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Too Much Central Banking

UrukaginaNov 5, 2019, 7:09:39 PM

The Austrian School of Economics shows how central banks can cause business cycles (booms and busts) by messing around with the money supply. If a central bank prints a lot of money and then dumps it into the markets, a different signal gets sent out to producers and consumers.

On the producer side, the extra money sends the signal that savings are ample, so that people are just walking around with a lot of excess cash from prior earnings (and loads of it stored up in the bank as well).

If that really were the case, then it'd be a good time for producers to begin longer-range projects with lower payouts--projects which were previously unfeasible--because the increase in real discretionary income (income beyond already-funded savings) justifies that there will be extra cash around to pay for it all.

On the consumer side, the extra money drives down interest rates--the "price" on loaned money--so that saved cash no longer earns as much of a return as before. This induces consumers to empty out their savings accounts and to spend all of the money on immediately-available goods.

It doesn't take a rocket scientist to figure out what happens next: At some point in the production cycle, the producer begins to realize that there actually isn't going to be a surplus of savings around by the time the "longer-term/lower-payout" project comes to fruition.

The recession which follows is the necessary market correction, as the producer retires the misallocated resources of his now-defunct production line. In reality, that line of production was always defunct--i.e., society "never" had the resources to pay for it. The producer was hoodwinked by the central bank.

To keep people from understanding how much harm the central banks are doing (how much they harm the affordability of our living standards), it is necessary to hide the inflation caused by the printing of money, and one way to do that is to just hide the money (by artificially and arbitrarily preventing a rise in money velocity).

In a carnival shell game with 3 walnut shells and a dried pea--your task is to follow the pea as it is shifted under one of 3 different walnut shells, all while the carnival employee with fast hands is trying to trick you (by quickly shifting the shells around so that you lose track of the pea).

While there may be some honest and genuine reason for the central bank to begin--in late 2008--paying interest on excess bank reserves, it must be acknowledged that a "possible" reason for it is to hide money in the bank vaults. Even if the policy was undertaken with pure motives, it must be acknowledged that it can now be misused to hide excess money.

If you do not hide excess money, prices rise and people become alarmed.

If a central bank is printing money to purchase real assets (things which should only ever be bought by market participants, not by central banks)--such as during the unconventional policy of Quantitative Easing--it could conceivable hide the excess money in bank vaults, preventing the public from discovering how much activity is happening behind the scenes to prop-up faultering markets.

The real solution is economic freedom (let markets adjust to reality), but to continue with a false solution--an artificial cover-up of lowered affordability of living standards (from a prior loss of economic freedom)--you must hide the money somewhere where the people wouldn't question it.

Here is the unconventional policy of awarding banks interest on excess reserves they hold:

Possibly-perverse Incentive for Banks to Hoard Cash

And here is a graph showing how the interest rate awarded to the banks has been above the federal funds rate--the rate for short-term, inter-bank loans--so that the banks would be incentivized to hoard cash, rather than to loan it out and get the economy moving again (with the risk of causing inflation):

Over 3 times the Earnings by Hoarding instead of Loaning

Note how even in 2019, it is still not any more profitable for a bank to loan to other banks, compared to simply hoarding cash in its own vaults. The advantage of hoarding here is because the "debtor" (the one paying interest) is the Federal Reserve itself, giving essentially a "risk-free" return on investment--whereas lending to other banks comes with some (minimal) risk.

The upshot is not that central banks are doing their job better. The affordability of living standards is actually falling, not rising (like it does in free markets).

The upshot is that central banks are better at covering up how bad they do their job--they are now better at hiding their mistakes, so that we can't easily see how they're lowering the affordability of living standards (and making our lives worse off).

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[1] Board of Governors of the Federal Reserve System (US), Interest Rate on Excess Reserves [IOER], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/IOER

[2] Board of Governors of the Federal Reserve System (US), Effective Federal Funds Rate [FEDFUNDS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FEDFUNDS