Obamanomics, Keynesian Theory, Red is the New Green & How It All Ties Together, Part 2

You can find Part One here: Obamanics and Keynesian Theory

Obamanomics, Keynesian Theory, Red is the New Green & How It All Ties Together

Part 2/7: Where The Bust Came From

The number one culprit for the boom and bust without denial by both (most) Keynesian and (all) Austrian economic experts is the Federal Reserve or the Fed for short (Woods, 2009). The Fed, controls the money supply or the amount of money in circulation, sometimes referred to as the M1 measurement. The Fed controls the amount of money in circulation by lowering and raising the Federal Fund Rate. “The federal funds rate is the rate charged by one depository institution on an overnight sale of immediately available funds (balances at the Federal Reserve) to another depository institution “ (Federalreserve.gov, 2010). Simplified, this is the rate that sets all interest rates. By raising this rate, the Fed can contract the supply of money and adversely, by lowering this rate, the Fed increases the money supply or creates new money. Following the years after the vicious 9/11 attacks the Fed began to lower their rates, creating new money and by doing so artificially manipulated/stimulated the economy. This cheap money overwhelmingly went into the housing market which inflated prices to unheard of levels. When this was occurring, Keynesians insisted or conventional wisdom there of believed that this was a sustainable phenomenon that would persist instead of an artificially induced bubble that had to burst. The so called Keynesian experts insisted/told Americas that their homes had to appreciate, that property was the best investment and that house flipping was a sure fire way to make a barrel full of money. Of Course, they ignored the warning cries from all Austrian economist.

The Dallas Observer, a newspaper located in Dallas, Texas, wrote an article that best exemplifies what lose monetary policies of the Federal Reserve encourages. In this article titled 'Better Off Deadbeat', does show how an individual used the low loan rates to take out loans to invest in the market. This investment, like many others as this individual was not the only one doing it, is what created the boom and the bust of the housing market. This is easy money created by the Fed that creates mal-investment that leads to the boom and the bust. I encourage everyone to read this article in conjunction with this part of the seven part series.

Article Link

The article mentioned above is a good example of how stock portfolios in connection with home prices razed in tandem during the forming of the bubble, making Americans feel more wealthy than they actually were. Americans during this time made consumption decisions on the basis of the so called experts statements, stating the economy was sound, that are decisions that Americans have now come to regret. Some businesses that began or expanded under the boom conditions could only continue profitably only if the boom condition and the artificial spending continued. Now with reality setting in and the easy credit no longer available, the market is trying to clear away these bubble activities, so that market resources can be used and made available for use by the real wealth and job creators of the economy.

The market, in short, is attempting to move consumers away from personal finance models based on indebtedness and too much consumption to a more sustainable level of consumption in conjunction with real saving. To accommodate this shift, labor and capitol will need to be reallocated out of some sectors and into other ones. “Stimulus” spending only corrupts and confuses this purgative process, by misdirecting resources into arbitrary projects and artificially stimulating politically favored industries at the expense of the economy's healthy and productive sectors. Obama's program for recovery, such as it is, looks instead to re-inflate the bubble, keep the spending spree going and give still more artificial stimulus to debt while providing disincentive to save. It refuses to allow the market to correct the unsustainable excesses in the economy. “No scheme which has ever been devised by them has ever made a collapse boom go up again,” said William Graham Sumner in 1896. Nothing in the historical record since then has altered that verdict.

The Federal Reserve, acting in true Keynesian fashion, is likewise trying to repair the economy by engaging in more of what caused the problem in the first place. On March 18, 2009, the Federal Open Market Committee (FOMC) announced it would purchase up to $300 Billion in long-term government bonds, with the intent of lowering mortgage rates and other rates on consumer debt. It also declared its intention to purchase up to $750 Billion in mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac. Instead of allowing the market to restructure along a sustainable path, the Fed instead seeks to keep home prices inflated, prop up the securitization model and encourage more borrowing and debt.

Part Three, Stimulus Spending Doesn't Work or Make Sense, will be release Next Friday, on schedule. Once again, thanks for reading.