The Federal Reserve's failure is not from human error or corruption, but rooted in its very nature. In fact, the Federal Reserve is constitutionally incapable of achieving its objectives. Far from a check on the boom-bust cycle and inflation, the Federal Reserve is the chief cause of each, along with an unholy host of other evils. Any expansion of credit - the only trick in a central bank's book - is, in essence, inflation, and initiates a business cycle which begins with a boom of false prosperity and concludes with a bust of great anguish. Since the creation of the Federal Reserve in 1913, it has, at the very least, caused and prolonged the Depression of 1920-1921, the Great Depression of 1929-1945, the Great Stagflation of the 1970s, the dot-com, tech, and housing bubbles and busts. In fact, the current "Great Recession" is simply the inevitable bust - albeit one which incessant government meddling has given an unnaturally long life - of the housing boom, a bubble which was not the outcome of corporate greed, deregulation, or tax cuts for the rich, but credit expansion from the Federal Reserve.
The latest example of credit expansion from the Federal Reserve is Chairman Ben Bernanke's four rounds of "quantitative easing." The term quantitative easing is an obfuscation of what is simply an inflationary policy of printing $85 billion per month until unemployment falls below an arbitrary figure, even though an artificial expansion of credit spawns the boom-bust cycles which cause unemployment in the first place. Factor in the upward trajectory of taxes, government expenditures, and regulations, and the prospects for unemployment going anywhere but up appear grim. In other words, "QE infinity and beyond!"
There is a silver lining to Bernanke's repeated bouts of quantitative easing, however, for it has starkly exposed the absurdity of central banking and challenged people to start asking questions. Whenever the Federal Reserve's money printing fails, it simply prints more. A popular definition of insanity is doing the same thing over and over and expecting a different result every time. By that standard, therefore, the Federal Reserve qualifies as insane. Perhaps the spectacle of four failed rounds of quantitative easing - with the promise of it lasting into perpetuity - will inspire a renaissance of the wisdom of Austrian economics and its magisterial theory of the boom-bust cycle, and, at long last, an overturning the tables of the money-changers in Washington D.C.
How an Economy Grows...
One of the great strengths of the Austrian school of economics is that it is completely systematic and rigorously logical. Beginning with self-evident, "a priori" truths (knowledge independent from experience, i.e. "A is A"), Austrian economics methodically builds upon a foundation of pure reason. The final result of this meticulous methodology is a glorious, majestic body of knowledge, all of which is ultimately derived from fundamental axioms, and thus completely consistent. Although Austrian economics is not dependent on "a posteriori" truths (knowledge dependent on experience) for validation, nevertheless, history has vindicated Austrian principles time after time. As Austrian economist Hans-Hermann Hoppe wrote in the introduction to Democracy: The God That Failed, "Theoretical propositions...can be illustrated by historical data, but historical data can neither establish nor refute them."
As expected, Austrian business-cycle theory is rigorously systematic, and consistently integrated into the whole of a larger school of thought. Unlike the business-cycle theory of John Maynard Keynes, which was a disembodied doctrine entirely divorced from any overall system, Austrian business-cycle theory is simply a logical extension of the basic principles of Austrian economics - in this case, the consequences of overriding the subjective valuations of consumers. In fact, years before Keynes concocted his reactionary, unsystematic theory, Ludwig von Mises and F.A. Hayek, two legendary Austrian economists of the 20th century, had been predicting the Great Depression throughout the 1920s, identifying an expansion of credit from central banks as its cause, and sound money such as full-reserve banking and a gold standard as its cure. From an Austrian perspective, catastrophic economic events like the Great Depression (which Keynesians consider sphinx-like in their inscrutability), are fairly easy to foresee and even easier to fix. Unfortunately, Mises' and Hayek's warnings that the "Roaring Twenties" were a period of false prosperity were ignored. Once the boom turned into a bust, their recommendations for recovery were even less popular than their previous predictions.
Austrian business-cycle theory originates with the concept of time preferences. Time preferences are the extent to which consumers prefer present satisfaction over future satisfaction. All else equal, present satisfactions are preferable to future satisfactions. Consumers balance their consumption over time according to their time preferences, consuming a proportion of their income in the present while deferring the remaining proportion to the future for future consumption (i.e. saving) as well. Since time preferences determine how consumers value present satisfaction over future satisfaction, time preferences, therefore, ultimately establish an economy's ratio of consumption to saving. The degree to which an individual values present consumption over future consumption determines the rate necessary to compensate him for foregoing the present use of his money - i.e. the rate of interest. Higher time preferences mean a higher-valued present, and thus a higher interest rate. A lower-valued present (and by implication, a higher-valued future) means a lower interest rate. Eugen Bohm-Bawerk, one of the elder Austrian economists, described interest rates as a "premium" on present consumption: a higher premium on present consumption yields a higher interest rate, and a lower premium on present consumption yields a lower interest rate. Everyone's individual time preferences, taken in total, establish what Mises termed the "originary rate of interest." Other factors, such as risk and inflation, complicate the picture, yielding an array of different interest rates, but time preferences determine the originary rate of interest upon which all these varying rates are based.
