Depression 1001

Few theories on the causes of depressions actually ascribe or work with the general theory of economics. To accept any of these theories is to suggest that proven basic economic concepts must be false. This would be the same as saying 12 is a prime number. To accept this notion as truth one would have to admit that the fundamental theorem of arithmetic is wrong. Knowing this we must throw out all theories that are not integrated with general economic theory. This does not mean that an answer for the cause of depressions does not exist. On the contrary, there is one theory that does incorporate this general theory and provides a valid explanation, not just for our recent recession, but also for the Great Depression and many other economic busts. This theory is known as the Business Cycle Theory[1] founded by the Austrian economist Ludwig von Mises.

To truly debunk the other theories, one only needs to think logically about what a depression is. A recession or depression is a phase that an economy undergoes to reallocate an immense amount of malinvestment. In other words, a majority of entrepreneurs made incorrect assessments of the desires of consumers and committed large amounts of money into these predictions. Keep in mind that this is how entrepreneurs make their entire livelihood, appeasing the desires of buyers. It is not out of the question for some of these predictions to be wrong. However, what makes a depression unique is the fact that an overwhelming majority of these businessmen have all made bad choices and have incurred large amounts of malinvestment. The question is what could have possibly misled over half of an economy’s brightest supply and demand minds? It would be a mistake to think that each was individually wrong for a magnitude of reasons. Logically there must have been some common item that deceived them all. The universal link between them all is the information that they use to determine the desires of their customers. The main tool at their disposal is the interest rate.

To many people, interest rates are simply an additional amount of money, determined by a set or adjusting percentage, which an individual pays on top of a loan or a mortgage that they have assumed. However, to businessmen, interest rates are a way to determine the desires of consumers, also known as consumer time preference.[2] In order to understand how this works, one must understand how loanable funds are collected by banks, the lending institutions, and how these establishments determine the interest rate that they charge. In a free market economy, banks receive money from their depositors, which are placed in checking and savings accounts. Once in their possession, the banks in turn take the money you give them and invest it to make a profit. This benefits multiple parties such as the bankers, corporations looking for funding, and individuals seeking money in the form of a home loan or for a multitude of other reasons. Banks can choose to invest your money into the bond market or stock market, providing capital to business. Another method, which is more commonly used, is for the banks to loan the money out and make more return of investment 0 in the form of interest. The banks determine the percentage of their interest rates in accordance with how much money the bank has to lend out. Just like any business the banks need to earn a certain amount of money off of each loan they offer in order to meet operational costs and still make a profit. So the more money the banks receive in deposits will in turn lower the rate at which they lend and vice versa the less they obtain the higher the rate will be for the customer. Another way to look at this is if interest rates are low, then Americans are saving their money and waiting to buy future goods. If rates are high then consumers/depositors are choosing to buy goods currently on the market, preferring immediate satisfaction. This is what consumer time preference essentially is.

In a free market economy, the interest rate is used to decide whether or not businesses should invest to meet current consumer demands or to undertake larger projects to meet the future demands that consumers are saving for. However, in America today, most people acknowledge the fact that consumer consumption has been at a high, yet at the same time, the interest rate has been at an all time historical low. This is not possible in a true free market economy. So, if this situation is naturally impossible, then what is its cause and what are its effects? One factor not discussed yet in this equation is the supply of money itself, which is regulated by the Federal Reserve. If the amount of money a bank has to lend determines the interest rate, then an issue of great importance is the total amount of money in an economy. Logically, the more money in circulation, the more likely it is that banks will have more to lend. This logic is part of an economic trend of thought known as Keynesianism[3], founded by the English economist John Maynard Keynes. The downside to this theory is the inflationary effects of a large money supply, which will lead to higher prices.

What does this all mean in application? The Federal Reserve, in an attempt to stimulate the economy, prints new money, which increases the money supply, which then in turn increases inflation and puts this new counterfeited money into circulation through banks by loaning it to them at a lower federal reserve rate. This provides banks with a much larger amount of money to lend out then the otherwise free market would have allowed. The big drawback to this, besides higher prices in the form of inflation, is how it distorts what the true consumer time preference really is. As discussed above, the interest rate divulges this information by showing whether or not people are spending money currently or waiting to spend it later. Conversely, if the government is printing new money and then gives it to the banks, which in effect lowers the rate of interest that they charge for loans, then the true consumer time preference cannot be known. This is what causes the extreme amount of malinvestment that result in the corrective depression phase. Businessmen are led to believe that consumers are saving money for later desires and purchases so that they invest money in long term projects. A great example of this is housing construction projects. More homes were constructed in the past decade then true consumer demand required because many believed there was a high demand for them due to the low interest rates. This is what led to the ultimate downfall in the housing market. The same can be said of the derivatives market and its effect on our current depression.

