Recent Banking Trends Offer Clues About The Business Cycle

Forbes ^ | 10/16/2012 | Bill Flax

[billflax]

Recent banking trends offer subtle clues about the business cycle. The financial crisis which burst across world markets in 2008 stemmed from explosive monetary policy during the preceding period. An old banking adage holds that the worst loans fund in the best of times.

Greenspan’s Put and Bush’s deficits injected cortisone after the tech bubble dislocated markets and 9/11 hit. Instead of allowing the recession’s curative surgery, intrinsic weaknesses were perpetuated. From artificially low interest rates and devalued dollars to fiscal deficits rewarding idleness, federal policies prodded us from savers to borrowers and from producers to consumers.

Nothing can be borrowed which isn’t first saved; nothing purchased which isn’t produced. With interest rates low and inflation high, Americans consumed all they made and more. Household wealth and personal income spiked, but debt climbed faster peaking at 359 percent of GDP before the crash.

When currency weakens, nominal prices rise. From 2003 through 2006, GDP grew about 3 percent annually, but residential real estate appreciated over 10 percent per annum and stock prices shot feverishly higher. Approximately three quarters of increased GDP came via Americans borrowing against inflated home values in a circular logic which ultimately unwound.

[billflax]

End the Fed, cut federal spending and stablize the currency to smooth out business cycles.

[Tublecane]

This is an oddly accurate assessment. Why wasn’t anyone saying this four years ago? Or, more pertinently, why wasn’t anyone listening.

I suppose it’s easier to say now that it’s not an emergency, fire is not raining from the heavens, and responsible government office owls are not threatening people with martial law to get their way.

Our knee jerk reaction in times of crisis is to Do Something, which means government doing something. So long as monetary policy can reliably produce crises, and it will, they can blame the market and subsume us all under the iron fist of help.

[mjp]

Most alarmingly, Washington combats the recession by rehashing the policies which engineered financial turmoil: low rates, weak dollars and large deficits.

And then, when inflation starts to get out of control during the expansion phase, the government becomes afraid of hyperinflation and has to put the brakes on the creation of money out of thin air. When there is a significant deceleration in the growth of the money supply, there is another contraction phase, and financial crises, and recession.

[billflax]

My Forbes page and book are both titled The Courage to do Nothing for that very reason. It takes courage for politicians to do nothing.