17th in a series of Economics for Cavemen (and women)…
The U.S. economy is in a tough spot right now. Historically low rates of interest in the early part of the decade generated the biggest housing bubble in the history of the nation. We didn’t notice all of the inflation that was generated by these low interest rates because Chinese labor was essentially free and unlimited. We weren’t paying higher prices for manufactured goods. The fact that labor costs in the U.S. were going up and real estate prices were skyrocketing didn’t strike folks as “core inflation.”
Gasoline, real estate, airline tickets, college educations, hotel rooms, meals at decent restaurants. These things are vastly more expensive than they were just a few years ago. Fortunately, these aren’t major expenses for the average American, at least according to the Consumer Price Index, which seems to be set up with a basket of the following goods: DVD player, kitchen sink sponge, 5 lb. bag of potatoes, 2 lb. bag of carrots, made-in-China T-shirt. Inflation is low; it is only the cost of stuff that you might actually want to buy that has gone up.
We read in the newspaper accounts of the debates of learned economists. They disagree to some extent about how to keep the U.S. from sinking into a depression. What can they all agree on? The cure is to lower interest rates and print more money….
If one is to believe the CNBC monkeys, then we should have zero interest at the discount window. That, and like the Wiemar Republic, we will all be stuffing suitcases full of notes to buy a load of bread at the corner store.
Now we appear to be looking at stagflation, a term most economic students think applies only to ancient history (Carter administration), i.e., inflation and persistent recession.
I wish lower interest rates would have a dramatic effect on the working classes, but I fear not — they seldom own real estate, and it’s just hard right now to afford dairy, fuel and other essentials. Made-in-China has dramatically lowered the cost of soccer cleats for their kids, both in real and nominal terms (a $20 item in the 1990s now costs less than $10), and apparel generally, electronics, etc., but then the perceived market basket has expanded to include cell phones (painters I recently hired declined offers to use our land-line phone as they all had cell phones) and home computers with internet access if their children are to keep up in school.
I have talked to the cleaning women at the YMCA, to whom my girlfriends and I always give a supermarket gift certificate for Christmas, and it’s tough, tough, tough right now.
Phil, I think your underlying point is that economists tend to be off in their own dream world, ignoring obvious events that affect our lives. I agree. It is always worthwhile to be skeptical of economists and relate their abstractions to the larger universe of physics, hotels, and human experience.
Having said that, the argument for lowering interest rates is not 100% dreamy. What expands the money supply is actual borrowing. You deposit $10,000 in your bank. A company with a good credit rating and a good idea borrows $9000 of your money from the bank to expand their solar-cell factory or whatever. Your money is put to good use. That’s the ideal. Interest rates are the macroeconomic lever which determines how many good ideas get carried out.
As your late neighbor John Kenneth Galbraith pointed out, the reality is messier. Advertising, which on the surface is a waste of resources, serves to rev up consumer demand. Nowadays, apparently, advertising does not suffice and we also need scams, such as sub-prime lending, CMOs, and whatever in order to prime the economic pump. As the sub-prime scam is shut down, actual borrowing diminishes, shrinking the money supply and throwing carpenters out of work. Rates must be lowered to increase borrowing and compensate for the loss of an important borrowing-and-lending scam.
As you point out, we also have scams, such as lawsuits against carburetor factories, that shrink the Main Street economy, rather than stimulate it. Interest rates are adjusted according to the balance of inflationary and deflationary scams.
Jim W.
Austrian economists, followers of Ludwig von Mises, Hazlitt, Hayek, and Rothbard, disagree strongly with that proposed ‘solution.’
The adherents to this school of economics can articulate the formalized process through which monetary inflation by central banks leads to the extreme boom and bust cycles that we experience in our economy. Austrian economists, by introducing the elements of time and capital, which many other economists disregard, show us how monetary manipulation leads businesses and investors to miscalculate the markets and the desires of consumers, leading to malinvestment.
Austrians can also explain how the inflationary process leads to artificial winners and losers, as the first recipients of the newly printed money spend and invest it before it has lost its value.
Perhaps unsurprisingly then, Austrian economists are not often quoted in newspapers or interviewed on television. Because of this wonderful medium we call the internet, however, it isn’t difficult to learn more. The Mises Institute publishes a great many books, articles, and a fantastic daily newsletter, all freely downloadable, on their homepage at http://mises.org/.
Jim- “Interest rates are the macroeconomic lever which determines how many good ideas get carried out.”
yes, provided there are screening measures in place to ensure the loans are in fact made to good ideas. otherwise you get the situation we have now.
there seem to be some knowledgeable economic brains here- i would love to hear people’s take on this video I watched on youtube the other day that explains the money creation process and the notion of the fractional reserve-> http://www.scrollinondubs.com/2008/02/11/money-as-debt/
sean
Your observation is dead-on. Sometimes I think our entire economy is a giant Ponzi scheme that explodes every five or ten years, with the biggest victims being those who buy in too late and the biggest winners being those who get out early enough and with enough to start another Ponzi cycle all over again. Those who practice the old-fashioned “middle-class virtues” of saving, postponing gratification, paying in cash, being prudent in investments, saving for the kids’ college, paying in full for the kids’ college, planning for old age, etc., are finding that these virtues aren’t worth as much as they used to be.
Maybe I’m way off in left field here, but I think there are a few issues with the economy. Number one right now is oil prices, which are being manipulated by third rate dictators and capitalized on by opportunistic speculators. Congress could easily rectify this issue by opening up ANWR and the Gulf to drilling, enacting emergency legislation to remove roadblocks to new refineries and giving some tax incentives to get those refineries built. These acts alone would be enough to dampen the speculators and give the petty dictators some reason to reconsider their actions.
The second issue is the sub-prime scandal. Low interest rates have been around long before the current sub-prime issues. Widespread no doc loans, no credit check and to a lesser degree, two loan mortgages are a fairly recent (couple of years) development. The people who perpetrated this fraud should be in jail, not being bailed out with our tax money. This includes the loan originators, the loan bundlers, the loan recipient and the inspectors who allowed this to happen. Giving $300,000 loans to people with $30,000 incomes is criminal, bundling those loans into a bond and giving it a AAA rating is beyond criminal, these people should pay. Bailing these people and financial institutions out is wrong, they should take their medicine and if these rogue financial institutions go out of business, we are probably better off in the long run.
What really scares me about our current economy is the Fed. We are due an adjustment in the market and the shenanigans by low life lenders have accelerated and deepened the pain. The Fed has reacted too quickly and strongly for my liking, shooting most of their bullets trying to stop the inevitable turmoil caused by shady characters. Greenspan managed this tool so well that now politicians think it is the panacea for all problems and they can wait for the Fed to fix everything. I think more pain is coming, hopefully not to the point of a depression.
Bankers are some of the most risk adverse professionals you should ever have the displeasure of dealing with. When a banker breaks that mold, we should all be scared.
Your almost namesake, Alan Greenspan, had the best shot at preventing the mess that Greenspan made by taking away the punchbowl when the party was reving up back in 2003 or 04. No thank you he said, we can only clean up the mess after the party, not prevent all the guests from getting drunk and driving home.