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Global Credit Crunch

We're on the verge of a global credit crunch. Thank the Federal Reserve. George Reisman supplies the context; I'll supply the rage.

Central banks fill the role of "lender of last resort" to provide liquidity for the purpose of avoiding financial panics. They've certainly been doing a lot of that recently — the central banks of the United States, European Union, Japan, Australia, Hong Kong, and Canada all injected funds last week, a sum of at least US$280 billion. (These are temporary funds.)

I'd rather they hadn't. The world needs a good credit crunch.

Everyone's pointing fingers at U.S. subprime and Alt-A mortgages, for which default rates have been rising significantly. But they should be blaming the Federal Reserve. The Fed's very loose monetary policy of the past few years fueled the housing and mortgage bubble, just as it had earlier fueled the tech stock bubble. If they cut interest rates (as is now expected) in order to prop up the economy, they will merely be adding to the malinvestment bad by keeping bad ventures viable.

Monetary inflation does make the economy look good — spending, revenues, and profits rise. On paper. But the new money is spent wastefully, inefficiently, irrationally. By competing away the real resources from sounder business ventures, inflation harms the economy. When the waste of resources eventually turn the inflationary boom to bust, the instinct of central banks is — of course — to provide more money! By propping up the ventures that never should have been started, they continue to waste resources.

As long as central banks can create money out of thin air, they will prevent a genuine credit crunch that would liquidate the malinvestments and strengthen the real economy.

The Fed created this mess and the Fed will create another mess in trying to clean up this one. The Fed is not merely unnecessary, it is an active malignancy, and it should be abolished. (This legislation was introduced by Ron Paul, of course.)


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