The Bad Gone Blog received a very lengthy comment from one of our readers suggesting that laissez faire capitalism was the main cause of our recent economic downturn.
Even though we at BGB vehemently disagree with the reader’s comments, we do appreciate the feedback and dialogue. We encourage everyone to give us feedback, both positive and negative.
In the end, this is how everyone becomes educated and some people will even “see the err in beliefs” and occasionally change their mind.
Feel free to read the comment section of the post by clicking, Truth Behind Clinton’s Surplus and Bush/Obama deficits.
You can read the first article in this series by clicking, The Myth that Laissez Faire Capitalism is Responsible for our Current Crisis Part 1.
Beyond all this is the further fact that the actual responsibility for our financial crisis lies precisely with massive government intervention, above all the intervention of the Federal Reserve System in attempting to create capital out of thin air, in the belief that the mere creation of money and its being made available in the loan market is a substitute for capital created by producing and saving. This is a policy it has pursued since its founding, but with exceptional vigor since 2001, in its efforts to overcome the collapse of the stock market bubble whose creation it had previously inspired.
The Federal Reserve and other portions of the government pursue the policy of money and credit creation in everything they do that encourages and protects private banks in the attempt to cheat reality by making it appear that one can keep one’s money and lend it out too, both at the same time. This duplicity occurs when individuals or business firms deposit cash in banks, which they can continue to use to make purchases and pay bills by means of writing checks rather than using currency. To the extent that the banks are then enabled and encouraged to lend out the funds that have been deposited in this way (usually by the creation of new and additional checking deposits rather than the lending of currency), they are engaged in the creation of new and additional money. The depositors continue to have their money and borrowers now have the bulk of the funds deposited. In recent years, the Federal Reserve has so encouraged this process, that checking deposits have been created equal to fifty times the actual cash reserves of the banks, a situation more than ripe for implosion.
All of this new and additional money entering the loan market is fundamentally fictitious capital, in that it does not represent new and additional capital goods in the economic system, but rather a mere transfer of parts of the existing supply of capital goods into different hands, for use in different, less efficient, and often flagrantly wasteful ways. The present housing crisis is perhaps the most glaring example of this in all of history.
Perhaps as much as a trillion-and-a-half dollars or more of new and additional checkbook-money capital was channeled into the housing market as the result of the artificially low interest rates caused by the presence of an even larger overall amount of new and additional money in the loan market. Because of the long-term nature of its financing, housing is especially susceptible to the effect of lower interest rates, which can serve sharply to reduce monthly mortgage payments and in this way correspondingly increase the demand for housing and for the mortgage loans needed to finance it.
Over a period of years, the result was a huge increase in the production and purchase of new homes, rapidly rising home prices, and a further spiraling increase in the production and purchase of new homes in the expectation of a continuing rise in their prices.
To gauge the scale of its responsibility, in the period of time just since 2001, the Federal Reserve caused an increase in the supply of checkbook-money capital of more than 70 percent of the cumulative total amount it had created in the whole of the previous 88 years of its existence — that is, almost 2 trillion dollars. This was the increase in the amount by which the checking deposits of the banks exceeded the banks’ reserves of actual money, that is, the money they have available to pay depositors who want cash. The Federal Reserve caused this increase in illusory capital by means of creating whatever new and additional bank reserves were necessary to achieve a federal funds interest rate — that is, the rate of interest paid by banks on the lending and borrowing of reserves — that was far below the rate of interest dictated by the market. For the three years 2001–2004, the Federal Reserve drove the federal funds rate below 2 percent and, from July of 2003 to June of 2004, drove it even further down to approximately 1 percent.
The Federal Reserve also made it possible for banks to operate with a far lower percentage of reserves than ever before. Whereas in a free market, banks would hold gold reserves equal to their checking deposits — or at the very least to a substantial proportion of their checking deposits — the Federal Reserve in recent years contrived to make it possible for them to operate with irredeemable fiat-money reserves of less than 2 percent.
The Federal Reserve drove down the federal funds rate and brought about the vast increase in the supply of illusory capital for the purpose of driving down all market interest rates. The additional illusory capital could find borrowers only at lower interest rates. The Federal Reserve’s goal was to bring about interest rates so low that they could not compensate even for the rise in prices. It deliberately sought to achieve a negative real rate of interest on capital, that is, a rate below the rate at which prices rise. This means that a lender, after receiving the interest due him for a year, has less purchasing power than he had the year before, when he had only his principal.
In doing this, the Federal Reserve’s ultimate purpose was to stimulate both investment and consumer spending. It wanted the cost of obtaining capital to be minimal so that it would be invested on the greatest possible scale and for people to regard the holding of money as a losing proposition, which would stimulate them to spend it faster. More spending, ever more spending was its concern, in the belief that that is what is required to avoid large-scale unemployment.
As matters have turned out, the Federal Reserve got its wish for a negative real rate of interest, but to an extent far beyond what it wished. It wished for a negative real rate of return of perhaps 1 to 2 percent. What it achieved in the housing market was a negative real rate of return measured by the loss of a major portion of the capital invested. In the words of The New York Times, “In the year since the crisis began, the world’s financial institutions have written down around $500 billion worth of mortgage-backed securities. Unless something is done to stem the rapid decline of housing values, these institutions are likely to write down an additional $1 trillion to $1.5 trillion.”
This vast loss of capital in the housing debacle is what is responsible for the inability of banks to make loans to many businesses to which they normally could and would lend. The reason they cannot now do so is that the funds and the real wealth that have been lost no longer exist and thus cannot be lent to anyone. The Federal Reserve’s policy of credit expansion based on the creation of new and additional checkbook money has thus served to give capital to unworthy borrowers who never should have had it in the first place and to deprive other, far more credit worthy borrowers of the capital they need to stay in businesses. Its policy has been one of redistribution and destruction.
The capital it has caused to be malinvested and lost in housing is capital that is now unavailable for such firms as Wickes Furniture, Linens ‘N Things, Levitz Furniture, Mervyns, and innumerable others, who have had to go bankrupt because they could not obtain the loans they needed to stay in business. And, of course, among the foremost victims have been major banks themselves. The losses they have suffered have wiped out their capital and put them out of business. And the list of casualties will certainly grow.
~Boo~
