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Looks like I've got way too much time on my hands
this Sunday morning in a note sent to a couple
of my correspondents. <FONT
face=Arial size=2>Maybe I'm coming up with my own
version of economic faith on this traditional day of Christian
worship.(:-) <FONT face=Arial
size=2>All fwiw.....thank you for your time and attention.
<FONT face=Arial
size=2>=====================================================================
I believe everything that is written in this
article to my core being. Intuitively; I know these economic
concepts to be the truth; and supported by
history. It seems to me that the
Austrian School of Economics are the only <FONT face=Arial
size=2>fundamental concepts and explanations that <FONT
face=Arial size=2>I can relate to as the basis of logic without flaws
and supported by facts and evidence.
Still; for me there exists an intellectual
dicotomy here regards this explanation of economic history; for even as I
read; and re-read the article; there are
gaps in my understanding of specific details
cited in this article. In other words; even if I memorized this piece
word for word; I would be unable to fully explain
how this works to someone at a cocktail party. If I could then I would be
fully able to explain and expand on why these
economic concepts are the truth about what has happened and <FONT
face=Arial size=2>what is now happening. It is the one good economic
oriented explanation I've seen as to why we are
in a secular bear market which is to
last for at least a few years to
come. I would love to see<FONT
face=Arial size=2> ONE book which breaks down this
economic logic into <FONT face=Arial
size=2>easy to understand examples; using specific numbers; and which addresses
what appear to be some unanswered
explanations. Perhaps it is a lack of understanding on my part; or
mental laziness and <FONT face=Arial
size=2>unwillingness to study this piece again and again.
Even before these economic comparisions
between the great depression and the current economic
period; cyclical and astro theorists have stated
that we can expect a period similiar to 1873 - 1886.
In looking at a log chart of prices during that
time the broad intermediate price swings that occurred
can be labeled as follows:
6 5/8....5....6 1/4....4 3/4....7 7/8....5 7/8....7
7/8.
6 5/8 is the level of prices; roughly; at the
beginning of 1873. At the end of 1886 note that prices
were roughly at the same level as the peak which
occurred in 1881. Interestingly; this pattern fits
perfectly with all the unique and historically
compelling studies of economic history that <FONT face=Arial
size=2>John Manuldin has been reporting in his
weekly e-mails. Of course the pattern is not going to be
exact;
because as some accurate observer stated; 'history
does not replicate it rhymes'. About all we know
is that there will be both <FONT face=Arial
size=2>great opportunities--and great <FONT face=Arial
size=2>frustrations-- for traders on both
the long and short side of the market.
I can't say if all this information can be tied
together in a synergestic manner that represents
an accurate blueprint for the future; but I haven't seen any other arguments out
there that I'm more willing to <FONT
face=Arial size=2>believe.
chas
----- Original Message -----
From: <A
href="" title=article@xxxxxxxxx>Mises Daily Article
To: <A href=""
title=article@xxxxxxxxxxxxxxxxx>Mises Daily Article
Sent: Friday, April 18, 2003 7:55 AM
Subject: Does a Falling Money Stock Cause Economic
Depression?
<A
href="">http://www.mises.org/fullstory.asp?control=1211
Does a
Falling Money Stock Cause Economic Depression?
By Frank Shostak
[Posted April1 18, 2003]
<IMG align=right border=0
src="">Despite the aggressive
lowering of the federal funds rate target from 6.5% in December, 2000 to the
current level of 1.25%, U.S. economic activity remains subdued. Faced with a
lackluster response to this aggressive monetary stance, it is tempting to draw
parallels with the 1930's economic depression.
Most economists hold that such comparisons are not warranted.
Following the writings of Milton Friedman, they are of the view that the policy
makers of the Fed have learned the lesson of the Great Depression and know how
to avoid a major economic slump.
In his writings Milton Friedman blamed central bank policies for
causing the Great Depression. According to Friedman the Federal Reserve failed
to pump enough reserves into the banking system to prevent a collapse in the
money stock (Milton and Rose Friedman's Free To Choose). In response to
this failure, Friedman argues, money stock, M1, fell by 33% between late 1930
and early 1933 (see chart).
<IMG border=0
src="">
According to Friedman, as a result of the collapse in the money
stock economic activity followed suit. Thus by July 1932 year-on-year industrial
production fell by over 31% (see chart). Also, year-on-year the consumer price
index (CPI) had plunged. By October 1932 the CPI fell by 10.7% (see
chart).
<IMG border=0
src=""> <IMG border=0
src="">
However, a close examination of the historical data shows that
contrary to Friedman the Fed was extremely loose and pumped reserves into the
system in its attempt to revive the economy (on this see Murray Rothbard's
America's
Great Depression). The extent of monetary injections is depicted by
changes in the Fed's holdings of U.S. government securities. Thus on January
1930 these holdings stood at $485 million. By December 1933 they had jumped to
$2,432 million—an increase of 401% (see chart). Moreover, the average yearly
rate of monetary injections by the Fed during this period stood at
98%.
<IMG border=0
src="">
Also, short-term interest rates fell from almost 4% at the
beginning of 1930 to 0.9% by September 1931 (see chart). Another indication of a
loose monetary stance on the part of the Fed was the widening in the
differential between the yield on the 10-year T-Bond and the yield on the 90-day
Bankers Acceptances. The differential rose from -0.51% in January 1930 to 2.37%
by September 1931 (see chart).
<IMG border=0
src=""> <IMG border=0
src="">
The sharp fall in the money stock between 1930 to 1933, contrary
to Friedman, is not indicative of the Federal Reserve's failure to pump money.
