Honorable mention goes to Bill Bonner for “An Even Better Trade of the Decade, Part III” :A drop in the gross market rate of interest affects the entrepreneur's calculation concerning the chances of the profitability of projects considered. 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.
The result of this calculation shows the businessman whether or not a definite project will pay. It shows him what investments can be made under the given state of the ratio in the public's valuation of future goods as against present goods. It brings his actions into agreement with this valuation. It prevents him from embarking upon projects the realization of which would be disapproved by the public because of the length of the waiting time they require. It forces him to employ the available stock of capital goods in such a way as to satisfy best the most urgent wants of the consumers.
But now the drop in interest rates falsifies the businessman's calculation. Although the amount of capital goods available did not increase, the calculation employs figures which would be utilizable only if such an increase had taken place. The result of such calculations is therefore misleading. They make 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. Entrepreneurs embark upon the execution of such projects. Business activities are stimulated. A boom begins.
The additional demand on the part of the expanding entrepreneurs tends to raise the prices of producers' goods and wage rates. With the rise in wage rates, the prices of consumers' goods rise too. Besides, the entrepreneurs are contributing a share to the rise in the prices of consumers' goods as they too, deluded by the illusory gains which their business accounts show, are ready to consume more.
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Of course, in order to continue production on the enlarged scale brought about by the expansion of credit, all entrepreneurs, those who did expand their activities no less than those who produce only within the limits in which they produced previously, need additional funds as the costs of production are now higher. If the credit expansion consists merely in a single, not repeated injection of a definite amount of fiduciary media into the loan market and then ceases altogether, the boom must very soon stop.
The entrepreneurs cannot procure the funds they need for the further conduct of their ventures. The gross market rate of interest rises because the increased demand for loans is not counterpoised by a corresponding increase in the quantity of money available for lending. Commodity prices drop because some entrepreneurs are selling inventories and others abstain from buying. The size of business activities shrinks again. The boom ends because the forces which brought it about are no longer in operation.
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The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.
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On the eve of the credit expansion all those production processes were in operation which, under the given state of the market data, were deemed profitable. The system was moving toward a state in which all those eager to earn wages would be employed and all nonconvertible factors of production would be employed to the extent that the demand of the consumers and the available supply of nonspecific material factors and of labor would permit. A further expansion of production is possible only if the amount of capital goods is increased by additional saving, i.e., by surpluses produced and not consumed.
The characteristic mark of the credit-expansion boom is that such additional capital goods have not been made available. The capital goods required for the expansion of business activities must be withdrawn from other lines of production.
The problem with trying to engineer a ‘recovery’ is the same problem with all central planning – it substitutes the honest signals from the marketplace with imposters. For example, instead of getting the message that they need to conduct their business in a different way, the banks get the idea that the feds will always bail them out…and automakers ... may get the idea that there is more demand than there really is…and everyone could get the idea that the economy is healthier than it really is, thanks to the feds $1.5 trillion deficits.
The authorities are trying to force the economy back into the shape it was in before the crash. They’re preventing it from taking a new, better shape…and preventing the correction from doing its work. A correction is supposed to cleanse out the mistakes from the 50-year credit expansion. But it’s hard to do so when you don’t know what is really going on.
Markets – when they are allowed to do their work – are always in the process of discovering what assets are worth. They were doing a good job of it in the fall of 2008. They were discovering that the US had too many houses, and too many shopping malls, (the US has 10 times as much retail space per person as France…) We also had too many derivatives backed by real estate, and too many private equity deals based on too many optimistic assumptions about the future.
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The market was in the process of discovering what assets were worth when the feds stepped in. They stopped the process of discovery. Instead, they forced the market into a process of Price Hiding.
Probably the most dramatic example of price hiding has been in the financial sector itself. There, the feds took away the risks of bad debt from the bankers and put it on the general public. The Fed bought the toxic loans, transferring hundreds of billions of losses from the banks’ balance sheets onto the balance sheet of the Fed.
The Fed also lent the banks money at near zero percent…and then the federal government borrowed it back. The banks were able to make profits without doing any work or taking any risks. No wonder they didn’t lend money to private businesses or consumers. It was too much trouble. And they didn’t have to.
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And now the Treasury has the gall to tell the public that it made money from its ‘investments’ in the banking sector. If so, those were the most expensive profits in the history of finance. They cost the nation about $4 trillion in fiscal stimulus deficits – added to the national debt. And another $1.8 trillion worth of dodgy debt on the FED balance sheet. And about $6 trillion more worth of financial guarantees of various sorts.
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Everything regresses to the mean. Everything tends to go back to normal.
Corrections are normal. They help things get back in balance.
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