In March of this year, wrote that the credit crisis is not an issue of liquidity but of malinvestment enabled by central banking’s penchant for inflation. This was also the chief cause of the Great Depression, and many economists’ misreading of the Depression as a liquidity problem has led the supposed free-market oriented Monetarists into the weeds ever since.
There is a good article over at the Von Mises website about why the bailout will delay recovery by continuing to prop up these bad investments, whether they are derivatives secured by worthless housing or anything else that is tanking. To proponents of the bailouts, Frank Shostak writes:
They argue that were it not for the Fed’s injecting $105 billion and the subsequent announcement of the rescue package, the stock market would have had a massive fall. They also believe that the massive monetary injection prevented a run on money-market mutual funds and prevented a major disaster.
They further believe that if people had taken the money out of their money-market mutual funds, banks wouldn’t be able to secure money to fund credit cards and various consumer and business loans. This in turn would have paralyzed the economy.
So let us think about this. Say that people take their money from the money-market mutual funds. What happens then? They will have placed it somewhere else, mostly likely with commercial banks. Hence money wouldn’t disappear and banks could continue to fund activities as before.
If large money-market funds were to go under, some of their assets would be sold and the shareholders would suffer losses; this however, cannot provide justification for the Fed to pump money and to introduce a rescue package. Monetary expansion and a rescue package do not undo the bad investment decisions of the money-market-mutual-fund managers. Why should people who didn’t risk investments in the fund pick up the tab?
A fall in asset prices, including stocks, and a run on financial institutions are just symptoms and not the cause of anything. The key factor behind the current difficulty in the credit markets is the lagged effect coming from the Fed’s tighter stance between June 2004 and August 2007, when the federal-funds-rate target was raised from 1% to 5.25%.
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