Another way of understanding how time preferences establish interest rates is grasping the role that time preferences play in determining savings. As described above, time preferences determine the degree to which consumers value the present over the future, and thus the degree to which consumers save and invest relative to their consumption. Those with higher time preferences value present consumption over future consumption, and therefore consume a greater proportion of their income than they save or invest. Those with lower time preferences, however, value present consumption over future consumption less, and therefore save and invest a greater proportion of their income for future consumption. Higher time preferences mean greater present consumption, lower savings, and higher interest rates, while lower time preferences mean greater saving/investment, lower present consumption, and lower interest rates. Since, as in any market, supply and demand determine the equilibrium price, then to the extent that time preferences determine the supply of savings, time preferences determine the rate of interest.
The production structure is best represented as a step pyramid, with each level representing a separate order of production. The base of the pyramid, the largest level of them all, represents consumption. Each successive level atop the base represents an additional order of production. Consumer goods are produced at the base, while capital goods are produced in the upper levels. Increased saving resulting from a fall in time preferences "lengthens" the production structure, simultaneously contracting the base and expanding the upper levels. If consumption ever increases, then the production structure will "shorten" to its original dimensions. In a free market, the dimensions of the production structure are zero-sum: a level cannot contract or expand without adding or subtracting resources from another level.
On a free market, falling interest rates are a signal from consumers to businesses that their time preferences have fallen and that savings have risen accordingly. Businesses take advantage of the falling interest rates by borrowing the newly available savings for "capital investments," such as the construction of a new factory or an upgrade to state-of-the-art equipment. Capital investments, centered in the "higher orders" of production most remote from consumers, yield greater future production, but are expensive and lengthy, and thus their financial viability is contingent upon interest rates. Because the fall in time preferences has led to a rise in savings, however, more time and money is now free for the financing of capital investments. The reduced interest rates render capital investments which were once unaffordable now profitable. Indeed, according to Mises, "A drop in the gross market rate of interest affects the entrepreneur's calculation concerning the chances of the profitability of projects considered," for "along with the prices of the material factors of production, wage rates, and the anticipated future prices of the products, interest rates are items that enter into the planning businessman's calculation." Previously, businesses who invested in building capital over producing consumer goods would have forfeited their share of the market and lost profits to their competitors. The fall in time preferences, however, not only encourages businesses to make capital investments, but also supplies them with the savings to sustain their investments. In the future, when consumers begin spending some of their savings, the completed capital investments ensure that future production will be capable of equaling - if not exceeding - future demand. Capital investments may be lengthy and expensive, but they boost productivity and output, which is what consumers are implicitly demanding when they exchange present consumption for greater future consumption.
As capital investment increases, demand for the goods and services - "capital goods" - used in the completion of such investments increases as well. Capital goods are of no particular value to consumers, except as intermediate goods used in the production of consumer goods. Businesses, spending their borrowed savings on capital goods like durable equipment, heavy machinery, raw materials, and construction, raise the prices of such capital goods. Holding all else equal, a savings-driven increase in demand for capital goods logically implies a decrease in consumption, and therefore a decrease in demand for consumer goods as well. Higher prices for capital goods are imputed to the originary factors of production - land and labor - in the form of higher rents and wages. Likewise, lower prices for consumer goods are imputed to the factors of production in the form of lower rents and wages. Following these inverse shifts in demand, factors of production currently employed in the declining consumer-goods industries take advantage of superior opportunities in capital-goods industries, shifting into the thriving production of capital goods. In short, in order to exchange present consumption for greater future consumption, economic resources are reallocated from the production of consumer goods to the production of capital goods. As Rothbard writes in Man, Economy & State, "An increase in saving resulting from a fall in time preferences leads to a fall in the interest rate and another stable equilibrium situation with a longer and narrower production structure."
Barring changes in time preferences, businesses will continue to rely upon a steady stream of savings to finance investments in capital goods and sustain the lengthened production structure. If time preferences rise, less savings will be available for the financing of capital investments. Businesses will then adjust to the change in consumer preferences, abandoning capital investments and resuming the production of consumer goods. Demand for capital goods having decreased, factors of production in the higher orders of production will be forced, at best, to accept lower wages and rents, but more likely will return altogether into lower orders of production, for the reason their job was created in the first place - lower time preferences - no longer exists.
To illustrate, suppose that savings rise as a result of a fall in time preferences. The increased supply of savings reduces interest rates, which makes capital investments more affordable. Since consumers are trading present consumption for greater future consumption - i.e. spending less today to spend more tomorrow - both time and money have been freed for capital investments. Taking advantage of this propitious signal from consumers, a German car manufacturer borrows the savings at the newly lowered interest rates in order to build a new plant in South Carolina. The construction of the plant increases demand for capital goods such as raw materials, equipment, and machinery, creating jobs and boosting wages in capital-goods industries. At the same time, since the construction is financed from savings, consumption has fallen, lowering employment and wages in consumer-goods industries. Resources like land and labor are diverted from their current occupation in the production of consumer goods into the production of capital goods. Because of capital investments from businesses like the German car manufacturer, men may abandon their current jobs to pursue more lucrative work in capital-goods industries like construction, mining, or the manufacturing of machinery. When the plant is completed, the German car manufacturer will be more productive, leading to lower prices from an increased supply, and satisfying the consumers' expectation of saving for greater future consumption. If time preferences ever rose, resulting in a shift in demand from capital goods to consumer goods, some of the resources currently employed in the production of capital goods would be forced to reallocate to employment elsewhere, the market for capital goods and consumer goods having contracted and expanded, respectively.
