When is the medicine worse than the cure?

At its most basic origin, money is an improvement upon the barter system. Prior to the establishment of a stable medium of exchange market participants would barter goods and services. This type of medieval system led to enormous problems and inefficiencies which common currency systems solved. Gold emerged as a viable medium of exchange because of its divisibility, store of value and portability. 

The Austrian school of economic growth place the emphasis on growth against savings and productions as opposed to spending and consumption. Any monetary policy that attempts to stimulate demand is viewed as counter-productive. Austrian economics grew in significance following the work of Karl Menger in 1871. Menger heavily criticised the miss-management of the Austrian economy and excessive spending. This economic philosophy believes that excessive government interventionism may lead to inevitable market excesses and the free market is required to step in occasionally [via a market correction] to re-centre the system. Unfortunately the social and economic collateral damage during these episodes is enormous. The Keynesian school of economic theory developed post-1929 crash arose as an antidote to the perceived failures of the capitalist free-market system to self-regulate itself in prevention of tragedy. “Austrians” draw philosophical comparisons between modern-day monetary policy and the latter part of the 1920’s. For different policy mandates the Federal Reserve suppressed interest rates which ultimately fuelled the speculative boom in asset prices. President Hoover used interventionist policies to protect businesses that perhaps should have been allowed to fail and prolonged the depression. Sound familiar? The home equity analogy is often used to describe the latency associated with excess leverage in the system. During periods of sharp asset price rises homeowners feel the “wealth effect” associated with the increasing value of their primary asset. Similarly, one could argue that continued market interventionist policy-making defers insolvency and actually increases indebtedness. This works out fine when the market makes higher highs in a nice linear fashion. Unfortunately market highs are temporary just like the equity in homeowner’s houses. The debt is permanent and like solvency is an unavoidable issue. It is a useful exercise to analyse what should occur in an economy from an interest-rate perspective if the personal and corporate debt profile increases rapidly. If you then take into account that savings rates are near historical lows, surely interest rates should be set at a level that acts as a disincentive to poor credit applicants. In fact the opposite is currently occurring with interest rates at zero as debt reaches historic levels. 

The System

Many have argued that the United States has transitioned from the world’s largest creditor to its largest debtor since the adoption of fiat currency and abandonment of the gold standard.

Interest rate policy

Monetary policy has consequences and not always on the positive spectrum. Many point to the artificial suppression of interest rates as the key catalyst to the hollowing out of the U.S middle class. In this type of system, savings are replaced by excessive borrowings and spending which fuels a consumption-based economy. Manufacturing jobs relocate to more competitive regions of the world. Protracted periods of low-interest rates result in market distortions and asset price bubbles. To maintain a consumption based economy, the Unites States relies on other “emerging” regions of the world to produce and supply these commodities. The inevitable consequence of this system leads to massive trade deficits most notably between the Unites States and China.

Why did the Gold standard matter?

When the US economy was aligned to the gold standard, financial discipline was ensured and government intervention was naturally limited to a degree. The transition to paper or fiat currency mean that the government could now print as much money as was required leading to increased interventionism. Much attention is focussed on the implications of too many dollars chasing too few goods and services leading to increased inflation pressures. However prior to 1971 and Nixon’s famous television address the price of goods and services actually decreased on a consistent basis, the cost of living decreased and people enjoyed a relatively higher standard of living

What is the Solution?

Some commentators [including Peter Schiff most notably] would argue that a healthy dose of deflation and creative destruction is required to level the playing field between the super-wealthy and the lower & middle-classes. A continuously suppressive interest rate policy maintains the status quo of burgeoning asset prices and widens the income inequality gap.

Can we let the government get out of the way?

In the purest form of free-market capitalism the market allocates capital and labour. A profit and pricing structural framework is required to facilitate this allocation and governments appear to have neither.


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