Excess liquidity drowns productivity

Two excellent quotes from John Hussman’s market commentary this week (see: Recognizing the risks to financial instability) The first is from Austrian School Economist Ludwig von Mises, writing about failed monetary stimulants in 1931:

“Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not a real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth [i.e. the accumulation of savings made available for productive investment]. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later, it must become apparent that this economic situation is built on sand.” –Ludwig von Mises, The Causes of Economic Crisis (1931)

The second is from former Federal Reserve Board member Adolph Miller, testifying to the U.S. Senate in 1931 about the Federal Reserve’s 1927 rate cuts and open market purchases (their QE) – which fueled wild-eyed financial speculation into the 1929 peak followed by the -89% market crash and Great Depression thereafter:

“It was the greatest and boldest operation ever undertaken by the Federal Reserve System, and, in my judgment, resulted in one of the most costly errors committed by it or any banking system in the last 75 years. I am inclined to think that a different policy at that time would have left us with a different condition at this time… Business could not use and was not asking for increased money at that time.”

Useful to be reminded that central banks have wielded the monetary madness of excessive liquidity several times over the past 100 years, and always to a devastating outcome. Still they are allowed–nay begged–by politicians and bankers to continue.

An aggravating feature in this saga, is that America is the birth place of modern finance and has served as a monetary policy architect and leader for the rest of the world. American trained economists devised the lax monetary policies that led to Japan’s credit bubble peak in 1989 and ongoing collapse ever since. It was none other than Ben Bernanke who as a Princeton professor in the 1990s, lectured Japanese officials for not aggressively doing asset purchases (QE). Japanese policy makers resisted for several years, pointing to the catastrophic effects of QE on the American economy in the late 20’s.  But finally in March 2001, the Bank of Japan capitulated and began buying government bonds and flooding commercial banks with excess liquidity that the real economy and businesses did not need or want.  The BOJ has done more of the same in fits and starts ever since as the economy has stagnated further.  Despite a series of speculative rallies (and then drops), the Japanese stock market remains today 50% below its 1989 peak.

In the past few years, the same destructive theories have spread like wildfire through the international policy-directing gurus, with Europe and China following suit.  To try and sustain unsustainable growth rates after 2008, China engaged in the greatest credit pumping episode in human history and still their economic growth rate has halved since 2007–and falling.

This week the Chinese government cut interest rates for the third time in the 6 months to try again and force more consumption on credit.  But as in the credit-pumping efforts of 1927, and all the QE renditions ever since, more credit is not wanted and can only make economic conditions more precarious.  The historical evidence is clear, excess liquidity created by debt does not buoy productivity and growth.  It drowns it.

While Sunday’s rate cut will induce “a short-term pop” on markets, it will not resolve the slowdown in economic growth, says Richard Jerram, chief economist at Bank of Singapore.  Here is a direct video link.

Also see: China’s stock market boom won’t erase bad debts, the wrong companies are taking advantage of China’s frothy markets

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