Falling time preferences are the key to economic progress, for they make possible the saving and investment which is the fountainhead of greater production, lower prices, and a heightened standard of living. Hoppe credits falling time preferences as the "process of civilization" by which civil societies become richer, healthier, more peaceful, and wiser.
...And Why It Crashes
Unfortunately, interference from the Federal Reserve disrupts the natural order of the market. On the free market, interest rates are a vital signal from consumers to businesses regarding the supply of savings in the economy and how savings should be allocated. When the Federal Reserve artificially lowers interest rates, however, businesses are deceived into thinking that the inflationary change in interest rates corresponds to a fall in time preferences and a rise in savings. In fact, no such change has occurred; credit has artificially expanded, but time preferences and savings have stayed the same. As a result, the investments that the businesses undertake in capital goods are doomed to fail, as they are predicated on savings which do not exist and will never materialize.
One of the Federal Reserve's two nominal goals is the promotion of full employment, which it attempts to achieve by expanding credit. The Federal Reserve can expand credit in two ways, both of which amount to the printing of money: expansionary open-market operations and reductions in reserve requirements. The former method, expansionary open-market operations, is when the Federal Reserve prints money to purchase Wall-Street bonds, in hopes that Wall Street, having borrowed for free from the Federal Reserve, will then lend its newly printed money to businesses for capital investment. The inflation in the money supply from the Federal Reserve's buying of bank bonds reduces interest rates, attracting new borrowers on the margin. The latter method of expanding credit, reductions in reserve requirements, is more straightforward than open-market operations. The Federal Reserve, in decreeing what fraction of deposits banks must hold in reserve, plays at regulating the fraudulent fractional-reserve banking system it perpetrates. If the Federal Reserve wishes to expand credit, it can simply reduce the reserve requirements of banks, increasing the amount of money they are legally permitted to print in the form of loans. In the fractional-reserve banking system which the Federal Reserve has foisted on the U.S., a reduction in reserve requirements means that banks will pyramid a larger amount of loans atop a dwindling base of reserves. Whichever way the Federal Reserve chooses to expand credit, inflation from printed money and artificially lowered interest rates from the inflated money supply will inevitably result in a boom-bust cycle of catastrophic proportions.
The Federal Reserve having expanded credit, the inflated money supply forces interest rates to fall. Businesses, who rely upon interest rates as a crucial signal of the level of time preferences and supply of savings, respond to artificially reduced interest rates as if time preferences had actually fallen and savings actually risen, borrowing at the lower rates to make capital investments in order to increase future production. Capital investments raise demand for capital goods, enticing factors of production away from the consumer-goods industries into more lucrative employment in the capital-goods industries.
Yet despite the muddled message businesses are receiving from manipulated interest rates, none of the economy's fundamentals justify the artificial reduction in interest rates. Time preferences have not changed, meaning consumers are still spending and saving in the same proportion they did prior to the Federal Reserve's expansion of credit. Unlike a genuine fall in time preferences, inflation, not rising savings, is behind the apparent demand for capital goods, as newly printed money from the Federal Reserve flows through the financial system to the capital-goods industries. Mises explains in his magnum opus, Human Action, that the "drop in interest rates falsifies the businessman's calculation," for "some projects appear profitable and realizable which a correct calculation, based on an interest rate not manipulated by credit expansion, would have shown as unrealizable." Therefore, the diversion of resources from consumer goods to capital goods is actually a systematic misallocation of resources, which, in restricting the level of present consumption demanded by consumers, not only lowers the overall standard of living, but also sets the economy on a crash course towards a bust. Businesses, in the belief that the reduction in interest rates implies a rise in savings, are tragically misled into making "malinvestments," capital investments which are based upon the expectation of savings which do not exist, and therefore are ultimately unsustainable.
Given the Federal Reserve's distortion of interest rates, the confusion of inflation with savings is entirely understandable. After all, interest rates, like any price, are a vital signal by which consumers communicate their preferences to producers. Prices, if left free, lead to the optimal allocation of scarce resources, "as if guided by an invisible hand," in the famous words of classical economist Adam Smith. Forcibly alter prices in any way, and chaos such as shortages or surpluses will inevitably ensue. Legislation from Congress cannot repeal the immutable laws of economics. Accordingly, when the Federal Reserves meddles with interest rates, the crucial information which consumers are trying to transmit to businesses is corrupted, overturning the natural equilibrium of the market, and leading to a wasteful and unstable misallocation of resources. Once the Federal Reserve prints money in order to artificially expand credit, the ensuing distortion of interest rates compromises its accuracy as a signal of the savings available for capital investment, twisting it into a counterfeit signal liable to lead trusting businesses from the straight and narrow into the jaws of roaring lions.
