The FED vs The Economy

We have been hearing for several years now that Inflation is too low. The implied problem is that, if we want to stimulate our Economy to produce more jobs, Inflation is the way to do it.

And, God forbid, we should slow Inflation down so much that… Gasp!… prices actually fall. Deflation would be too much for the US Economy to recover from.

Nonsense! Rising prices DO NOT stimulate the Economy. Quite the opposite – tinkering

with the money supply to cause prices to rise differently (either up or down) from what the Free Market would provide naturally on its own, actually slows the Economy.

Since 1971, when Richard Nixon removed all restraint on money supply by closing the Gold Window, the US Economy, as demonstrated by the level of Non-Farm Payrolls, has NOT followed the path of the CPI. Since 2000, as the US has moved more and more away from a Free Market Economy, the Economy and Employment have stagnated.

Chart courtesy of http://www.Macrotrends.net

The essence of Capitalism is that humans act, causing prices (of goods, labor, and money) to go up or down. Humans use these ups and downs as signals of what the best next action is.

Imperfect? Of course. But, it beats every other system hands down.

If the price of a product goes up, allowing for greater profit, more resources will move to capture that profit, and more of the product will be produced. If wages in an industry are too low compared to the profit potential, the wages will rise to attract more employees, so that more profits can be captured. If the expected return on investment in one area of the Economy goes down (think oil price plunge), then projects will be canceled, and the capital will move to greener pastures.

This is neither good nor bad – it’s just the most efficient way for people and money to be deployed to give the highest standard of living possible. When some Keynesian/socialist economist interferes with the price signals in the Economy, it makes Americans poorer.

So, why would they interfere?

Alas, humans are imperfect beings. When they are in positions of power, many will choose to use that power for their individual benefit, regardless of what the effect is on society as a whole.

In the Free Market, the exercise of this power is held in check by the effect of their actions on the actor’s well-being. A business owner who doubles prices or lowers wages in order to gain greater profit soon will find he has lowered his profit because he loses customers or workers.

However, in politics, “profits” are made by bestowing favors. Increasing Inflation helps some groups, and that’s worth a political (or other) contribution.

Without Inflation, the price of the money (interest rate) which banks use to lend out would be higher. Lower rates means bigger profits in the financial industry. Banks and stock brokerages generally favor increasing the money supply, which by the way causes prices to rise (too bad for everyone else).

Without Inflation, wages could rise only as much as the Economy’s natural growth could support. This averaged 3-4% during the whole 19th Century, so that’s highly beneficial to “Labor.” However, only 3-4% a year wage growth is not enough to support a labor union. With an additional 3-4% Inflation (the late 20th Century rate), that’s 6-8% wage raises possible, and that’s plenty to support unions. Unions support inflationary government policies.

Without Inflation, politicians would have to spend much more on the interest on the National Debt – which they cause. By keeping interests artificially low (think Zero Interest Rate Policy for 7 years now), politicians can make believe that their Deficit Spending is almost free. They can dispense vote buying favors, and too bad for all who have to suffer the consequences.

During the 19th Century, the US money was Gold and Silver, which increased as the Precious Metals were mined. This increased the money supply naturally at roughly the same rate as the Economy grew. The result was that the general price level within the US Economy was mostly flat for the entire 100 year period. A Dollar in 1900 had the same value as a Dollar had in 1800!

Contrast that to the most recent 100 years, since the US Federal Reserve (FED) was created. The Dollar today can buy barely more than a Penny could buy 100 years ago.

Yes, US productivity still grew during that time, but at the much reduced rate of about 2% a year. The price signals in the Economy are muddied by the continuous debasement of the Dollar by the printing press, money creation out of nothing, which the FED has done – for the benefit of the politicians, the financial institutions, the unions, and other favored groups, to the detriment of everybody else.

It’s time we ended the FED!

But, low or zero interest rates, and the expanded paper money available because of it, are like an addiction. Remove it cold turkey and there will be a lot of suffering as the Economy adjusts quickly to the real price signals.

Remove the heroin slowly, and the pain can be tolerated more easily, although the process of economic adjustment will take longer. It’s a Hobson’s Choice, but I prefer the gradual approach.

Action Item: Allow interest rates to reach Free Market levels gradually, over a period of a couple of years. Allow interest rates to rise according to the following schedule (1 basis point = 0.01%):

• Below 0.50% – allowed to rise 1 basis point, 1 day each week
• Below 1.00% – allowed to rise 1 basis point, 2 days each week
• Below 2.00% – allowed to rise 1 basis point, 3 days each week
• 2.00% & up – allowed to rise 1 basis point, 4 days each week
• Once interest rates do not rise for 1 month, all government activities designed to influence rates – up or down – will cease
• The 1913 Federal Reserve Act shall be declared Unconstitutional, and all valid functions of the FED shall be taken over by the US Treasury Department