Instead it is indicative of a shrinking base of investable
capital brought about by the previous loose monetary policies of the
central bank. Thus the yield spread increased from -0.9% in early 1920 to 1.9%
by the end of 1925 (an upward sloping yield curve indicates loose monetary
stance). The reversal of the stance by the Fed from 1926 to 1929 burst the
monetary bubble (see chart).
<IMG border=0
src="">
In addition to this, at some stages monetary injections were
massive. For instance, the yearly rate of growth of government securities
holdings by the Fed jumped from 19.7% in April 1924 to 608% by November 1924.
Then from 0.3% in July 1927 the yearly rate of growth accelerated to 92% by
November 1927. Needless to say that such massive monetary pumping amounted to a
massive exchange of nothing for something and to a severe depletion of the pool
of real funding, that is, the essential source of current and future capital
needed to sustain growth.
As long as the pool of real funding is expanding and banks are
eager to expand credit (credit out of "thin air") various nonproductive
activities continue to prosper. Whenever the extensive creation of credit out of
"thin air" lifts the pace of real-wealth consumption above the pace of
real-wealth production the flow of real savings is arrested and a decline in the
pool of real funding is set in motion. Consequently, the performance of various
activities starts to deteriorate and banks' bad loans start to rise. In response
to this, banks curtail their lending activities and this in turn sets in motion
a decline in the money stock.
The fall in the money stock begins to further undermine various
nonproductive activities, i.e. an economic depression emerges. In this regard
after growing by 2.7% year-on-year in January 1930 bank loans had fallen by a
massive 29% by March 1933 (see chart).
<IMG border=0
src="">
How is it possible that lenders can generate credit out "of thin
air" which in turn can lead to the disappearance of money? Now, when loaned
money is fully backed up by savings, on the day of the loan's maturity it is
returned to the original lender. Thus, Bob—the borrower of $100—will pay back on
the maturity date the borrowed sum plus interest. The bank in turn will pass to
Joe, the lender, his $100 plus interest adjusted for bank fees. To put it
briefly, the money makes a full circle and goes back to the original
lender.
In contrast, when credit is created out of "thin air" and
returned on the maturity day to the bank this amounts to a withdrawal of money
from the economy, i.e, to a decline in the money stock. The reason for this is
because there wasn't any original saver/lender, since this credit was created
out of "thin air."
It follows then that the sole cause behind the wide swings in
the stock of money is the existence of fractional reserve banking, which gives
rise to unbacked-by-savings credit. (In the <A
href=""
target=_blank>Mystery of Banking Murray Rothbard showed that it is the
existence of the central bank that enables fractional reserve banking to
thrive).
Observe that economic depressions are not caused by the collapse
in the money stock (as suggested by Milton Friedman), but come in response to a
shrinking pool of real funding on account of previous of loose money.
Consequently, even if the central bank were to be successful in preventing the
fall of the money stock, this would not be able to prevent a depression if the
pool of real funding is declining. Also, even if loose monetary polices were to
succeed in lifting prices and inflationary expectations (as suggested by Paul
Krugman), this would not revive the economy as long as real funding is
declining.
Again, note that contrary to popular thinking, depressions are
not caused by tight monetary policies, but are rather the result of previous
loose monetary policies. On the contrary, a tighter monetary stance arrests the
depletion of the pool of real funding and thereby lays the foundations for
economic recovery. Furthermore, the tighter stance reveals the damage that was
done to the capital structure by previous monetary policies.
Have we learned the lesson of the Great
Depression?
Do central banks have all the necessary tools to prevent a
severe economic slump similar to the one that occurred in the 1930's? Most
economists are adamant that modern central banks know how to counter the menace
of a severe recession.
But if this is the case why has the central bank of Japan failed
so far in reviving the Japanese economy? The Bank of Japan (BOJ) has used all
the known tricks as far as monetary pumping is concerned. Thus interest rates
were lowered to almost zero (see chart) while BOJ monetary pumping as depicted
by its holdings of government securities increased by 323% between January 1990
and March 2003 (see chart).
<IMG border=0
src=""> <IMG border=0
src="">
It is likewise in the U.S. For over two years the Fed has been
aggressively lowering interest rates and yet economic activity remains subdued
(see chart). For instance, in relation to its long-term trend industrial
production remains in free fall (see chart). The Fed's holdings of government
securities have increased by 189% between 1990 Q1 and 2002 Q4. The yearly rate
of growth of these holdings jumped to 14.1% in Q4 2002 from 9.8% in Q1 (see
chart).
<IMG border=0
src=""> <IMG border=0
src="">
<IMG border=0
src=""> <IMG border=0
src="">
Moreover, a steep fall in the personal income to personal
outlays ratio indicates that the pool of real funding is under
pressure (see chart). Note that during the 1930's the fall in this ratio wasn't
as steep as now (see chart).
<IMG border=0
src=""> <IMG border=0
src="">
We suspect that there is a strong likelihood that if the economy
does not rebound soon, the Fed will lower interest rates further and will
intensify its monetary pumping. This, however, will only further prolong the
economic misery.
Frank Shostak is an adjunct scholar of the Mises Institute and a
frequent contributor to Mises.org. Send him <A
href=""><FONT color=#000080
size=2>MAIL and see his outstanding
Mises.org <A
href=""
target=_top>Daily Articles
Archive. Special thanks to Michael Ryan for his
comments, thanks Peter Stellios for assisting in collection of historical
data.
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