The difference between genuine economic progress from a fall in time preferences and a boom from a credit expansion is that in the former case the money supply is unchanged, while in the latter case the money supply inflates. Because the money supply stays the same, when time preferences fall, income and employment in consumer-goods industries shrinks, while income and employment in capital-goods industries grows. When credit is expanded, however, both consumer- and capital-goods industries grow, inflation having bloated income and employment in capital goods. Rothbard, in his magisterial Man, Economy & State, illustrates the difference in graphical terms:
“Increased saving on the free market leads to a stable equilibrium of production at a lower rate of interest. But not so with credit expansion: for the original factors now receive increased money income. In the free-market example, total money incomes remained the same. The increased expenditure on higher stages was offset by decreased expenditure in the lower stages. The ‘increased length’ of the production structure was compensated by the ‘reduced widith.’ But credit expansion pumps new money into the production structure: aggregate money incomes increase instead of remaining the same. The production structure has lengthened, but it has also remained as wide, without contraction of consumption expenditure.”The credit expansion having sown the seeds of a boom in the capital-goods industries, malinvestments, the fruit of the boom, begin cropping up across the economy. The malinvestments of the boom are unsustainable because they are based upon a mirage of savings which will eventually vanish. Indeed, following the credit expansion, as soon as consumers spend and save their money according to their time preferences, the gulf between what interest rates are signaling about the supply of savings versus what consumers are actually saving would be starkly revealed. Since businesses would quickly learn that consumers are not saving in sufficient proportion to finance their capital investments, they would abandon their malinvestments before they took root. Factors of production currently employed in the production of capital goods would be temporarily displaced, but given the undiminished demand for consumer goods, would gradually find employment elsewhere. To counteract the reestablishment of time preferences and perpetuate the boom, however, the Federal Reserve must make its credit expansion a continuous, escalating process, in which ever-increasing sums of money are printed to force interest rates to ever-lower depths. Indeed, according to Mises, "The boom can only last as long as the credit expansion progresses at an ever-accelerated pace."
The boom cannot go on for all eternity. Since credit expansion is simply inflation in the form of lending, each loan of newly printed money depreciates the purchasing power of the currency. Once credit expansion is underway, calamity is inevitable, and the only question is whether the boom will end in a collapse of the currency (resulting from Weimar-style hyperinflation) or a crash in capital goods (resulting from credit contraction). The boom, according to Mises "could not last forever, even if inflation and credit expansion were to go on endlessly," for "it would lead to...the breakdown of the whole monetary system." A currency collapse having been the downfall of many a mightier empire than the U.S. government, the Federal Reserve always opts for the lesser evil of ceasing inflation by contracting credit, despite the certainty of a crash in capital goods. To contract credit, the Federal Reserve must deflate the money supply, and so reverts to a painful policy of selling bank bonds rather than buying them. The ensuing deflation leaves banks with less money to lend, leading to a rise in interest rates which contracts credit. Credit having contracted, the inflation masquerading as savings vanishes, revealing that the boom was a merely an illusion conjured up by monetary magic, or in the apt words of Mises, an "airy castle." Businesses, however, have grown dependent on borrowing to sustain their capital investments, so the credit contraction triggers a precipitous plunge in the demand for capital goods. Once the newly printed money which was confused with savings evaporates from financial markets, businesses learn the hard way that consumers were spending more and saving less than they expected. In particular, consumers were not saving in sufficient proportion to sustain capital investments of the boom. Although some underlying demand for capital goods still stems from savings, what little savings remain are far beneath what the artificially low interest rates led businesses to believe existed, and are incapable of supporting the massive malinvestments of the boom. "As soon as credit expansion stops," writes Rothbard, in his classic essay, Economic Depressions: Their Cause and Cure, "then the piper must be paid."
Instead of factors of production transitioning smoothly into other occupations, as is the case during a natural change in time preferences, the sudden and severe crash in capital goods leads to overnight widespread unemployment. Businesses, doing the best they could with the twisted signals they were given, believed they were building upon a solid rock, but had actually laid a foundation upon sinking sand. Inflation from the Federal Reserve, disguised as genuine savings, tricked businesses into making capital investments which seemed sound and sustainable at the time, but were, in the end, unsound and unsustainable. Mises uses the construction of a house as a metaphor to describe the boom-bust cycle:
"The whole entrepreneurial class is, as it were, in the position of a master-builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master-builder’s fault was…an inappropriate employment of the means at his disposal."Rothbard, in a succinct eulogy of the boom, concludes that, "Businesses...seduced by the governmental tampering and artificial lowering of the rate of interest...acted as if more savings were available to invest than were really there," and accordingly "overinvested in capital goods and underinvested in consumer goods."
