-Caveat Lector-
~~for educational purposes only~~
[Title 17 U.S.C. section 107]
Economic Woes and the Federal Reserve
Ron Paul
Last week was tumultuous for worldwide stock markets,
some of which ended the week at their lowest levels
in years. Our own Dow-Jones and NASDAQ market indices
both suffered heavy losses, while the Japanese Nikkei
index fell to its lowest level since 1985! Nervous
investors scrambled to sell even blue-chip holdings,
especially after news that projected 2001 earnings
would be lower than expected for many companies.
The market downturn is not surprising. An economic
slowdown began in 2000, accelerating in the last quarter
of the year. All indications suggest the U.S. economy
is headed for a further slowdown in economic growth,
if not an outright recession. Already we have seen
thousands of job cuts, and not only in the
market-sensitive high tech sector. Economic output,
as measured by the gross domestic product, dropped
every quarter in 2000.
Amazingly, some in Washington and the popular media want
to blame President Bush and his administration for our
current economic predicament. Never mind that growth
began slowing fully one year before he took office.
Apparently, certain politicians believe that the President
is causing a recession merely by talking about the economic
data. One prominent Congressman fretted that "we've been
talking ourselves into this. Now it's happening." In other
words, Mr. Bush is "talking down the economy," making a
recession more likely simply by discussing reality.
Such thinking should be dismissed as absurd. Economic
recessions are not the result of a gloomy national state of
mind; if so, we could create economic prosperity simply by
positive thinking. Yet basic education in economics is so
badly lacking in America that many will accept this
preposterous idea. The same ignorance of economic principles
is behind the fallacy that capitalism is to blame for
recessions, that a free market system causes an inevitable
cycle of booms and busts. In reality, it is government
intervention in the economy, particularly in the areas of
money supply and interest rates, which creates the precarious
financial bubbles that cause economic recessions.
The Federal Reserve did two things to artificially expand
the economy over the last decade. First, it relentlessly
lowered interest rates whenever growth slowed. Interest
rates should be set by the free market, with the availability
of capital (i.e. savings) determining the cost of borrowing
money. In a healthy market economy, more saving equals lower
interest rates. When savings rates are low, capital dries up
and the cost of borrowing increases. When interest rates are
set by the market, individuals and businesses make good
spending decisions, because they pay an accurate interest
rate for their debts. However, when the Fed set rates
artificially low, the cost of borrowing becomes cheap.
Individuals incur greater amounts of debt (evidenced by
the record number of personal bankruptcies), while businesses
overextend themselves and grow without real gains in
productivity. The bubble bursts quickly once the credit
dries up and the bills cannot be paid.
Second, the Fed also steadily increased the monetary
supply throughout the 1990s by printing money. Recent Fed
numbers show yearly increases of nearly 15% in the M2 money
supply. Since 1996, the Fed has poured more than $100
billion in new dollars into the U.S. economy. These new
dollars may make Americans feel richer, but the net result
of monetary inflation has to be the devaluation of savings
and purchasing power. Prices seemed stable over the last
decade, but many types of inflation were not reported as
such. An obvious example is stock prices, where companies
making little or no profit often sold shares at ridiculous
price/earnings ratios. Housing and energy prices also
rose dramatically, and wholesale price inflation is an
increasing threat. So while monetary inflation creates a
sense of prosperity in the short run, long-term it simply
makes your dollars worth less.
Only six months ago, market pundits were still proclaiming
a new era of unending prosperity. They claimed that the
fundamentals no longer mattered, that technology would
save us from any more bear markets. Technology is wonderful,
but it cannot save us from our own misguided monetary
policies. Until we stop permitting the Fed to manipulate
the economy, real prosperity will elude us. The Fed received
credit for the boom times of the 1990s, yet its policies
are responsible for the market correction and economic
recession we are experiencing today.
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