Fed, Banking Regulations, Capital Flow, Crisis, Part 8
1937 recession is a proof that money supply cannot be kept too loose, by lower interest rates, for too long. By 1937, the disastrous effects of very loose money supply for a long time became undeniable. Also, Fed, and government thought that their interventions have worked and depression is going away. That was not the case. Market had not been able to adjust due to interventions from Fed and government. Somehow, Fed got convinced to tighten the money supply, and government cut down the money pumping programs. Government also raised the taxes by imposing Undisritbuted profits tax. This tax coupled with tightened money supply turned out to be a disaster. By that time unemployment did go down a little bit. But, it was still very high.
As soon as these new interventions took effect, the unemployment jumped from 14.3% to 19% in 1938. Industrial output fell by 37% from 1937 peak to the 1934 level. What we see in this recession is that the hourly wages continue to rise which show that there was a scarcity of skilled labor. Unfortunately, on several occasions in our history, the education system has not been able to keep pace with industrial and technological advancements. Ultimately, rising unemployment start taking its toll, and consumer expenditures and industrial production declined, as well, making unemployment even worse.
The problem that a Keynesian does not understand is that the tax payers cannot finance recovery, forever. It was proven, again, in recent sovereign debt crisis in Europe. At some point debt servicing, money printing and inflation become intolerable, unavoidably. This is where the economies have to switch gears from money pumping to austerity. The government interventions do not allow economies to adjust, so, when suddenly gears are switched to austerity, the crisis starts showing its real face and gets even worse. Artificial recovery based on pumped up money supply from central banks and government programs mostly go to the sectors that are not even that competitive. Most of those cannot survive at their own.
So, when money supply is cut off or reduced, the artificially maintained structures start falling off, again. The resultant situation turns out even far worse than original crisis. At least before government intervention, there wasn’t as much debt and money did worth more. Now, there is much more debt that needs to be serviced with a money which is far more devalued due to printing out of thin air. One other reason, they have difficulty understanding this, is because one of the major goals of debt financing and money printing is to actually devalue money, intentionally.
Their logic is, since the debt was bought at higher valued money and now is paid back in a devalued money, makes it cheaper and easier to service. In actual net terms, government is now going to pay less in net payments. For example, if 1000 dollars’ worth one ounce of gold when debt was borrowed and it is now worth 1000 dollars per half ounce of gold than government is now paying what is half the worth of amount borrowed, since it is still going to pay 1000 dollars back, regardless of its value.
But, these idiots do not understand that this does lots of collateral damage. First of all, whoever still has to borrow whether it is government businesses or consumer, they have to borrow lot more because you need more money to buy same amount of capital. Second of all, since lenders realize that the value of money is falling rapidly, they start charging more interest, so borrowing becomes larger and more expensive. For example, if you needed 10,000 dollars before on a five percent interest rate, you may have to borrow now 20,000 on ten percent interest rate, now.
This increases the cost of your debt servicing, exponentially. If your monthly installment was 200 dollars before, now, it is going to at least 400 dollars, and it will take longer for you to pay off. So, you will be paying higher installments for a longer period of time. Now, earning a devalued money, at a higher cost and a longer indebtedness, reduces your ability to buy new products, services and supplies, hire more people, raise wages and invest in research and development. The result is suppressed demand for products and services, more unemployment, stagnant or reduced wages and less innovation and creativity to increase efficiency and improve everyone’s life.
Many businesses cannot cope with this increased cost of business, and go bankrupt. This reduces the competition, causes more unemployment and less demand for labor resulting into depressed wages. Monopolies increase and surviving big corporations can now charge whatever they want while providing lower quality products and services, including increasingly sucking customer service and tech support. So, you know now, why the market interventions from Fed and government have such a huge support from big corporations, banks and their lobbies? Why do they ‘donate’ billions of dollars to the campaigns of big government politicians?
In fact these donations are not donations. They are investments in their monopolies. This whole reality has even a far worse ending. But, who cares? At some point like European economies, it becomes impossible to borrow more. Investors realize that paybacks in seriously devalued money are not worth, anymore. So, they stop investing in currency, securities and bonds. When for years and decades, governments have been addicting economies to pumped up money supply, and the whole structure is dependent on extra money supply from government, whatever the cost may be, government and central banks’ inability to do that anymore, gets turned into a disaster.
Sooner we realize that markets work the best when they are allowed to work free of government and central banks’ interventions, better it is. Realizing it now is going to be far better than realizing when it hits us. The point where economies and sovereign debt becomes insolvent. All of us who run personal, family and business finances know that debt is serviceable only up to a certain limit. After that it becomes a disaster and results in defaults and bankruptcies.