Unfortunately, malinvestments have already taken root in the capital-goods industries. Factors of production, responding to inflated wages and rents in the capital-goods industries, have hitched their wagon to a falling star. Because credit has contracted, businesses can no longer borrow newly printed money from the Federal Reserve to finance their capital investments, leading to a steep drop in demand for capital goods. Without sufficient demand, businesses must begin the painful process of liquidating their malinvestments. Income and employment in the capital-goods industries will be reduced. Labor will be unemployed, land will be vacant, and the wages and rents of both will be beneath what they earned during the boom. Rothbard, in Man, Economy & State, paints a bleak portrait of the economy in the wake of a crash in capital goods:
“The depression is the...stage during which malinvested businesses become bankrupt, and original factors must shift back to the lower stages of production. The liquidation of unsound businesses, the ‘idle capacity’ of the malinvested plant, and the ‘frictional’ unemployment of original factors that must suddenly and en masse shift to lower stages of production – these are the chief hallmarks of the depression stage.”Known as the "bust" or "depression," this painful period of the business cycle is when, according to Rothbard, "the inevitable readjustments liquidate the unsound overinvestments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production." In other words, the bust is when the mistakes of the boom are corrected. In fact, the bust is essentially the reemergence of the time preferences which were buried beneath the mountains of money the Federal Reserve lavishly heaped upon the economy. The factors of production are reallocating from the production of capital goods for which there is no longer - and was never - a market into the production of consumer goods for which a neglected market has been rediscovered. As old jobs in the capital-goods industries become obsolete, new opportunities in the previously neglected consumer-goods industries will emerge. Rothbard concludes that, "the depression phase is actually the recovery phase," in which the distortions of the boom are purged and the economy begins to rise again, harder and stronger:
“The depression period...is the necessary recovery period; it is the time when bad investments are liquidated and mistaken entrepreneurs leave the market – the time when ‘consumer sovereignty’ and the free market reassert themselves and establish once again an economy that benefits every participant to the maximum degree. The depression period ends when the free-market equilibrium has been restored and expansionary distortion eliminated.”Once the bust occurs, optimal government policy would be total laissez-faire, i.e. the government does absolutely nothing. For the economy to recover, resources must be free to reallocate into the production of goods in accordance with consumer preferences. The unemployment of the bust will quickly vanish as the factors of production, responding to readjusting prices, reallocate from the higher orders of production to the lower, finding employment in new occupations geared towards satisfying consumer preferences. So long as the government abstains from intervening in the economy, busts will be steep but swift.
Sadly, it is not in the government's nature to do nothing, for the government always lusts for more money and power, and will always invent some pretext to do something. Waging an eternal war on the boom-bust cycle is the perfect pretext for the government to expand its usurpation of life, liberty, and property, for so long as central banks exist, booms and busts will never disappear. Thus, in a lame attempt to overcome the depressions it creates, the government expands credit, props up prices, and taxes and spends more money, usually all three at once. As expected, this unholy trinity of government intervention makes everything far worse, prolonging the bust and hindering a recovery.
First and foremost, the government must resist falling prey to the temptation of inflating its way out of a bust. Even if reinflating the bubble provides a temporary stimulus, it resolves none of the fundamental issues plaguing the economy, and merely delays and deepens the inevitable day of reckoning. Another round of credit expansion will spawn more malinvestments that must eventually be liquidated and debase the purchasing power of the currency. Like an addict clamoring for one more indulgence, credit expansion may feel good in the moment, but only makes the inevitable detoxification worse. Since it was an expansion of credit which crashed the economy in the first place, the folly of resorting to the same measure should be evident, but the government is not above cheap tricks to exculpate itself from responsibility for its failures, if only until after the next election.
Second, without prices free to readjust as an expression of consumer preferences, the natural recovery of the economy will be subverted. Government meddling with prices can take several forms, ranging from imposing a minimum wage to bailing out bankrupt businesses. A minimum wage, by restricting the levels to which the price of labor may fall, keeps a few employed at artificially an artificially high wage rate, but keeps many more unemployed. A minimum wage, therefore, creates systemic unemployment, the effect of which is amplified during a bust, when the number of unemployed willing and able to work at wage rates that the government has forbidden is greater than ever. Attempts to "prop up wage rates or prices of producers' goods," according to Rothbard, "will prolong and delay indefinitely the completion of the depression-adjustment process," causing "indefinite and prolonged depression and mass-unemployment in the vital capital-goods industries." A minimum wage is not the only way that the government meddles with prices, however. Bailouts overturn the vital signals of profit and loss, without which a free market cannot function. Profits are a signal to businesses from consumers that they are producing something which consumers demand, as well as a call for greater supply. To increase supply, businesses invest in expanding production, bidding away resources from other less profitable businesses. Losses, by contrast, signal to businesses that they are no longer producing something which consumers demand, and that resources could be better-utilized elsewhere. Accordingly, businesses respond to losses by cutting costs (freeing up resources), and attempting to improve or redevelop their products (trying to more efficiently utilize their remaining resources). Bailouts, however, disrupt the free market's circle of life, diverting resources to failing businesses for the sake of saving jobs as if they were an end in themselves, not a means to producing what consumers demand. The signals of profit and loss thus perverted, the strong are punished while the weak are rewarded. Scarce resources will remain wasted in jobs which consumers have signaled no longer produce anything of value, and businesses which actually satisfy their consumers will be unable to expand production fully. So the vaunted Bush-Obama bipartisan bailout of Detroit, which "saved" the U.S. auto industry, was actually a colossal misallocation of resources, keeping land and labor employed in obsolete jobs in defiance of consumer preferences. Rothbard cautions against attempts to "prop up unsound business situations," stating that the government "must never bail out or lend money to business firms in trouble," for "doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease." In both cases, government intervention thwarts the valuable signals which falling prices send, preventing the reallocation of resources from malinvestments and into productive employment.
