Depression 2008 for Beginners: Counterfeiting and the Keynesian legacy
Understand the Federal Reserve and you understand our problems.
[QUOTE]A headline in last Wednesday's Pahrump Valley Times quotes Nye County Commissioner Midge Carver as wondering, "Why doesn't money grow on trees?" The meaning of Mrs. Carver's statement is easily understandable, and her statement was probably quite appropriate for the circumstance in which such words were uttered. But I would like to suggest that, metaphorically speaking, money does "grow on trees" in our flawed financial system, and the fact it does grow on trees is -- contrary to the wishes of Mrs. Carver -- a major destructive force rather than a blessing for the economy. Let us proceed with showing why this is the case.
In what follows I will suggest an overriding reason for the ailing economy we are currently experiencing is the pervasive influence of the perverse economic philosophy of John Maynard Keynes (pronounced "canes"). Public policies stemming from Keynesian economics are still having a huge negative impact on the economy even though his insights have been soundly refuted almost since the day he penned them. Time may separate us from bad theory, but popularity often overrides reason when politics rules. This is clearly the case with Keynesian theory. It is poor theory, but ever so popular in political circles.
Written in the 1930s, the work of Keynes is most often associated with Roosevelt's New Deal. But his theories also influenced such populist measures as Kennedy's deficit spending of the 1960s, Lyndon Johnson's Great Society spending programs of the 1970s, and very prominently the recent stimulus measures related to the current financial crisis. But Keynes did not properly understand economics, and especially the monetary policies branching from his misunderstandings, have led to serious economic destruction over the years.
In several recent articles written for the Ludwig von Mises Institute ([url]www.mises.org[/url]), Frank Shostak has used simple examples of a baker and a potato farmer to illustrate the impact of one aspect of the Keynesian philosophy on an economy. When a baker produces 12 loaves of bread in a week, and uses only two loaves to feed his family, he is engaging in what economists call "saving." This saved bread can be loaned to a potato farmer in exchange for potatoes which were similarly saved by the potato farmer. The potatoes and bread sustain the baker and the farmer, and their families, while they are engaged in the production process, thus making it possible for both the baker and the farmer to increase their future production of bread and potatoes, respectively. Thus we can clearly see that it is the act of saving -- consuming less than one produces -- that is the very key to increased production and real wealth creation.
Before going further with our explanation, please note the bread and potatoes in our example are "things" of real value in the eyes of people other than those who produced them. These "things" need not be tangible or physical, but their physical existence does make it easier for us to understand the process. It is important to note the actual production of these "things" has already taken place in order for the existence of real savings to actually come about. Something (saved bread) is being exchanged for something else (saved potatoes).
Now, in an actual society the baker would likely sell his 10 loaves for money that had been obtained from someone who similarly engaged in savings by producing more of something else than he needed. And then he would use the money to buy potatoes from the farmer who had "saved" potatoes in a similar way. But the existence and use of money does not change the essence of this wealth creation process at all, except in the sense that money facilitates the exchanges of the various goods involved. Please note that money is only a medium of exchange. The key to the wealth-creation process is still the act of saving, and not money as such. It is still the case that, essentially, something (bread) is being exchanged for something else (potatoes).
[B]Now let us suppose that an able printer is willing to print up a crisp picture of a dead president with some fancy artwork that passes for a $10 bill. When he passes this $10 bill to the baker in exchange for 10 loaves of bread, he is exchanging "nothing for something" in the economic sense. He is obviously, of course, a crook in the moral sense, but in the economic sense he is also guilty of a grievous sin of equal significance. The $10 in fake money is not the result of any production that has been "saved" in the economic sense, and resources are therefore being "misallocated" in society. In exchange for his fake $10, the counterfeiter gets the 10 loaves that would have gone to the potato farmer. Because the potato farmer is denied the bread that would have sustained his production of potatoes, such production is necessarily impaired.[/B]
The creation of money through Keynes-inspired factional-reserve banking on the part of the Federal Reserve (money that is "grown on trees," in the words of our own Midge Carver) produces the same damaging effect as that produced by the counterfeiter. The expansion of the money supply sets in motion the misallocation of resources from those who have earned them in the direction of those who have not earned them, thus creating a false prosperity bound to show up in things like housing bubbles, which must eventually come crashing down to reflect reality at some point.
Money's main legitimate purpose is to serve as a medium of exchange. When money represents the accumulated savings of real goods by real people, then it serves its purpose well. When money is counterfeited -- illegally by crooks or legally by government central banks -- it causes illegitimate booms which must turn into busts.
(Glen Tenney teaches economics and finance at Great Basin College in Pahrump. He can be reached at [email]firstname.lastname@example.org[/email].)