Depressions are not mythical anomalies that occur for unknown reasons, nor are they the cause of greedy capitalists. In fact, they are the result of government intrusion into the free market financial system in the form of the Federal Reserve System. An important historical fact to consider is the time line of American history after the Federal Reserve System was adopted in 1913. The immediate effect was a small depression before the boom of the roaring 20’s. Then in 1929, the nation found itself in the worst depression it had ever seen then and now. It is not a coincidence that this just happened only two decades after the system’s inception. By giving the Federal Reserve control over the financial system of the country it allowed government inflation to increase six times the amount it had previously been. This was caused by the Federal Reserve lowering the reserve requirements of national banks, which is the amount of money banks must keep on hand to cover their depositors, and by giving the banks the power to print money at their discretion. Again in the 1970’s, two decades after the end of the Great Depression the country was once again suffering from depression in the era of Stagflation. The country faced inflation rates of 11-13%, while also suffering from high interest rates as the Federal Reserve withdrew money from the system in an effort to combat the high inflation they had created in the 50’s and 60’s.[4] At the same time, the country suffered from a 9% unemployment rate for two years, which were sandwiched by several years of 7-8%.[5] Yet again in 2000, twenty years after the end of stagflation during the 1980’s, America suffered from another recession known as the Dot Com bust. The solution for this recession was more of what had caused it, an increase in the money supply that only delayed and worsened the unavoidable crash for another seven years. Of course, this is the current recession we now face.

There is only one way to avoid depressions of such great enormity; that is to prevent the malinvestment from ever happening and to allow free market principles to operate at their natural pace. There is no quick way to prosperity as Keynes tried to claim. Increasing credit through the form of money creation, only leads to higher prices for consumers and producers, malinvestment by corporations, and the destruction of the middle class and businesses as they are encouraged and forced into further debt. The true problem is the very nature of the fractional reserve banking system and their relationship with the Federal Reserve. For example, before the Federal Reserve was created in 1913, banks kept an average of 20% of deposits on hand to cover their clients. By 1917, that number had decreased to 10% and today banks with transaction below $55.2 million or less only have to hold no less the 3%.[6] That means that a bank that holds $55.2 million dollars in deposits only needs to have $1.65 million on hand to cover all their clients. This is not logical by any stretch of the imagination; and, furthermore is not sustainable in an unsound economy. This is a downward spiral that is not viable. These policies will only result in complete economic collapse if seen all the way through. The scary part about our current situation today is that the Federal government seems to be putting all their eggs in Keynes’ basket, but apparently they forgot that it is hard for a dead man to keep the basket from falling.

---

[1]Ludwig von Mises, Theory of Money and Credit, p.134

[2]Murray N. Rothbard, America’s Great Depression, p.

[3]John Maynard Keynes, The General Theory of Employment, Interest, and Money, p.165

[4] Bureau of Labor Statistics, ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.tx

[5] Bureau of Labor Statistics, http://www.bls.gov/web/empsit/cpseea1.pd

[6] Federal Reserve, http://www.federalreserve.gov/monetarypolicy/reservereq.htm

The Right or Just Wrong?

It is bad enough that our country’s lawmakers no longer have any regard for the rule of law and the American people. However, how are we to overcome this problem when some of the leading voices on the conservative side are ignorant to the actual issues. I bring this point up because of a segment of Rush Limbaugh’s radio show that I happened to tune in on the other day. I would first like to say that I agree with a good bit of what Mr. Limbaugh has to say. That being said, he also has a responsibility to make sure that the information he provides to his listeners is factually correct. This is where Mr. Limbaugh failed the other day.

In an effort to play party politics, something the Mr. Limbaugh is very accustomed to doing; he made a statement claiming that it was the Democrats who caused the current economic recession. One could make this claim, however it was in the details that Rush fell short. According to him the “Democrats tried to talk [the United States] into a recession in 2005. They tried to talk [the United States] into a recession in 2006. And in 2007 they talked us into a recession.” Mr. Limbaugh elaborated by asserting that it was their intention to do so. This makes no rational sense what so ever. Not that the Democratic party is above doing anything like it, but just the notion that any group of individuals can “talk” a recession into happening in the first place. This shows a clear ignorance by Mr. Limbaugh of not just economics in general, but of how the financial system in this country actually operates.