Last but not least, the government, in the words of Rothbard, "must do nothing to encourage consumption, and it must not increase its own expenditures." Aside from the obvious absurdity of confiscating property from taxpayers for redistribution to tax-beneficiaries will grow the economy (what Mises rightly ridiculed as "Santa Claus"), the logic of Keynesian economics - that consumption drives output, "under-consumption" causes depressions, and that stimulating consumption can counter the business cycle - is spurious, root and branch. In fact, it is "over-consumption," not under-consumption, which causes the bust in the first place, as businesses, acting on information which indicated that consumers would spend less and save more than they actually did, made investments in capital goods which proved ultimately unsound and unsustainable. As Rothbard keenly observes, "What the economy needs is not more consumption spending but more saving, in order to validate some of the excessive investments of the boom." Salvation can be found in saving, yet Keynesian fiscal policy sacrifices saving on the altar of consumption, thereby exacerbating the depth and duration of the bust. For at a time when savings are the only hope of redeeming misguided malinvestments, savings are seized to spend on stimulus.
In 1850, Claude Frederic Bastiat, a French classical liberal, wrote a brief but brilliant essay titled, "That Which is Seen, and That Which is Not Seen." Bastiat begins his essay with the profound insight that:
"In the economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause - it is seen. The others unfold in succession - they are not seen."Bastiat concludes that a bad economist merely "takes account of the visible effect" and thus "pursues a small present good, which will be followed by a great evil to come," but that a good economist is "one who takes account of both the effects which are seen and also of those which it is necessary to foresee," and thus "pursues a great good to come, at the risk of a small present evil." Bastiat then proceeds to refute all forms of economic intervention - including stimulus, known then as "public works" - on the basis of their evil unseen consequences. Indeed, the seen effects of stimulus are the multitude of supposed benefits from public works, but the unseen effects are the opportunity costs, the alternative possibilities which could have been achieved had all the money taxed and spent as stimulus remained in private sector. What is seen are "jobs created" from repairing pothole-ridden roads during rush hour, or "jobs saved" (to borrow a particularly preposterous piece of Obama's parlance) from bailing out broke state and local governments and their unions, but what goes unseen are the jobs that would have been created or saved if consumers were able to spend and save more of their money according to their own preferences. Furthermore, while the seen are jobs favored by politicians for whatever reason, the unseen are jobs stemming from consumer demand. The seen are jobs created at the expense of others for some politician's pork-barrel project, but the unseen are the jobs that would have been created for the production of a good/service mutually beneficial to the business and consumer alike. Factoring in the detrimental substitution effects of taxation, it becomes clear that when government endeavors to counteract the boom-bust cycle, it does more harm than good. Just as the Wizard in "The Wizard of Oz" urges Dorothy and her companions to "pay no attention to the man behind the curtain" as he attempts to dazzle them with sound and fury, so the government attempts to awe the people with the seen while keeping the unseen concealed. Indeed, revelation of the unseen deals a fatal blow to the entire concept of countercylical policy, and thus a source of tremendous money and power for the government.
The terminology of the two rival schools is shockingly revealing. Austrian economics prescribes a natural healing process in which the economy recovers as the factors of production reallocate to reflect the preferences of consumers, while Keynesian economics demands that "shocks," "jolts," "injections," and even "experiments" be forced upon the economy in order to "stimulate" it back to life. Austrian economics treats the economy like a recovering addict struggling through rehabilitation, while Keynesian economics treats it like Frankenstein's monster.
