This is Not the 1930’s Depression, Which Means High Inflation to Come

This is Not the 1930’s Depression, Which Means High Inflation to Come
The Market Oracle ^ | May 07, 2009 | Michael Pollaro

Posted on 05/11/2009 2:28:38 PM PDT by An Old Man

Many comparisons have been made between today’s financial and economic crisis and the Great Depression, none more than the specter of deflation. Well, contrary to what happened during the Great Depression and contrary to the deflationary forecasts of government leaders, central bankers and economists, deflation, while always possible, is, in this man’s opinion, highly unlikely. Why’s that? Because the monetary and political framework of today is nothing like that of the early 1930’s. In fact, it’s nothing like anything seen, ever. Quite simply, today’s monetary and political framework is built for inflation, as much inflation as the government, the Federal Reserve and their banking partners want. And inflation, and a whole lot of it, is exactly what we are about to get.

Inflation and Deflation Defined

Let’s begin with some definitions to help us through this discussion. Today, when most people talk inflation, they mean generally rising prices, and when they talk deflation, they mean generally falling prices. This leads to endless consternation because it confuses cause and effect. For the purposes of this essay, inflation will be defined as it was in yesteryears, as an increase in money and money substitutes, which, holding all other things constant, brings about higher prices. The former we will call inflation, the latter we will call price inflation. Deflation will be defined as a decrease in the supply of money and money substitutes, which, holding all other things constant, brings about lower prices. The former we will call deflation, the latter price deflation. Why are these distinctions important? Because they focus attention on the driving force behind price inflation and price deflation; that being, the Federal Reserve and the fractional reserve banking system.

Today’s Monetary and Political Framework, Truly Different this Time

Now, what is so different about today’s monetary and political framework versus that which existed on the eve of the Great Depression? Simply put, all the checks on inflation, all the deflationary holes in the system that brought on the deflation of the 1930’s have been removed. In so doing, the government, the Federal Reserve and their banking partners have given themselves all the tools necessary to create as much inflation as they like. What we have today is a fiat based monetary system at the discretion of politicians and bankers bent on printing and spending our way to supposed prosperity (not to mention helping a few campaign reelections and banking interests along the way). That is not what we had on the eve of the Great Depression, not even close.

Let’s take a closer look:

On the eve of the Great Depression and until 1933, there was nothing to protect banks from prudent depositors wanting their money, that being currency or gold, or conversely, to assure depositors that there money was safe when they feared for their savings. Fractional reserve banking, where banks are permitted under law to loan out depositor money, while pretending the money is still in their vaults redeemable on demand, is an inherently unstable system, always susceptible to a bank run. (1) Murray Rothbard, the great Austrian economist and expert on the Great Depression (Ben Bernanke isn’t the only one), taught that it’s this fear, the fear of a bank run that keeps the banking system in check. To paraphrase Rothbard, there is nothing like a bank run to squeeze inflation out of the system. So when things started going wrong in 1929 and worsened thereafter, true to form, scared depositors, fearing for their savings, withdrew their money from the banking system en masse. Deflation, via a contraction in bank loans and deposits, engulfed the early 1930’s. To make sure this never happened again, the government in 1933 created the FDIC giving the US banking system federal deposit insurance. Today, back-stopped by the Federal Reserve’s printing press, the FDIC insures all bank deposits up to $250,000. (2) And when and where FDIC insurance falls short, both the government and the Federal Reserve have shown they will stop at nothing to provide trillions of dollars in asset and or debt guarantees, even equity capital to any and all banks to keep depositors in the banking system. I ask you, when’s the last time you saw a bank run? That’s right, the Great Depression. Today, the banking system can inflate without fear of a bank run.
On the eve of the Great Depression and until 1933, the US was on a gold standard, whereby domestic and international dollar holders could redeem dollars for gold. Gold redemptions, and the ever present threat of those redemptions, limited the amount of money the Federal Reserve could create. Today, there is no gold standard. FDR ended the right of US citizens to redeem their dollars for gold in 1933, and Nixon did the same to international holders of dollars in 1971. Did dollar holders avail themselves of the right to redeem their dollars for gold before 1933 and international holders before 1971? Yes they did. Now, the ultimate bank run, that being a run on the Federal Reserve itself, has been “outlawed.” The dollar is redeemable into nothing. As a consequence, the Federal Reserve is free to expand its balance sheet and print money to its heart’s content
On the eve of the Great Depression, the Federal Reserve’s monetization activities were essentially limited to Treasury securities, banker’s acceptances and direct loans to member banks, the latter largely consisting of rediscounted business paper. In 1932, the government greatly expanded those monetization tools by broadening the assets eligible as collateral against Federal Reserve loans. Today, with the passage of the Monetary Control Act of 1980 and several other “tweaks” along the way, the Federal Reserve can pretty much buy anything it wants, from any bank or non-bank that it wants, by writing a check on itself. And it can pretty much loan money to any bank or non bank that it wants, virtually with whatever collateral it deems worthy. Think Ben Bernanke’s alphabet soup of funding programs. Think the defacto nationalized of AIG.
Until the establishment of social security and unemployment insurance in 1935, there was no large scale federal social safety nets through which money could be injected into the economy. Today, we have a plethora of long standing, and deeply imbedded safety nets, overseen by politicians able, willing and ready to use them, especially when they are funded, not by taxes, but stealth through the printing press of the Federal Reserve. Think about that. The ability to inject an unending stream of newly printed money to needy recipients sure to spend. How big is this stream of money? Given that the unfunded liabilities of social security, medical insurance and other trust funds are some $55 trillion, about 3.5 times nominal GDP, and growing rapidly, very big indeed.
Hoover, FDR, indeed all subsequent administrations have given us all sorts of bailout packages over the years. But I think we can agree that we have never seen anything like this before. Some $30 trillion in bailout money has been advanced or guaranteed by the Treasury, FDIC and Federal Reserve in response to this crisis. And it’s likely not over. Simply unprecedented. Combine government bailout packages and social nets with the Federal Reserve’s printing press, and throw in a few government make-work programs for good measure, and what do you get? A huge and determined spender of last resort, with bottomless pockets. This year’s federal deficit, the one the Federal Reserve is now telling us it plans to increasingly monetize, is likely to surpass $2 trillion. And by the looks of it, we are only getting started.
On the eve of the Great Depression, the US was a nation of savers and a creditor to the world. Today we are the largest debtor in the world. Given that inflation favors debtors, vote seeking politicians can be “excused” if they see the “value” in inflation; and voters, neck deep in debt, with little savings to boot, can be “excused” for voting them into office. And if foreigners take dollars in return for their mercantilist toil, only to deposit those dollars in US government IOU’s wholly denominated in currency they know is coming off a printing press, then hey, what’s not to like about inflation. Sure the US is paying off its foreign obligations in deflated dollars, but foreigners don’t vote, right.
During the Great Depression, there were numerous voices, even inside the Federal Reserve, calling for free markets and advising against government intervention. Who today argues against an active government and for free markets? Very few. Think no further then the highly respected Federal Reserve Chairman Ben Bernanke. This is a man who has waited his whole career to prove that it was the Federal Reserve and its tight monetary policy before and after the stock market crash that gave us the Great Depression, that the correct policy response by the Federal Reserve post the stock market crash was to print money and to continue printing money until economic recovery was assured. Unfortunately, the opposite is the case, and it is why a Bernanke led Federal Reserve virtually guarantees inflation. Contrary to what Bernanke thinks, the Great Depression was caused by the low interest rate and loose monetary policies of the Federal Reserve in the 1920’s. These policies created the 1920’s boom which NECCESITATED the stock market crash of 1929 and economic bust of the early 1930’s. You see, by lowering interest rates and increasing the money supply, you create economic and financial distortions – mal-investments, which eventually must be liquidated. Sooner or later, the Federal Reserve induced boom of the 1920’s REQUIRED a bust, and there was nothing the Federal Reserve could have done to prevent it. (3) Does this have a familiar ring? It should, because it’s the same policies that caused today’s economic mess. So how can more of the same “fix” the current economic and financial crisis? It can’t. Indeed it will make matters worse. And when it does expect a clueless Bernanke to respond with yes, even more inflation.

Let’s recap. A run on the banking system or the Federal Reserve, what gave us the deflation of the 1930’s, is no more. The Federal Reserve and the fractional reserve banking system have virtually no limitations on their ability to inflate. The transmission mechanism through which money can enter the economy isn’t limited to just the banking system anymore and its ability or desire to pyramid loans on top of reserves. Not by a long shot. The Federal Reserve can inject money directly into the economy, bypassing the banking system altogether. And then there is the federal government as the spender of last resort, perhaps at this juncture, the most important inflation outlet in the new inflation toolset. And to top it all off, we have a clueless Ben Bernanke at the inflation levers, as the world cheers him on. Like I said, today’s monetary and political framework - it’s nothing like anything seen, ever.

TOPICS: Business/Economy; Culture/Society; Government; News/Current Events
KEYWORDS: doomgloom; moneylist; thecomingdepression

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