Carte Blanche: The Amazing Trump Economy And The Bubble

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Nobody seems to realize that we are at currently at the end of a monetary policy test. The past ten years of dramatically low-interest rates is an experiment of fiscal stimulus that the United States has never experienced in this length and scale. Although it's clear why nobody will realize this because in our political climate we consider central banking and monetary policy to be complicated matters that only government approved economists are capable of understanding, and this is exactly the notion the Federal Reserve wants you to have. Politicians would love to point out the expansion as proof that monetary stimulus “works”, however, before they make this bold claim we have to completely end the credit expansion and raise interest rates without a recession. They will have to show that the expansion of the past decade is not a bubble economy. Similar to the 2008 financial crisis, when this next one hits, politicians will act like nobody could have possibly predicted the recession, when in reality plenty of conscious people have, and many have something in common. Austrian school economists have predicted nearly every financial crisis of the last century, including 1929 and 2008, specifically with the reasoning of Austrian business cycle theory.

Austrian business cycle theory is best understood with a basic knowledge of interest rates, and the difference between free-market and central bank manipulated interest rates. Put in the simplest terms, the rate of interest is the market price to borrow saved resources in the present. The debtor borrows money because they value the money in the present more than the equal amount plus interest at a future date. Likewise, the creditor values the future amount plus interest over the number of saved funds in the present. Interest rates are always positive in the marketplace because we value goods in the present more than equal goods in the future. The debtor and creditor make this mutually beneficial exchange because they have different subjective values, more specifically, different time preferences. In a free market, supply and demand determine the rate of interest, similar to any other good or service, where demand is simply the demand for credit in the present, and supply is the amount of saved, or loanable funds. Since a free market does not have a central authority that can print or digitally create new money, credit can only be taken from real savings, resources deferred from present consumption. Therefore, increased saving lowers the interest rate in a free market, because the supply of loanable funds has increased. (Garrison, 113).

Time is an extremely important factor in economics, specifically time preference. Increased savings is not only an increase in loanable funds but an indication that individuals prefer less consumption in the present, in exchange for more abundant consumption and living standards in the future. Saving must always have an inverse relationship with present consumption. When entrepreneurs invest loanable funds, the interest rate plays a role in the type of capital to which they will invest. Capital is not homogenous nor quantifiable, but it can be ordered by its distance from the final consumer good that it will later produce. If the final consumer good is a cotton shirt, the higher ordered goods are sheets of cotton, and the even higher ordered goods are cotton plants to be farmed. Lower interest rates signal investors to invest in higher ordered goods which produce a higher amount of consumer goods at a point relatively further in the future. Higher rates, on the contrary, induce investments closer to the final good. These investment signals also coordinate with the time preferences of savers, because increased saving shows the desire to defer consumption in the present in exchange for increased consumption in the future. The action of increasing saving increases the supply of loanable funds and lowers the interest rate, leading investors to make choices that coordinate with the time preferences of society.

Now, while free-market interest rates are determined in this framework, what happens when a central bank enters the picture and manipulates the market for credit, by artificially lowering interest rates? The first thing to point out is how the interest rate becomes lower. Since the manipulated rate is lower than the market rate, there are not enough real savings to sustain the low rate, so the banks must create money out of “thin air”, through the process of fractional reserve banking. The central bank, the Federal Reserve System directs this process with reserve requirements, a process best explained in The Mystery of Banking, by Murray Rothbard. The important thing to note is that artificially low-interest rate policy necessarily means an increase in the money supply. However, the inflationary credit expansion also changes the incentives for investors. The new lower rates signal investments in higher ordered goods, just like in a free market, but the saving and time preferences of society has not changed. Therefore, the manipulation creates capital investments that are in higher stages of production than society demands, and are therefore malinvestments.

In the period of low-interest rate policy, or “easy money” the malinvested capital is seen by the public and political atmosphere as a booming economy and bull market. As long as they can be fueled with artificially cheap credit, the malinvestments will not be revealed as unprofitable. Furthermore, the sweeping monetary policy of the entire country by the central bank will mislead investors in masses. These boom periods are the periods known as the “Roaring Twenties” or the period of unlimited housing prices before the 2008 crash. Whatever politicians are in power will claim the booming economy as the result of their own policies, and they will have the self-interested incentive to keep the easy money policies going as long as possible at the Federal Reserve. Regardless of politics, the malinvested capital must eventually be liquidated in a recession. The central banks cannot inflate forever as this is unsustainable, or they can “normalize” monetary policy, which will inevitably expose the malinvestments and begin the recession.