Rothbard concludes that any government intervention, however well-intended, is doomed to fail, and that a pure policy of laissez-faire is the only way for an economy to overcome a depression and resume its natural progress:
"Thus, what the government should do, according to the Misesian analysis of the depression, is absolutely nothing. It should, from the point of view of economic health and ending the depression as quickly as possible, maintain a strict hands-off, laissez-faire policy. Anything it does will delay and obstruct the adjustment process of the market; the less it does, the more rapidly will the market adjustment process do its work, and sound economic recovery ensue."Fame, Fortune & the Federal Reserve
Since Woodrow Wilson enacted the Federal Reserve into law in 1913, every president has circled the wagons around the Washington D.C.'s own counterfeiting cartel. Wilson, obeying the orders of the Rockefeller puppet-masters of his presidency, was following the ignoble example of Dishonest Abe, who signed the National Banking Acts of 1863, 1864, and 1865 at the behest of his Treasury Secretary, Salmon Chase. All of these men, however, puppets and puppet-masters alike, were part of Alexander Hamilton's grand design. Hamilton, the American godfather of central banking, national debt, high taxes, and corporate welfare, schemed to unite the economic interests of the wealthy with the power of the federal government, in hopes that the wealthy would then develop an entrenched interest in consolidating federal power. As soon as American independence was won, Hamilton embarked upon a subversion of the Revolution, what his arch-nemesis Thomas Jefferson trenchantly labeled "the means by which the corrupt British system of government could be introduced to the United States." After orchestrating the overthrow of the classical-liberal Articles of Confederation, Hamilton, acting as George Washington's Treasury Secretary, under false pretenses of "establishing national credit," incurred an enormous national debt, levy exorbitant taxes, and found an unconstitutional central bank. A national debt would grant rich bondholders access to the spoils of the federal treasury, and a regime of high taxes would plunder taxpayers to repay the bondholders - stealing from the poor and giving to the rich. The most damning example of Hamilton's dishonor and greed was his formation of an insider trading ring among his political allies. Hamilton and his cronies, acting on privileged information, bought war bonds from patriots of the Revolutionary War at a steep discount, which they redeemed at face value once the federal government nationalized the states' wartime debts. Hamilton, a veteran who served under Washington himself, had ulterior motives in fighting for American independence: not for freedom from English tyranny, but for control of the very same tyranny reestablished on American shores. Far from a Founding Father like Jefferson or Madison, Hamilton's betrayal of the founding principles of the U.S. makes him more of a Founding Stepfather than anything else.
The First Bank of the United States would be Hamilton's crowning achievement. As with the national debt and taxation, Hamilton pretended to support the First Bank of the United States as a matter of public policy, but he harbored ulterior motives. Specifically, a central bank like the First Bank could provide cheap credit to Northern bankers and manufacturers - inflation be damned - further wedding the economic interests of the wealthy to the federal government, all part of Hamilton's plan to create a ruling class in the North. The South, which was predominantly classically liberal, agrarian, and reliant on free trade (unlike Hamilton's North, which was predominantly statist, industrial, and mercantilistic), refused to be enslaved in a Hamiltonian regime of central banking, high taxes, and corporate welfare. For generations, the South fought for its freedom in corridors of Washington D.C., the halls of state capitals, and, ultimately, on the battlefield. Today, Hamilton's corrupt union between the wealthy and the federal government - what Thomas DiLorenzo calls "Hamilton's curse" - is still plaguing politics, and has only worsened with age. As columnist George Will profoundly observed, "We honor Jefferson, but live in Hamilton's country." In particular, the supposed success stories of Mitt Romney and Barack Obama capture how Hamilton intended for central banks to corrupt politicians of any party.
Romney, the Republican presidential candidate attempting to weasel out of his statist past and into a taxpayer-funded lavish lifestyle in the White House, is, predictably, a staunch proponent of the Federal Reserve. In token tribute to the Ron-Paul libertarians his campaign ruthlessly suppressed at the Republican National Convention in Tampa, Romney makes vaguely sympathetic noises about "auditing" and "overseeing" the Federal Reserve, but otherwise ignores the subject altogether, instead rallying Republicans around "repealing and replacing" ObamaCare (with RomneyCare, the blueprint for ObamaCare), "cracking down" on China for "manipulating its currency" (to prop up the dollar, keep Chinese goods affordable in the U.S., and finance federal deficits), and drawing a "red line" on the impotent Iranian government's nuclear ambitions (which, if they ever existed at all, were abandoned almost a decade ago). Romney as a supposed alternative to Obama is a disheartening prospect, to say the least, but that is what a century of two-party statism has wrought: two tyrannical political parties that differ only in degree, not in kind.
As chief of Bain Capital, Romney made his billions during the longest bull market in U.S. history. Alan Greenspan, Chairman of the Federal Reserve during Romney's reign at Bain, oversaw monetary policy that was so inflationary - even by central-banking standards - that Wall Street invented a term, "the Greenspan put," to describe Greenspan's proclivity of expanding credit to prop up securities markets. Romney, like other private-equity investors at the time, made his money by taking advantage of the artificially low interest rates from Greenspan's Federal Reserve to acquire small but stable companies which he promptly resold after stripping for parts and saddling with debt. Shortly after Romney plundered his profits, most of the companies in which he invested would declare bankruptcy, unable to cope with the burdens that Romney had left them. David Stockman, Ronald Reagan's budget director, calls private-equity investors "capitalism's natural undertakers - vulture investors who feed on failing businesses." In a free market, this ugly but essential role would be a part of the market's circle of life - reallocating resources from lower-valued to higher-valued uses. Thanks to the Federal Reserve, however, Stockman says "they have now become monsters of the financial midway that strip-mine cash from healthy businesses and recycle it mostly to the top 1%." Although Romney tries to pose as John Galt, he did not build a business the old-fashioned way, by investing his savings and creating a customer, but by leveraging cheap credit, speculating amid a bubble, and banking on bailouts.
