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Where is Milton Friedman (pictured) when you need him? For that matter, where is Hans Sennholz?Both men were great economists who understood clearly what inflation was and why it should be avoided. In our current age of massive federal bailouts, stimulus packages and increases in the money supply, we are badly in need of their clear headed explanations of the dangers of inflation, where it comes from, and how it is to be avoided. Unfortunately, neither economist is with us any longer. Milton Friedman passed away in 2006 and Hans Sennholz in 2007. Fortunately, we have their writings to guide us in our current age of inflation.
Sennholz, author of the book Age of Inflation, issued a prophetic warning on his website in 2007. In an article descriptively titled "Money is Flooding the World Market," he warned:
Last year, household debt alone rose by more than one trillion dollars. The federal government itself has been adding more than two billion every day. The Federal Reserve System, together with some 7,900 commercial banks, provided the funds; and foreign central banks and commercial banks invested their dollar earnings in nearly one-half of the federal government's debt.Easy money led to a bubble, which Sennholz also described:
Such credit expansion, unsupported by genuine savings and capital formation, generates illusionary gains making people believe that they are more prosperous than they actually are. Stock and real estate prices soar, tempting people to spend their gains, improve their homes and build mansions. Actually, they all-- businessmen and stockbrokers, executives and workers-- may consume their material substance. But no matter how low the Federal Reserve may set its rate, the boom is bound to come to an end as soon as the maladjustments inflict losses on business. As more and more businesses face difficulties or even fail, the readjustment begins, forcing them to respond to the actual conditions of the market.The bubble has burst, as Sennholz said it would, and the readjustment has attempted to get underway in the form of falling prices as the demand for goods and services falls following the so-called seizure of the credit markets. Ultimately, the reduced availability of currency should have caused the value of the dollar to rise (as a corollary to falling prices elsewhere). This is exactly what the market forces in the economy have tried to do. Left unmolested, eventually equilibrium in supply and demand would again have been reached if the process had been allowed to play out.
It has not been allowed to play out, however. Both fiscal and monetary policy levers have been pulled in the hope that federal action can stimulate the economy. Dollars have been pumped into the economy and federal spending is rapidly on the rise. As far as policy goes, we are doing exactly those things that got the economy in trouble in the first place, on the mistaken assumption, apparently, that we just need to do more of it faster. It is a recipe for further disaster.
If that is the case, what alternative course might there be? First, though it has become a catch phrase among Ron Paul libertarians, there is a strong element of truth in the notion that we should "end the Fed."
To understand why the Federal Reserve is a problematic institution (to put it charitably), simply turn to Milton Friedman. In an interview with Playboy (happily it is available in a collection of Friedman's essays on public policy entitled There's No Such Thing as a Free Lunch), Friedman explains the problem with the Fed:
The Fed, because it's the government's bank, has the power to create -- to print -- money, and it's too much money that causes inflation. For a rudimentary understanding of how the Federal Reserve System causes inflation, it's necessary to know what it has the power to do. It can print paper money; almost all the bills you have in your pocket are federal reserve notes. It can create deposits that can be held by commercial banks, which is equivalent to printing notes. It can extend credit to banks. It can set the reserve requirements of its member banks -- that is, how much a bank must hold in cash or on deposit with the Federal Reserve Bank for every dollar of deposits. The higher the reserve requirement, the less the bank can lend, and conversely.Supposedly, all this power was granted to the Fed on the very erroneous assumption that economic planning, when applied to the money supply, would allow for a smoothly functioning economy. The trouble is, economic planning does not work.
These powers enable the Fed to determine how much money -- currency plus deposits -- there is in the country and to increase or decrease that amount.
The greatest "experiment" in planning was conducted for many decades in the Soviet Union. There, planning was applied to all facets of the economy and not just the money supply. The government planning agency, GOSPLAN, dictated what would be produced, and how much. The result was that some things were severely over produced while others were severely underproduced. At best the result was poverty and breadlines; at worst, starvation and genocide.
It is no surprise to any informed observer that economic planning of this sort would similarly fail when applied to the money supply. And it has, spectacularly. Speaking of the Fed, Milton Friedman noted:
These men [those running the Federal Reserve] have attempted for the past sixty years to predict where the economy is headed and to keep it on an even path of growth. I have studied the monetary history of the United States and written a book on the subject, and it's my opinion that there have been more severe crises in the years since we've had a Federal Reserve System that in the years from the Civil War until 1914. Even if you leave out the years covered by the two world wars, the Fed seems to have failed in its mission of keeping the economy on a steady plane.
The reason it fails, Friedman explained, was because it was based on the whims of men, and not on a system of rules. Despite his criticism of the Fed, Friedman yet thought it could be reformed, as long as its powers could be limited. But he hasn't lived to see the economic devastation that has now been wrought by a solid decade of serious Fed mismanagement of the money supply.
Clearly, the Fed has far too much power, and whether through accident or design, when that power is not applied carefully, it has the propensity to destroy. Hence, one solid step toward repairing the damage would be for Congress to take action to shut down the Fed.
But that is not all that should be done. The Fed pulls on the levers of monetary policy, while fiscal policy lies elsewhere within the halls of Congress. And unfortunately, in collusion with the executive branch over the last decade, fiscal policy too has come off the rails.
Whether at home or abroad, the federal government spends far too much money. It and the states also tax too much. In both spending and taxing, government at all levels is crowding out the market.
The solution is to shrink the governments that now take too much from taxpayers. That would mean bringing troops home from the costly deployments that have seen hundreds of thousands of our soldiers stationed overseas. It would mean Congress making a serious effort to stop pork-barrel spending. It would mean curtailment of entitlements programs, and it would mean that governments should close whole departments and deregulate the industries those departments purported to govern. And after shrinking, drastically, the size of government, it would mean giving a serious tax break to the American people. After all, it is their money, they should get to keep some of it.
We're doing just the opposite, naturally. In one of his final essays, after analyzing the trends he was seeing in the public policy decisions that were being made regarding the economy, Hans Sennholz warned: “This economist is bracing for a gradual increase of political controls over economic life, leading to countless maladjustments, distortions, and stagnations."
He was right, and as long as government persists in pursuing destructive monetary and fiscal policies, it is a safe bet that we are far from being out of the woods.
[Milton Friedman image courtesy of www.freetochoosemedia.org)
