  Policies that would return to the pre-Civil War era before the passage of the disastrous National Banking Acts would ultimately be the best solution.  Granted, given the present political and economic climate, a return to sound money is not a possibility.

However, in the short run, Greenspan at least can stop the ridiculous roller-coaster ride that has plagued us during his tenure as chairman of the Federal Reserve System.  That would mean stopping the spikes in money growth, stopping the erratic policies of forcing down interest rates below the “natural” market rates, and calling for a major cutback in government spending.  Once upon a time, Greenspan would have advocated such policies.  Today, however, he is just another cog in the Washington, D.C., machine that grinds down everything that is good in our society.