Our current recession was no more caused by the Democrats talking about it; then illness is caused by a surplus in blood and bile! No amount of talking causes the large quantity of malinvestment that is required to send an entire economic system into a depression, unless the people talking are the governors of the Federal Reserve Board discussing whether or not to increase the money supply. That is the true cause of the financial disaster that our country just faced and it is what Mr. Limbaugh should have said if he wished to address this issue. He had the opportunity to discuss how an increase in the money supply does this by distorting the information that entrepreneurs use to determine what the consumers’ time preference is, i.e. interest rates. He could have spoken abstractly about business cycles and their existence. Besides, even if he honestly believes in his statement it fails to explain the fact that it is not consumer goods that fail to sell, but is rather in sharp decline in the purchase of capital goods. Instead Mr. Limbaugh was too busy trying to take a cheap whack at the Democrats or was just too thick to realize that he should not speak of things that he has no knowledge of. Either way is just as bad.

Only a well informed populace will have the ability to reestablish the American Republic. If we the American people ever hope to take our government back from the political hack jobs in Washington then we need to hold the political talk show figure heads accountable. Their misinformation is just as bad as any terrible piece of legislation that our government can pass. They also drive away any intelligent citizens who are sitting on the fence trying to see which side actually has solutions to our countries problems. Conservatives must realize that men like Rush Limbaugh are not the leaders of their cause that they should desire. They only serve to isolate the conservative movement from mainstream America very much like what Keith Olbermann does to the progressive movement. So when you hear Rush Limbaugh makes these blatantly incorrect claims, write to him expressing your displeasure as I have done. Although next time I hear him say something so sickening I might just have to resort to bleeding!

Feeling Any Better Yet?

I never thought that I would find something moving enough to motivate me to write in this blog. Apparently all it took was the total abuse of the Federal government’s power and the shredding of our nation's Constitution. I hope this and more will drive me to keep this blog going if for no one else then for myself.

Never in my short life have I been more sickened to the stomach than I am now, after watching the passage of this unconstitutional garbage that they call a bill. Nowhere in the Constitution does it state that the Federal Government has the power to pass such legislation. Anyone that believes that I am incorrect has obviously never read the Federalist Papers which clearly defines the language used in the Constitution. The ability for the Federal government to regulate Commerce was never intended to be used in this manner. It was written into the Constitution to prevent the states from erecting trade barriers between one another, such as inter-state tariffs.

Even if you try to support H.R. 3590 through the Supreme Court decision of Gibbons v. Ogden, you will run into a problem. Health Insurance companies do not operate over state lines. This means that their businesses are not that of inter-state commerce. So how do you justify the passage of regulations, through the use of an inter-state commerce clause (Article I, Section 8 of the U.S. Constitution) on businesses that do not operate in an inter-state manner? The fact is that it is not possible in any sense of rational logical thought. But that is what seems to be missing from every branch of our Federal government these days, among many other aspiring traits.

One aspect of H.R. 3590 that few have discussed, but are of major importance to every young American is the amendment which affects student loans. The fact that a Health Care Reform has an amendment to it that even concerns the way student loans are handled is pathetic and baffling enough. Now consider the fact that this amendment is a complete overhaul of the student loan system. Everything from how these loans are handed out, how they are administered, and to amount of such loans. I was forced to stop writing for just a moment as I heard Barack Obama give his speech following the bill’s passage. Speaking of the house bill H.R. 3590, this bill “removed [items] from the Senate bill which should never have been there.” The timing of this statement is almost laughable and would be were it not for the reality and severity of what has happened here tonight.

In conclusion, what you of Congress have done here the night of March 21, 2010 is a disgrace not just to the history of our faltering country, but also to the rule of law and ultimately to the American people. If you wish to treat our Constitution as just a piece of tissue than I will do the same to this crap that you call a bill. I vow that I will not pay any new taxes for it and I challenge the Federal government to force every other American citizen who shares my opinion and me to pay. I warn you though that should you do so you will be forcing the hand of the American people who stand firmly against the oppressive use of illegal power and there will be a price to pay for you.

I also conclude with a challenge for the American people. If you wish to stop this oppressive Federal government from further abuse of its power then you must educate yourself so that you know how they are breaking the law in order to strip you of your right. Read your Constitution and follow up by reading the Federalist Papers and the Anti-Federalist papers which explain the laws of our country and why the Framers of the Constitution wrote the document the way they did.