Saturday, August 8, 2009

Bad Policy Prescriptins

by Thorsten Polleit

The debacle is the outcome of the government-controlled fiat money system. State-owned central banks hold a monopoly over the money supply, and they increase it out of thin air by extending circulation credit. Such a monetary regime inevitably creates disequilibria.

The rise in circulation credit lowers market interest rates below their natural levels — that is, the levels that would prevail had the credit supply not been artificially increased. The downward-manipulated interest rate induces additional investment and, at the same time, provokes a rise in consumption out of current income at the expense of savings. As a result, the increase in the money supply makes the overall monetary demand outstrip the economy's resource capacity; the economy starts living beyond its means.

A rising money supply pushes up prices sooner or later, be it the prices for consumer goods or those for assets (such as, for example, stocks, bonds, houses, real estate, etc.). Indeed, rising prices are the characteristic feature of the notoriously inflationary, government-sponsored fiat money system.

What is more, the artificially suppressed interest rate shifts scarce resources increasingly into the more time-consuming production processes for capital goods — at the expense of production processes for consumer goods. While the increase in the money supply initially stimulates economic activity, the ensuing boom is, rather tragically, economically unsustainable and must be followed by bust.

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