Fed, Banking Regulations, Capital Flow, Crisis, Part 14
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Governments and big businesses love wars because they provide governments an excuse to increase money supply through the war spending and lowered interest rates so that the loans and credit would be available for war efforts. It is very a very good situation for big government contractors, especially for defense contractors, as they get large contracts from government, of course funded by tax payers’ money. They can also get easy, low interest credit with lowered interest rates. With all this tax payers’ money going out, initially it looks likes that the war has been a blessing for nation. GDP increases, employment rates go up, wages and benefits are improved and it becomes easy for consumers and businesses to get credit and loans.
But, this apparent boom has serious costs and side effects attached to it. There is lot worse hidden behind the observable good. First of all, it causes inflation. Prices and cost of living goes up. Due to excessive government spending the sovereign debt level goes up, and with lot more money in circulation, the currency is devalued. This coupled with higher prices, causes even more inflation. The businesses and consumers accumulate more debt, and the levels of disposable income in both cases decline. While, in the beginning, most of that extra money is spent, the net capacity to spend, and overall spending declines, in long run.
So, after a while businesses and consumers have less money to spend, as most of it is going in debt payments. This decreased ability to spend ends the artificial boom created by war and bubble bursts. The bursting of these bubbles cause recessions and depressions, as economy which was over expanded by war, shrinks. Consumers and businesses, with lowered interest rates, acquire large amounts of debt in a very short period of time, but, it takes very long for them to pay-off these debts. So, even when economy starts recovering, the recovery phase is usually much slower and longer than the boom phase.
All this gets even worse when the war ends and the fiscal and monetary policies are tightened in the middle of serious inflation. Businesses, who were getting lots of money in government contracts, and credit and loans, suddenly stop getting those. Now, there is reduced demand for their products and services, as the biggest sponsor of that artificial boom, government, is now cutting back. This reduced demand brings down the prices which hurts the profits and revenues, even more. With decreased revenue and margins, businesses have to cut the spending. They have to cut production, close branches and reduce operations.
So, now they need fewer employees. Hence, the next step is lay-offs, increasing unemployment. They also have the reduced capacity to pay. Hence, they start cutting wages and benefits. Therefore, in addition to more unemployed people, the people who are still employed, are getting paid, less than before. Cuts in the benefits means they have to pay benefits out of pocket, now. This cuts down the net disposable income in the economy, even further, driving down the net demand. Reduction in net demand drives down the prices, even more.
Therefore, the economy goes into a spiral of reduced demand, reduced prices, decreased revenue and profits, increased unemployment, cuts in wages and benefits, less overall disposable income, until the prices and cost of doing business are down enough to make savings and investments feasible, again. From there the upward trend starts and economy starts recovering by renewed savings and investments, more research and development, new and improved products and services, increased demand and spending, increased revenues and profits, new hiring, rise in wages and benefits, more disposable income and recovered demand. We can see that an average Joe and small businesses lose a lot in these economic cycles, related to wars.
Only ones who are really benefited are government, now being bigger with more authority and regulations, big corporations and government contractors who got lots of easy credit and large contracts, and big banks which landed large some of tax payers’ money and now earning a lot in loan and credit payments, and interest. The recession of 1969-70 was a very good example of it. Increased government spending due to war and lowered interest rates due easier monetary policy by Federal Reserve, increased money supply and caused lots of inflation. The economy appeared to be booming as a result of war, in the beginning.
But, soon, the high inflation and reduced value of currency started hitting the consumers and small businesses, caused a recession. It lasted for about eleven months from December 1969 to September 1970. The economic slump actually started in 1966 and became really serious in 1968, resulting into recession in 1969. This also ended the second longest expansion in U.S. history. The longest one was in 1990s. None of these were highest, though. The events that ultimately resulted into recession were government’s attempts to close down the Vietnam War deficits (tightened fiscal policy) and Federal Reserve raising the interest rates (tightened monetary policy).
GDP fell by 0.6% and unemployment kept rising even after the recession ended and peaked at 6.1% in December 1970. Of course, government and Fed did not learn any lesson from it. But, it was very clear that the increased money supply through lose fiscal and monetary policies, cannot be kept in place for long periods of time. The resultant inflation and reduced value of currency ultimately starts showing its serious adverse effects forcing a pull back on those policies, making the situation even worse, and causing recession with rising unemployment rates. Unfortunately, our government cannot stop policing the world although we the people get messed up again and again due to reckless government interventions into the matters of sovereign countries.
The recent real estate boom was partially funded by increased money supply in the wake of Afghanistan and Iraq wars. It, too, caused serious inflation and currency devaluation, ultimately resulting into the worst financial crisis since great depression. Now, the government and its illicit child Federal Reserve are so scared to pull back policies regarding the recklessly high and easy supply of money which is making the situation even worse, every day. Sovereign debt is mounting. Inflation is on rise. Employment situation and wages are not improving, significantly.