On June 12, 2013, Bob Adelmann writes on TheNewAmerican.com site:
Two analogies are often used to describe the actions of the Federal Reserve in the United States as well as other central banks around the world: the punch bowl, and the drug addict. Each is helpful in explaining the addictive nature of easy money (or alcohol or drugs) and the inevitable withdrawal that takes place when the stimulus is removed.
According to Austrian school business cycle theory these declines in markets are the inevitable consequences of an expanding money supply, sold as the answer to fighting a recession. Low interest rates, Keynesians believe, help to stimulate borrowing and investment which works to reverse the economic downtrend and get things moving again. There are numerous flaws in this theory, including not knowing just how much new money needs to be printed, or when to stop. The problem is simple: Central bankers don’t know the answer to either question and as a result are unprepared for the consequences, or even to recognize them while they are occurring.
My colleague at the Center for Economic and Social Justice (www.cesj.org) Michael D. Greaney comments:
The main problem here is that the people in charge of the world’s central banks have no idea what a central bank is supposed to do. Their guiding assumption is that central banks were invented to finance government. They also believe (erroneously) that “money is peculiarly a creation of the State” (Keynes, Treatise on Money).
That being the case (which is demonstrably not the case), the money supply (which they believe is limited to coin, banknotes, demand deposits, and some time deposits) necessarily consists of bills of credit emitted by the State and used directly as money (e.g., the U.S. “Greenbacks”), or accepted by the central bank and used to back central bank promissory notes, which are in turn used to back new demand deposits or banknotes, i.e., “print money.” The result is an unstable, debt-backed currency.
What has been happening on the world’s stock markets is that massive quantities of money are being created by the world’s central banks to “stimulate growth.” All of this money is backed only by government debt. Very little of it is going to new capital formation, however. In an economic downturn, banks are reluctant to lend for that purpose.
The demand for new capital is derived from consumer demand — but the demand (“stimulus”) that is being pumped into the global economy in massive quantities is not going to consumers, but to financial institutions. Seeing little or no return in lending the money for new capital formation, the banks “prudently” put the money into the secondary market where they see good returns from speculating in shares, making money by going both long and short.
This, naturally, drives up the prices of shares, creating a bubble in the stock market — just as was seen in the Mississippi and South Sea Bubbles in the early 18th century, the Panic of 1825, and the Crash of 1929, among others. In the meantime, the productive capacity continues to decay, and the production of marketable goods and services that provides the tax base that stands behind the government debt and the profits that support the prices of shares declines relative to the amount of money being poured into the economy. A crash is inevitable, because there is nothing behind either the rise in the price level on the secondary market, or the new money that is causing the rise in the price level — a double whammy.
This breaks so many rules of sound finance (much less binary economics) that it is hard to know where to begin. I’ll limit myself to three:
One, central banks were never intended to finance government. They were invented to be “banks for banks,” i.e., where a commercial or mercantile bank could always get “accommodation,” i.e., liquidity, on demand by discounting or rediscounting bills of exchange, and selling securities (mortgages and bills of exchange) on the “open market,” i.e., not directly with a member bank. Governments got into it because the Bank of England, the first true central bank, couldn’t get its charter unless it bribed King William with its gold reserves, which the government replaced with “government stock,” i.e., debt.
Two, an iron rule of banking is that the reserve currency must absolutely be asset-backed. For centuries this was done by making the paper banknote currency convertible into gold or silver on demand. The Federal Reserve took this one step further, following the example of the Reichsbank, in the late 19th and early 20th centuries the soundest financial institution in the world. The Federal Reserve was established, in part, to retire the national debt, and phase out the debt-backed National Bank Notes of 1863-1913 and the Treasury Notes of 1890 (and, presumably, eventually the United States Notes of 1862-1971, the “Greenbacks”), and replace them with government debt-backed Federal Reserve Bank Notes, which would, in turn, be replaced with private sector asset-backed indistinguishable Federal Reserve Notes as the national debt was paid down.
If properly used, the Federal Reserve would have established an elastic, uniform, stable and asset-backed paper reserve currency — an incredible advance over reliance on the inelastic, albeit uniform, stable and asset-backed gold reserve currency, and, of course, eons beyond any debt-backed reserve currency, unstable by its very nature. This would in part free economic growth from the slavery of past savings. Leaving the fractional reserve requirement in place, however, still limited commercial bank lending to a multiple of the bank’s reserves, necessarily in the form of past savings.
Three, central banks should not be dealing in government securities of any kind, except as an expedient in an emergency (and even that is questionable), or as a way of retiring government debt as backing for a currency and replacing it with private sector hard assets. This latter is the only original reason the Federal Reserve was permitted to deal in secondary government securities. To prevent the Federal Reserve from being used to monetize government deficits, it was not given the power to deal in primary government securities.
Ironically, the federal government has no power to emit the massive quantities of bills of credit it has been emitting since 1862 (Article I, Section 8 of the Constitution), while the states are specifically prohibited from doing so (Article I, Section 10) — the magic words “and emit bills of credit” were deleted from the first draft of the Constitution. “Emit bills of credit” is the constitutional term meaning “create money.”