What then happens during the crash, or depression? After interest rates are normalized, the malinvestments become unprofitable, as the only reason they were made profitable in the first place was from the manipulations by the central bank. In other words, the central planning induces investment decisions that otherwise would not have happened. Therefore, this fiscal stimulus is not sustainable growth and must have an end. The recession period is then a period of the correction and reallocation of time preferences and the liquidation of malinvested capital. Many of the malinvestments have already been physically built, and the workers must be unemployed and the prices of the assets rapidly fall. The culprit of the depression is the central bank for creating the unsustainable bubble in the first place, and the only way “out” is to let the reallocation proceed. A recession is not simply a fall in so-called “aggregate demand”. It is a period of accumulated business failures being liquidated and freed up for more productive uses.

In the current state if the economy, the Federal Reserve has embarked on the longest credit expansion in the history of humanity. After the recession of 2009, the Fed pushed interest rates to their lowest level in American History at 0.25%. Furthermore, this period led to three rounds of quantitative easing (QE) from 2008-2013, where the Fed directly increased its balance sheet and the money supply. The M2 money supply has nearly doubled during this ten year period of easy money.

In the latest years, the Federal Reserve has attempted to “normalize” interest rates and sell off the balance sheet. Although interest rates are higher than near zero rates, they are still lower than they would be on the free market, and all that needs to happen for malinvestments are rates lower than they otherwise would have been. In December, we saw the stock market fall dramatically to a slight tightening of monetary policy. This should be a signal that the entire so-called Trump economy is a house of cards.

A collapse of the ten-year bubble will have an enormous impact on American politics. Republicans have made the devastating decision to claim the current bull market and low unemployment as the Trump Economy ™. After crediting the entire ten-year expansion’s illusionary effects to the Trump Administration, the public and the Democrats will likely credit the Republicans with the crash as well. This mistake by the GOP is made by several errors. The first is the idea that if the Fed raises rates gradually, the already-created bubble will disappear into the ether. This makes little difference in exposing malinvestments to the economy. Now, it is entirely possible that Trump only believes in low rates now to kick the can down the road until he is reelected, because a financial crisis would probably end hopes of winning in 2020. It is also possible that he really has no idea, similar to many Republican politicians and conservative supporters, which leads to another error, which is that modern conservatism ignores the Federal Reserve as a political issue. Other errors include the deification of Trump through the euphoria of his election, with the refusal to acknowledge any negativity about the economy under his watch.

The Democrats, on the other hand, will most likely use the recession to take power and blame it on all the wrong reasons. Similar to every recession in American history, the culprit will always be the same on the left: unregulated capitalism. Even centuries after abandoning laissez-faire, for them, it is still to blame during any recession and will be at any point in the future. If the boom turns into a bust before 2020, it would probably create the possibility of a far-left candidate to win the presidency. The stage is perfectly set for another depression caused by the “ravages of capitalism” and deregulation, and for a New Deal 2.0 to nationalize more major industries, expand the administrative state, implement green programs, inflate the currency, “make-work”, and more. But this isn’t 2008, and there is already $22 trillion of debt. Do they launch even more rounds of Quantitative Easing (QE) and double or triple the federal deficit? It is for this reason that Peter Schiff believes the recession will be inflationary rather than deflationary.

To contrast, the likely politics of bubbles and recessions, what are the best actions governments can take in the current scenario? Based on Austrian business cycle theory, and the economics of the crash, there is a clear agenda to allow the best living standards of individuals to sustain. At this point, the bubble already exists and the recession is inevitable, so the question is over how to handle it. During the contraction, the economy changes. Malinvestments liquidate, insolvent banks fail, workers change jobs, and the cycle is seen as a sharp rise in unemployment and failure of businesses. This is all happening to realign the distortions originally caused by the credit expansion. With this in mind, Murray Rothbard suggests the things governments should absolutely not do in this case, in his book, America’s Great Depression. They should not artificially fix prices higher than they would be on the market, including wages. They should not artificially “make-work” or embark on new spending programs. No bailing out failed businesses, including any bank, and no tax increases. Finally, and importantly, the central bank should not begin a new artificial credit expansion! In other words, the government should not intervene to keep the market from reallocating resources out of a mess that they caused.

Unfortunately, it is most likely that the government will do the exact opposite of these suggestions. The Democrats already favor many of these interventions whether we are in a recession or not. On the other hand, Republicans have shown that they support unlimited deficits too, and many of the same interventions as Democrats. The only way to prevent this problem in the future would involve major ideological shifts in mainstream politics, to support of laissez-faire banking and an abolition of the Federal Reserve. Keynesian economics must be overhauled from mainstream political thought, with the correct understanding that monetary inflation always distorts the capital structure of an economy. John Maynard Keynes wrote, “in the long run we are all dead”. This next recession will be the long run he is referring to. The collapse of the housing bubble in 2008 was a Keynesian “long run”, as well as the Great Depression.