Obama, the reigning president poised to win reelection despite doubling the federal deficit (which he promised to halve), keeping unemployment above 8% for practically all of his presidency (which he promised his stimulus spree would prevent), codifying into law Dubya's unconstitutional surveillance, detention, torture, and assassination powers (which he promised he would abolish), expanding the foreign wars in Afghanistan and Iraq (which he promised he would end), has recently learned the value of the Federal Reserve's printing press to a president intent on spending trillions of dollars until kingdom come - priceless. Before his days of dancing on the Ellen Degeneres Show and "slow jamming" the news on Saturday Night Live, Obama worked in Chicago as a "community organizer" for the Association of Community Organizations for Reform Now (ACORN). In its "People's Platform," ACORN pledged that, "We will continue our fight until the American way is just one way, until we have shared the wealth." A glorified shakedown syndicate, ACORN was a creature of the Community Reinvestment Act, truly idiotic legislation which, in the name of equality, violated banks' property rights and fiduciary duties by coercing them into making excessively risky loans to minorities with poor or no credit. ACORN, one of the "community organizations" created under the CRA to enforce its affirmative-action lending, would threaten banks that unless they paid a bribe, ACORN would file a lawsuit with the Federal Reserve, which was in charge of administering the CRA. Although ACORN was supposed to loan the money it pilfered to subprime borrowers (what could possibly go wrong?), most of it was redirected to voter-registration drives, donations to political campaigns, and lobbying efforts. To put it bluntly, ACORN committed legalized extortion, relying on the threat of punishment from the Federal Reserve to intimidate banks into submission. Many innocent businesses facing lawsuits are subject to the same infuriating dilemma as ACORN's victims, for the cost of fighting and winning a legal battle is much higher than the cost of simply settling out of court. Past presidents, despite their unforgivable crimes against life, liberty, and property, at least came from honest professions, and many were even self-made men, war heroes, or scholars - sometimes all three. Barack Obama's origins, however, were as a low-life criminal with delusions of grandeur who collaborated with the Federal Reserve to profit from the exploitation of unjust legislation, and that was before he went into the organized crime of politics.
To paraphrase U.S. Senator Robert Toombs' exhortation to his native Georgia to secede from the Union, no wonder Romney and Obama cry aloud for the glorious Federal Reserve, for by it they got their wealth. In protecting the Federal Reserve for their own personal gain, Romney and Obama are crony capitalists of the ruling class after Hamilton's own heart. Thanks to the Federal Reserve, Romney, a private-equity pirate who sailed the stock-market seas in search of sinking ships to sack, made his fortune, and Obama, a street thug who muscled banks into paying protection money to him and his fellow militant Marxists, made his name. The Founding Fathers, their Revolution having been betrayed, must be rolling in their graves, but Hamilton, his diabolical plan proceeding exactly as he foresaw, is surely sleeping like a baby.
Conclusion
Love of sound money and hatred of central banking is as American as apple pie. Gold and silver are the only forms of money endorsed in the Constitution, while the issuance of paper money is prohibited. Thomas Jefferson feared that central banks were "more dangerous than standing armies," and Andrew Jackson condemned central banks as "a den of vipers and thieves." Both of the Federal Reserve's predecessor banks were enthusiastically abolished, and the most prosperous periods in U.S. history were those founded upon a gold standard. Despite the success of sound money and stigma of central banking, however, the Federal Reserve still exists, and has become a permanent fixture in the federal pantheon, its pronouncements accorded undeserved reverence from the rulers and ruled alike. Nothing could be more contrary to America's heritage than the mere existence of the Federal Reserve, to say nothing of the outrageous respect it commands.
So long as the Federal Reserve exists, the economy will continue to lurch from boom to bust, the country's prosperity dwindling with every crash. The Federal Reserve is a cancer afflicting the economy, and until it is abolished, all other economic issues are obsolete. In the full scheme of things, whether tax rates are a few percentage points higher or lower, whether government expenditures should comprise a greater or lower share of gross domestic product, and whether regulations should tighten or loosen, is meaningless beneath the towering shadow of a Federal Reserve which generates massive misallocations of resources that can trap the economy in a permanent state of stagnation or regression. All other economic issues pale in comparison. In the words of Ron Paul in End the Fed:
"After all is said and done, the Fed has one power that is unique to it alone: it enables the creation of money out of thin air [...] Given that money is one half of every commercial transaction and that whole civilizations literally rise and fall based on the quality of their money, we are talking about an awesome power, one that flies under cover of night. It is the power to weave illusions that appear real as long as they last. That is the very core of the Fed's power.""Ending the Fed," as Ron Paul urges, would preserve peace and prosperity, as well as protect the life, liberty, and property of the people. Austrian economics shows that the writing is on the wall for the Federal Reserve. Even if the Federal Reserve is never abolished, it will ultimately destroy itself, for the economy cannot survive an eternal onslaught of booms, busts, and inflation. The Federal Reserve will either be repealed voluntarily or collapse beneath its own weight, for an institution that unnatural and evil cannot endure forever. In the wise words of Bob Marley, "As it was in the beginning, so it shall be in the end."
