Is Active Monetary Intervention Necessary?

Friedman's "solution for reducing the prospect for active intervention as well as the margin of human error was to propose the establishment of monetary rules instead of monetary authorities," explains Vox Day the author of a new book Great Depression 2.0, who predicted the current crisis and warns it's going to get much worse before it gets better.” He "wrote the book in order to give people a means of understanding what created the present economic situation and why there is a severe dislocation between what they are experiencing in the daily lives and what the government and the financial media are telling them."


Monetary authority is a common term in finance and economics for the institute that controls the money supply of its currency, setting interest rates, and other parameters, which control the cost and availability of money, actually the central bank - the Fed.

Monetary rules or policy is the process by which the government actually the central bank – Fed - controls the supply of money, its quantity, and the rate of interest to promote growth and stability of the economy. It is the management of the total money supply either to decrease or increase the quantity of money in circulation, to combat unemployment in a recession by reducing interest rates or raising those in the event of inflation. Another tool is the fiscal policy that refers to government borrowing, spending and taxation.

Monetary policy involves changes in the base rate of interest to influence the growth of aggregate demand, the money supply and price inflation. Monetary policy works by changing the rate of growth of demand for money. Changes in short term interest rates affect the spending and savings behaviour of households and businesses and therefore feed through the circular flow of income and spending.

“Day argues that while Friedman parted from Keynes on fiscal policy, he reached the conclusion that monetary policy could be even more effective than Keynes had ever imagined."

Friedman's "solution for reducing the prospect for active intervention as well as the margin of human error was to propose the establishment of monetary rules instead of monetary authorities," Day explains.

To better understand how all this works out in practice and before making a conclusion about whether it is a good or bad solution, first a look in recent the past.

The last quarter century the economic model that was applied by the various governments created more mistakes than miracles. It encouraged people to spend, borrow, and speculate. And each time Mr. Market made a correction, the authorities came along with more money and easier credit. Businesses that should have gone bust years ago kept themselves alive with more and larger loans. Homeowners added more debt than they could carry. Speculators kept taking ever-bigger risks in a row. Total debt as a measure of the size of the bubble in the credit markets rose from only about 150% of GDP in the 70s and 80s, to 370% during 2000 -2008.

During the entire last half century leading Western economists imagined a world that actually couldn’t exist for one minute — where consuming wealth created conditions through monetary rules makes people wealthier, and where simply making more credit available can stimulate consumption. Each time the economy slowed down, the authorities induced people to buy more of what they didn’t need with more money they didn’t have. This produced “ economic growth. ”

However it was a fake growth. Every dollar of borrowed money would one day have to be paid back. Every step forward would have to be followed, eventually, by another one backwards.

"The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand, which must cease when the increase of money stops or slows down, together with the expectation of a continuing rise in prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate - or perhaps even only so long as it continues to accelerate at a given rate.

What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganization of all economic activity." Explained Friedrich Hayek (1899 – 1992).

The way it works is simple: an economy is geared to produce for real demand. Or it is misled by artificially low interest rates to produce for a level of demand that doesn't in reality exist. The falseness can go on for a very long time. But, eventually, some form of adjustment must take place - usually a recession restores order by reducing both production and consumption. If it goes on for too long, or to too great an extent, as it did in Germany in the late '20s, economic activity becomes disorganized, which actually started The Great Depression 1.0.

The stimulus is working, they said. The problem is not that anyone believes this, but just that everyone believes in it. It is deluded group thinking on a massive scale.

Markets are not mathematical, nor mechanical; they're moral. Their purpose is not to make people wealthy, but to make them wise. If they purely were mathematical, one would be able to anticipate price movements with computers and PhDs in math. Many have tried it, but so far as known none has ever really succeeded.
It's not a mechanical system either. When prices go down, there are no levers that can be pulled, or injectors that can be applied. It's not that simple.
Instead, markets are complex natural systems they can never really be controlled or predicted. Markets are always teaching or correcting something. Those are the moral lessons in the broadest sense.

The purpose of a bear market (after Aug. 2007) is to correct the errors of the preceding boom called bull market- (before Aug. 2007). Most prominent among those errors is to think that money can be made by speculation. When this idea is successful for a while, good sense is lost. People buy dotcoms with no business plan, and houses not to be lived in.
 
When people don’t want anymore be involved with those stuff, the market has changed and that can take a long while.

Recently was read, "... people of (all) nations around the world will discover that the solution will not be found in more government control over society, but through an increase in human liberty and freedom for the individual economic actor..."

And so it is, all the interventions from B&B and before them by Greenspan and Busch II, going back to Reagan have made matters worse. The Governments' duty is to protect their own people and keep their hands of the economy, which is regulated by the market. The moment intervention is applied a distortion is created and opportunities are created for the crooks to steal taxpayer's money, it becomes a Casino's where everyone tries his luck but in this event Wall Street executives play not with their own money but that of the taxpayer.

All these interventions are distorting the market and create either deflation or inflation, which both are bad for the market economy.

Temporarily seen neither inflation nor deflation is necessarily bad, because prices have to adjust. That’s how the market conveys its signals. When prices rise, it tells producers to get busy and increase output. When prices fall, it tells them to lay-off staff. At present situation prices fall, or they should fall. This is ‘good’ deflation. It just means that producers are becoming more efficient, as they should. There’s good inflation too – when prices rise due to increased real demand. When people earn more money, they can buy more things; prices rise.

But what nowadays is observed is bad, bad inflation, and bad deflation. It is the result of monetary mismanagement. And it is going to send all the wrong signals and inevitably make things worse. First, the deflation is bad because it is result of a massive de-leveraging – paying down debt accompanied by a write-down of debt and assets. This technically is called a depression, or a major recession, or a ‘great contraction.’ Call it what you like. It’s a deflation in which prices fall, which is no fun at all.

Afterwards, most likely bad inflation will start – caused by the central banks printing too much money. This is bad inflation because it is just an increase in the quantity of paper money, not an increase in real demand.

In general, the higher government’s debt and deficits go the harder it is to pay these down honestly. Eventually, the feds reach the point of no return they will be so deep in debt they can’t possibly work their way out. Then, another crisis follows, either in the form of default, or (hyper) inflation, or even both.

Conclusion any kind monetary intervention in a market economy is bad. Neither the ideas of Friedman or Keynes are good ones, but the approach from Friedrich Hayek expresses a thoughtful attitude towards monetary intervention. Interventions on a massive scale as happens at present are the worst enemy of the economy only temporarily intervention on a limited scale sometimes is helpful. But that’s for another essay.