Scaring away elephants

The following excerpt is a little harder to read than most of the stuff I use, but it has important points, especially about the key problem with the worldwide economy, and america's economy in particular.

"The problem is that the recession is not due to a lack of aggregate demand, whatever that may actually be, but due to what Friedrich Hayek, winner of the 1974 Nobel Prize in economics, called malinvestment. Hayek subscribed to what is now called Austrian business cycle theory. This theory is that business cycles are caused by credit injections by the central bank which artificially lower interest rates. This lowered interest rate distorts the price signal for producers as to the willingness of consumers to forgo consumption today in return for goods in the future. Producers then engage in production of capital goods, such as housing, for which the demand is not sustainable. The upside of the business cycle results in overemployment in certain industries. When the credit expansion ceases, or in some cases, merely slows down, the reality of demand and supply becomes apparent. In order for labor and other resources to move to industries where the demand is sufficient to sustain employment, labor and resources must become temporarily unemployed. This is the downturn of the business cycle.

In his Nobel address, “The Pretence of Knowledge,” Hayek explained that once the central bank has set in motion the excess liquidity that distorts the price signal for savers and investors, there is little to be done other than await the market response that will result in equilibrium in the goods and labor markets. The labor and resources that have been misallocated will eventually find their proper location. Attempts by government to prop up prices and artificially stimulate demand in the sectors with malinvestment will only continue the misallocation and lengthen the time it takes for resources and labor to find those industries where consumer demand is sufficient to employ them.

The recent recession is a textbook case of Austrian business cycle theory. The Federal Reserve lowered the federal funds rate from 6.4% in December of 2000 to 1% by July of 2003 and kept the rate there for one year. Then, fearing inflation might occur, the Fed increased the rate gradually to 5.24% in July of 2006. The lowering of the interest rates created an artificial boom in housing, with the malinvestment of resources that Austrian business cycle predicts. Once the artificial interest rates were lifted, it became clear that the demand for housing was not sufficient to maintain absorb the amount of housing that had been built and sustain the employment of resources in the housing industry. Housing prices collapsed and the distortion of resources was felt throughout the economy.

A problem with ability of the market system to repair itself and create wealth for the masses is that government action which slows the recovery will be held up as having been the cause of the recovery. In the past I have suggested this is akin to the story of the man who is sitting on a park bench and every two minutes jumps up and waves his newspaper in the air. A second man, observing this for awhile, walks up and asks what the first man is doing. The first man says, “I’m scaring away the elephants.” “There are no elephants around here,” protests the second man. The first man responds, “See. It works.”

This is what is happening as our federal government engages in stimulus packages, health care reform, regulatory reform, and every other reform of which it can think. Each action actually slows down and hampers the recovery, but the economy still makes steady progress repairing itself and thus the federal action is held up as if it were the cause of the recovery."

Full article

The bottom line of this article is that government shenanigans like you see in chart above, with the explosion in the amount of money the Fed has made available (borrowed and printed), causes huge distortions in the market as people react to the mountain of more or less free money. This causes bubbles, then downturns, which we don't need. Then the government screws around some more and pretends to fix the problem while making it worse and simultaneously funding all their pet projects that help their friends. Despite what they have done, the economy recovers and the useless politicians say, "Tada! It worked."