Saturday, September 17, 2011
Econ 101: How Central Banks Wreck Economies Through Business Cycles
The free market is not responsible for the current economic crisis, because we do not really have a free market economy. In a true free market, government does not manipulate the price of goods and services, but rather allows those prices to be set by supply and demand.
The most important good in the market is money, which the government, through its private arm called the Federal reserve, maniuplates regularly. This, in turn, has a marked effect on all of the other goods and services that we use that money to purchase.
The price of money is the amount of interest that is charged to borrow it, so that price (the interest rate) should be set based on supply and demand of money.
In a truly free market economy, a banker who wished to have a greater supply of money to lend out would offer higher interest rates on savings accounts, so that more people would deposit money is his bank. When the bank has a lot of money to lend, it lowers interest rates on its loans so that more people will want to borrow the bank's money.
Under real free-market conditions, low interest rates indicate that people are saving a lot of money. But in an economy manipulated by a central bank, it doesn't often mean that. Rather, it usually means that the federal reserve has flooded the economy with extra currency (or allowed the banks to reduce their reserve requirements and offer new loans), giving people the mistaken idea that now is a good time to take out a loan on something that they cannot really afford.
An economy is healthy when companies that choose to borrow for expansion of their businesses do so because consumers have saved a lot of money. That is the way they can be more confident that consumers will have money in the future to purchase new products that business expansion will allow.
The Federal Reserve (or any other central bank) negatively affects the health of an economy by introducing additional currency into it. This gives banks the idea that they can loan more, so they reduce their interest rates to entice more people to take out loans. But because the money they have to lend is not by way of saving, consumers will not have the ability to purchase the new products that are provided as a result of business expansion.
Because of the manipulation (increase in the money supply) by the central bank (and the false signals that such manipulation sends to the economy), businesses expand and hire many new employees who are put to work making things that consumers either will not want or will not be able to afford. This is what is called the business cycle--the "boom" created by unwise expansion of the money supply by the central bank, followed by a "bust" when the mania of production during the boom cannot be satisfied by consumer demand.
Thus, not only is the central bank's manipulation of the money supply responsible for businesses making things that consumers will not purchase, it is also responsible for the increase in unemployment that always occurs during the "bust" phase of the business cycle.
Businesses would have been better off not expanding, but rather waiting for consumers to start saving more money. But this introduces yet another problem: because the interest rates were kept low by the central bank, consumers were discouraged from saving.
Central banks cause booms and busts. Central banks, ironically, have never solved the problems that they were ostensibly designed to fix. Rather, in every case where they have been tried, they have eventually enslaved the bulk of the population in poverty while lining the pockets of the rich.