by Nelson Hultburg
(The Daily Bell) The essential economic problem we confront today is that our dominant Keynesian intellectuals have abandoned reality. They do not grasp what they have wrought with the mountainous loads of debt and malinvestment that are overwhelming us. Much of this burden must be liquidated before genuine demand and growth can be restored, which will require radical reform if we are to evoke a genuine cure.
To try and solve today’s debt created crisis with more debt (as the Keynesians are presently doing) can only bring on a bigger bust the next time around, which will require still larger “debt injections” to stave off a still larger crisis. Eventually, the economic implosion will be so monstrous that it can no longer be rectified with “corrective debt injections.” Consumers and businesses will have reached their limit. The Keynesian system will have met its Waterloo. Perhaps this denouement has already arrived.
This dilemma began because we altered the creation of money in a profoundly dangerous way with the inception of the Federal Reserve in 1913. Government expansion of the money supply today does not have to be redeemed in gold as the banks’ fractional reserve loans were in the 19th century. What the Fed does now is pyramid excessive levels of credit upon totally irredeemable currency. It can print as much money as it wishes, and banks can loan out nine dollars in credit for every printed dollar. The Fed has been creating, over the past 100 years, far more excessive debt than the worst banking systems of the 19th century. This must end in an eventual collapse.
Keynesian rationale, however, maintains that the “total catastrophe” scenario can be averted by use of this credit pyramiding process. The Fed can continue injecting fiat money into the economy indefinitely and thus bring about an expansion of purchasing power for consumers and businesses. Why? Because somebody is always willing to sell bonds to the Fed, and that’s all it takes. The Fed prints billions in new money to make the purchases. Liquidity is thus injected into the system, which will eventually recharge all producers and consumers to begin anew the boom cycle. Keynesianism has solved the “total catastrophe” dilemma.
But what Keynesians conveniently ignore is that the fiat money from those bond sales does not become credit until a banker offers it for a loan, and a borrower desires to borrow it. If consumers and businesses become overloaded with debt, and if bankers become worried about prospective borrowers’ credit worthiness, then much of that fiat money remains just fiat money. It sits in the banks and does not find its way into the 9-1 fractional reserve lending process whereby $9 in credit is generated for every $1 of fiat money printed by the Fed for its periodic “liquidity / debt injections.” In other words, the newly printed money does not so easily expand into mega-purchasing power via Fed credit pyramiding, which is what is needed to bring recovery from a recession.
Therefore, the Fed becomes basically ineffective in its efforts to restore real growth after a deflationary credit contraction that results from consumer and business debt saturation. This is because the Fed’s only effective policy tool is the offering of more debt, which is the very poison that is destroying the system. Sure, the Fed can stop the deflation with massive “debt injections,” but at what cost? The cost will be either runaway price inflation because of the size and repetition of the debt injections needed, or a pseudo-growth economy where relentless stagflation prevails and the stock market registers nominal gains rather than real gains.
The Wildest Credit Binge In History
Our economy today is so top-heavy with credit and debt that it is unlike all other economies in the past. Keynesians somehow believe that consumers and businesses will continue to borrow still more in face of this. Reason tells us they will not. There has to come a saturation point, and it appears we have reached it with the credit crisis and Dow collapse of September 2008. We have experienced, over the past 43 years, the wildest credit binge in our history. This time the inevitable hangover will be more than a regular hangover.
Because the Fed must fight the economic crisis with massive monetary inflation, the dollar must depreciate disastrously in the upcoming decades. Eventually, holders of U.S. dollars, stocks and Treasury bonds will sell their dollar related investments, which will bring severe deterioration to our economy and to the standard of living that Americans enjoy as either heavy price inflation or prolonged stagflation invade our lives.
In response to all this, our government leaders will continue to put forth an array of market manipulations, financial gimmickry and bailouts for Wall Street such as what we saw with Hank Paulson’s Troubled Assets Relief Program (TARP) in 2008. Our leaders will grasp at straws. They will jawbone and delude themselves. They will stonewall and try to dump the more insurmountable problems into the next administration’s lap. And, of course, they will continue to relentlessly inject massive debt into the system in hopes of not having to descend into the nastiness of a full-blown depression.
What has worked for the Keynesians for 78 years is now in its death throes. The policies of interest rate rigging and debt injections mixed with confiscatory taxes, which they have used since 1936 to manage their booms and busts, could conceivably have one more stimulatory credit bubble left, but it’s doubtful.
Will Credit Reflation Work?