Thursday, May 27, 2010

Money supply shrinking due to regulation -more economic woes on the way

While the economic illiterate believed that the Great Depression was caused by "the business cycle" or a "failure of capitalism", it has been known for years that the Depression was largely caused by Federal Reserve blunders which caused the money supply to plummet, combined with the Fed's failure to support banks which were hit by runs by nervous depositors.

The current downturn was initiated by the failures of government sponsored entities (GSEs) Fannie May and Freddie Mac due to mandated programs to provide mortgage loans to people who couldn't afford them. When the value of their mortgage backed securities, which were one of the foundations of the financial system, were found to be crumbling, they took down a number of major banks and other financial institutions such as AIG with them.

Now, according to an article in the London Telegraph, "The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.

'It’s frightening,' said Professor Tim Congdon from International Monetary Research. 'The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly,' he said."

Not surprisingly, the Administration is not letting this crisis go to waste, but is proposing more Keynesian "stimulus" AKA spending, in spite of the fact that the last huge spending blowout didn't prevent unemployment from rising. The fact that fiscal "stimulus" has never worked anywhere is no reason not to keep using it as an excuse to do what the Dems want to do anyway - increase the government share of the economy.

"Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown 'Friedmanite' monetary stimulus.

'Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty,' he said.

Mr Congdon said the dominant voices in US policy-making - Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke - are all Keynesians of different stripes who 'despise traditional monetary theory and have a religious aversion to any mention of the quantity of money'. The great opus by Milton Friedman and Anna Schwartz - The Monetary History of the United States - has been left to gather dust.

Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.

This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 - just as the Fed raised rates - gave a second warning that the economy was about to go into a nosedive."

So it appears we have yet another example of government claiming it needs to regulate capitalism to avoid economic chaos, and using regulation to produce economic chaos instead. Is anyone surprised?

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