Printing more money won’t solve world’s economic problems

Monetary contraction is a reaction to previous inflationary policies

July 6, 2012

TORONTO, ON, Jul 6, 2012/ Troy Media/ – These days, the casual reader can’t go far without hearing about a lack of money in the world. And no, I am not referring to crippling poverty in third world countries in lieu of the material wonders capitalism has brought the West. I am speaking to the growing number of economists and commentators clamoring over the reluctance by central banks the world round to turn the gauge on their money printers to ‘high.’

Recently in the Financial Post, applied economics professor Steve Hanke shared his concern over the lack of private money creation in the United States. Hanke reasons that the lack of credit expansion is proving to be the true hurdle of growth for both America and the Eurozone. His solution is to scale back banking regulations to decrease political uncertainty and set the foundation for a boom in lending.

Now there is certainly merit in arguing for the relaxing of banking regulations as they serve as barriers to entry by small-time competitors. By increasing the cost of entry to business through various mandates and requirements, industries become dominated by large firms. This is very much the case in today’s modern financial system presided over by central banks that are given government grants of monopoly over their respective currency supplies.

Back to the core question however, would an increase in private lending really get the ‘animal spirits’ spending again? Historical evidence would suggest as much, despite human action being unpredictable. But should central banks start shoving their favored banks with liquidity en masse?

To answer this question, we must first define what money is and what function it has in a market economy. Money, properly understood, serves as a medium of exchange.

Money is important, but it isn’t wealth. In its predominant paper form, its only function is to facilitate transactions. No increase in the supply of money, no matter how massive, produces consumer goods or services. As famed economic scholar David Hume once theorized, if everyone were to wake up one day to find their wallets magically packed to the brim with newly-printed dollars, it may induce of feeling of immediate euphoria but there would be no increase in their material well-being. As soon as the funds begin to be spent, prices will be pushed upward. Whatever perceptions of being richer that may have been felt would be quickly extinguished.

More importantly, monetary inflation engineered by central banks must set off the business cycle. A century ago, economist Ludwig von Mises developed a groundbreaking theory on how central bank manipulation of interest rates and money supply distorts relative prices and leads to malinvestments in unsustainable lines of production. We have had the misfortune oft witnessing von Mises’ theory at work over the past decade. In the early 2000s as the Federal Reserve, under the leadership of Alan Greenspan, took interest rates to then-historically low levels, this led to a decrease in borrowing costs and mortgage rates. From December 2000 to June 2003, the Fed lowered its federal funds rate (the rate charged to banks to borrow from each other overnight) from 6.5 per cent to 1 per cent. It stayed at 1 per cent till June of 2004. According to economist Joseph Salerno, 30 year mortgage rates would go on to fall from over 7 per cent in 2002 to 5.25 per cent in 2003 while one-year adjustable rate mortgages fell from about 7 per cent in 2000 to 3.74 per cent in 2003.

Housing prices skyrocketed as mortgage standards were relaxed. Bankers and politicians alike rode the wave of optimism till the inevitable collapse as Greenspan gradually raised interest rates to prevent the rising of prices from becoming more widespread. Consumes did their part by using the manipulated value of their homes as collateral to go into debt in order to purchase things like high end electronics, expensive meals, and scenic vacations. When money supply growth slowed, Greenspan’s house of cards built on unrealistic feelings of affluence collapsed as home prices came back down to Earth.

The burst of the housing bubble was just one instance of the boom-bust cycle brought about by government-sanctioned inflationary policy. The evidence is clear that the advent of central banking has been responsible for more severe economic crises than a hard currency system with minimal government oversight. Monopoly and easy-access to a printing press is a combination too enticing for the political class to pass up.

Hanke is correct in pointing out Ben Bernanke has engaged in a sort of orgy of money printing over the past three years, with private money creation lagging behind. But should private lending really begin to take off, it would eventually need to come to an end, less the complete destruction of the currency.  Germany knows this outcome too well as Weimar hyperinflation would eventually lead to the rise of Nazism.

In the end, what Hanke and his like-minded peers fail to realize is that monetary contraction is really just the market’s collective reaction to previous inflationary policies. The slowdown in growth isn’t a market failure but an adjustment to the Fed’s previous manipulation. Inflation is always implanted with the seeds of its own destruction.

It is only through the production of goods and services that wealth is ultimately created. If money printing was really the great cure-all peddled by many of today’s prominent economic commentators, then Zimbabwe would have a first world economy by now. Instead, it too succumbed to the hubris of central bankers who believe themselves capable of knowing the proper supply of money used by millions.

James Miller is Editor in chief with the Ludwig Von Mises Institute of Canada

This column is FREE to use on your websites or in your publications. However, Troy Media, with a link to its web site, MUST be credited.

Please follow and like us:

One Response to "Printing more money won’t solve world’s economic problems"

  1. Contrapreneur   July 6, 2012 at 2:31 am

    Money is a lubricant for the economy. It is true that more money won’t lead to greater wealth, but the production of services won’t either (though it may lead to greater health).  The problem now is that money is being concentrated in fewer and fewer hands. The money needs to get out to those who will use it to buy goods and services, which will promote consumers buying more goods. If goods are not purchased, they stop being produced. The way to get the economy moving is to get the money out of the hands of bankers and large corporations and into the hands of the little guys who pull the wagon of the economy. That’s what Clinton did in the U.S. in the 90’s. Reducing taxes for the wealthy does little because they already have most everything they need, so they generally just horde the excess. The little guys are the ones who spend the money and keep the economy moving. If you want a vibrant economy it is imperative that you get the money to the little guys. Unfortunately, the previous way this was done was to pay the little guys for working at jobs. Now they are being replaced by machines, so they are not getting the money. No money means not spending. No spending means no goods purchased. No goods purchased means no more production. It is a vicious circle.  Income redistribution through taxation is the answer. We need more “tax and spenders”, less “cutback and don’t spend.” And we need more taxation to do that. Unfortunately, globalization creates a race to the bottom on taxes, which will damage the economy worldwide except in those areas where consumers have jobs and need goods, e.g., China, India, etc. Stagnation is bound to continue in those areas where jobs are declining. It is inevitable. Globalization hands the power to corporations who can move operations to wherever the costs are lower. Great for achieving economic efficiencies, but if you are a worker in an area where the labour costs are higher, you are out of luck.