October 29, 2011

Stimulate demand through more credit

October 23, 2011 Financial Times

Lawrence Summers , former secretary of treasury under Clinton administration, former head of the White House National Economic Council under Obama administration

Article: Why the housing burden stalls America’s economic recovery

“The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending.”


October 28, 2001 Interview with Aaron Task (The Daily Ticker)

“Because the reason firms aren’t hiring people is that they don’t have the demand. And the only way they’ll get the demand is to get more spending. And the only way people will be able to spend more if they have access to credit. So, we’ve got to find ways to work through the old debts, to enable people to take on new debts. That’s why people speak of bankruptcy as a cleansing process. But unless we are able to get more demand going, we’re not going to generate incomes that are necessary to have the growth that is going to let us move forward."


Unfortunately, Mr. Summers thinks of the economy as an engine, which has no gasoline (credit) to run properly. Despite the fact that he acknowledged himself that we got into this recession because of too much borrowing, lending and spending, he said that the only way to get out of this recession is to increase borrowing, lending and spending. According to the following quote which has been attributed to more than one person, I conclude that Lawrence Summer is insane: “insanity is doing the same thing over and over and expecting a different result” The problem, however, is that Mr. Summers is not the only insane economist in Washington D.C. This recession was brought about by enormous expansion of the credit, which artificially stimulated the economic growth and bid up prices for factors of production way too high. Then, after the bubble, came the bust, in which we are in right now. However, since depressions and recessions are not allowed to happen, the Fed decided to stimulate the catallaxy (economy) with even more money. The Fed increased the money supply by influx of cash and by lowering the interest rate to its minimum. However, it did not work. Now, the Fed will have to begin paying people for borrowing money to continue to stimulate the demand to create jobs. The fact that the Fed cannot lower interest rate any further makes many people (except Mr. Summers and others like him) to realize that this recession cannot be fixed like other recessions in the past. According to Austrian school of economics believes that

the "depression" is seen as the necessary and healthy phase by which the market economy sloughs off and liquidates the unsound, uneconomic investments of the boom, and reestablishes those proportions between consumption and investment that are truly desired by the consumers. The depression is the painful but necessary process by which the free market sloughs off the excesses and errors of the boom and reestablishes the market economy in its function of efficient service to the mass of consumers. Since prices of factors of production have been bid too high in the boom, this means that prices of labor and goods in these capital goods industries must be allowed to fall until proper market relations are resumed. ….. The government must not try to inflate again, in order to get out of the depression.

However, Government does not allow natural forces to do its work to liquidate its unsound, uneconomic investments of the boom and to bring down the prices for factors of production. Government is afraid that public will recognize such a healthy process as “depression,” which is unacceptable. However, according to Austrian school of economics, there is no way to avoid this painful, healthy process forever. Sooner or later it will have to take place. The economy can go through the correction (“depression”) phase right now and then grow organically, or, with the help of politicians, it will go through the inflation/stagflation period, due to further money supply expansion, before it will go through the corrective (“depressive”) phase. The only problem is that the longer government reinflates, the greater the magnitude of depression and consequently of the pain will be. Since the government cannot lower interest rates any further, looks like it has chosen to expand money supply through government borrowing and spending.

Unlike Mr. Summer, Mises told that once a depression arrives, a government should do nothing to stimulate the demand, and to stop inflationary policies as soon as possible , to cut its spending, and not to prop up unsound business. We need Margaret Thatcher to help the US government to get back on the fiscally responsible (Austrian) way of running the government. The Catallaxy will fix itself.

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