We are now into our sixth
year of a recession that the Federal Reserve had promised to deliver us from
five years ago. Japan, with its own version of a central bank, is now well into
its second decade of what was once call its “lost decade.” Before the second
world war broke out, America was in its tenth year of a depression that the
Federal Reserve bank could not deliver us from. Why does the Federal Reserve
always fail to save us from the economic catastrophes that it promises to have
solutions to?
The answer is simply that
recessions are caused by inflation (which generally precedes the actual
recession) and the Federal Reserve attempts to cure them with more inflation
(what Ben Bernanke calls “Quantitative Easing“). The additional inflation
precedes the next phases of the continuing recession. The remedial inflation
only postpones the correction that is needed to cure the recession.
To understand why inflation
causes (and prolongs) economic mayhem we need to use a simple thought
experiment. Imagine a small economy where the people only consume bread and
wine. The bread takes only a year to produce from planted wheat seeds, while
the wine, properly aged, takes five years to produce. The important point being
that the wine is more time extensive than the bread. The cost of the additional
time to produce the wine is expressed economically by our term “interest.” The
higher the rate of interest, the more expensive the wine is to produce compared
to the bread. Interest is the charge that a member of the economy demands for
the sacrifice of postponing consumption for four additional years to have wine.
Left to the market, the rate
of interest is determined by the negotiations that occur between those people
who save (that is, postpone consumption) and those people who must borrow to
produce the wine. This market rate of interest determines exactly the amount of
capital that is needed to produced the wine that the people of the economy are
really willing to wait for.
However, when borrowers have
an outside source of money, such as Bernanke’s inflation, the rate of interest
becomes cheaper by the simple rule of surplus supply. This has the effect of
making the wine cheaper than the people of the economy are willing to postpone
their consumption for. Wine production is more profitable, causing farmers to
convert wheat (bread) land into vinyards. Wine becomes cheaper, but at the cost
of bread becoming shorter in supply and therefore more expensive. The immediate
effect is that more postponing of consumption occurs and the people’s standard
of living is reduced. This, however, is not yet a recession because all the
land is used and there is still full employment. The land and laborers are just
not being used optimally, making the people poorer.
The recession occurs,
however, when the injection of Bernanke’s inflation is over, The supply and
demand for borrowed money returns to the market rate, the rate that is higher
than the artificially low rate caused by the surplus of Bernanke’s money. Now,
wine becomes more expensive to produce and there is more of it because good
wheat land was converted to wine production. Vinyards will lose money and go
out of business; they will dismiss workers; and the land and human resources of
the economy will go unused. There will be a recession as land and people go
through a correction process and return to bread production.
Left to itself, the use of
the economy’s resources will correct and the recession will be over and the
people will regain their standard of living. However, the recession will never
end if Bernanke prevents the return to bread by announcing another round of
inflation. Another round of “quantitative easing” will inject new money into
the economy, keep the interest rate low, and keep the people poor by producing
more wine and less bread than they really want.
Bernanke’s subsidization of
wine causes even more land to be moved from wheat production to wine making,
meaning that when this next dose of inflation is used up, the correcting
recession will be even deeper and more catastrophic. The rate of interest will
go back up to its market rate and wine will become even more expensive to
produce. A greater dislocation of resources towards wine means a greater
correction is needed when the inflation ends.
That is when Bernanke will
announce yet another round of “quantitative easing,” so we can have even more
of what we don’t want.
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