Posted by
Andrews on Wednesday, October 08, 2008 8:41:37 PM
I knew it was coming, but I am still disappointed that the Fed decided to inflate the money supply to try to hold off facing this problem. Oh, granted, they said it was to "restore confidence in the markets", but the truth,
as I wrote over a week ago, the real reason is that these loans were effectively expansions of the money supply, and their failure represents
a deflationary force. As the Fed, in its blind
Keynesianism views
any deflation as a bad thing, they are loathe to allow it to pass without a matching inflation.
Of course, the best response would be to end our fiat currency and return to a non-managed commodity standard, maybe gold. (Even better, establish no standard, and allow individuals to determine their own medium of exchange, defining currency only for government debts, but that is even more far fetched.) Since we aren't going to do that anytime soon, as everyone seems convinced the gold standard is "unstable" (as compared to the rousing success our managed fiat currency is proving to be, I suppose), the best of the bad choices is to let the deflation take place.
Whether we have a fiat or commodity currency, unchecked inflation of the money supply has one, and only one, logical outcome, an eventual deflation. A very modest inflation can keep pace with economic growth, and thus not cause a deflation, but we have never seen a state which accepted the modest pace of inflation consistent with that pattern. As the government always wants to play games with the interest rates, as well as to monetize debt, inflation inevitably runs ahead of growth, leading to an inevitable deflationary crisis. The only question is whether we allow the deflation, or pile on yet more inflation to defer it.
If we allow deflation, it will slow the economy, cause some problems, and the current politicians will get the blame. So, as a result, politicians always choose to inflate, either believing that this time there will not be a deflation, or else hoping the crash won't come until they are out of office. That is why we so rarely have a gentle deflationary slowdown and inevitably have market crashes and recessions.
And obviously this time will be no exception. The Fed is showing every sign of joining with the Congress in turning a minor deflation into a full fledged crisis a year or two down the road. And that sad part is, it is completely avoidable. But for the lack of political backbone, and a total lack of economic understanding among the public and their elected officials, we could have suffered a minor slowdown, instead we have sown the seeds of a major catastrophe.
POSTSCRIPT
Should anyone think I am underestimating the current crisis, think about the S&L bailout, which was larger, or the economic losses after 9/11. Neither of those destroyed our economy. Nor will this crisis. What we are seeing is the outcome of a media driven panic more than the real results of a some bad loans. This did not need to be even as big as it is, and certainly doesn't need to grow any larger. Stripped of media panic and government hyperbole, this is a relatively small problem. However, as I said above, the Fed and Congress seem determined to make it a larger one, and the press is doing all it can to fulfill that ambition.