October 2011 issue of Freedom's Phoenix magazine - fr33aid

Continued from Page 34 - The Myth that Laissez
Faire Is Responsible for Our Financial Crisis
increase in the amount by which the checking
deposits of the banks exceeded the banks' reserves
of actual money, that is, the money they
have available to pay depositors who want cash.
The Federal Reserve caused this increase in illusory
capital by means of creating whatever new
and additional bank reserves as were necessary
to achieve a Federal Funds interest rate — that
is, the rate of interest paid by banks on the lending
and borrowing of reserves — that was far
below the rate of interest dictated by the market.
For the three years 2001—2004, the Federal
Reserve drove the Federal Funds Rate below 2
percent and from July of 2003 to June of 2004,
drove it even further down, to approximately 1
percent.
The Federal Reserve also made it possible for
banks to operate with a far lower percentage
of reserves than ever before. Whereas in a free
market, banks would hold gold reserves equal
to their checking deposits, or at the very least
to a substantial proportion of their checking
deposits, 6 the Federal Reserve in recent years
contrived to make it possible for them to operate
with irredeemable fiat money reserves of
less than 2 percent.
The Federal Reserve drove down the Federal
Funds Rate and brought about the vast increase
in the supply of illusory capital for the purpose
of driving down all market interest rates. The
additional illusory capital could find borrowers
only at lower interest rates. The Federal Reserve's
goal was to bring about interest rates so
low that they could not compensate even for the
rise in prices. It deliberately sought to achieve a
negative real rate of interest on capital, that is,
a rate below the rate at which prices rise. This
means that a lender, after receiving the interest
due him for a year, has less purchasing power
than he had the year before, when he had only
his principal.
In doing this, the Federal Reserve's ultimate
purpose was to stimulate both investment and
consumer spending. It wanted the cost of obtaining
capital to be minimal so that it would
be invested on the greatest possible scale and
for people to regard the holding of money as a
losing proposition, which would stimulate them
to spend it faster. More spending, ever more
spending was its concern, in the belief that that
of the same dates. I then subtract the result for 2001 from that for 2008
and divide the difference by the sum calculated for 2001.
6 If the creation of checkbook money in excess of currency holdings
is in fact an attempt at cheating, as I described it earlier, then it
follows that a free market would actually require a 100 percent reserve.
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is what is required to avoid large-scale unemployment.
As matters have turned out, the Federal Reserve
got its wish for a negative real rate of interest,
but to an extent far beyond what it wished.
It wished for a negative real rate of return of
perhaps 1 to 2 percent. What it achieved in the
housing market was a negative real rate of return
measured by the loss of a major portion of the
capital invested. In the words of The New York
Times, “In the year since the crisis began, the
world's financial institutions have written down
around $500 billion worth of mortgage-backed
securities. Unless something is done to stem the
rapid decline of housing values, these institutions
are likely to write down an additional $1
trillion to $1.5 trillion.” 7
This vast loss of capital in the housing debacle
is what is responsible for the inability of banks
to make loans to many businesses to which they
normally could and would lend. The reason
they cannot now do so is that the funds and the
real wealth that have been lost no longer exist
and thus cannot be lent to anyone. The Federal
Reserve's policy of credit expansion based on
the creation of new and additional checkbook
money has thus served to give capital to unworthy
borrowers who never should have had it
in the first place and to deprive other, far more
credit worthy borrowers of the capital they need
to stay in businesses. Its policy has been one of
redistribution and destruction.
The capital it has caused to be malinvested and
lost in housing is capital that is now unavailable
for such firms as Wickes Furniture, Linens
'n Things, Levitz Furniture, Mervyns, and
innumerable others, who have had to go bankrupt
because they could not obtain the loans
they needed to stay in business. And, of course,
among the foremost victims have been major
banks themselves. The losses they have suffered
have wiped out their capital and put them out of
business. And the list of casualties will certainly
grow.
Any discussion of the housing debacle would
be incomplete if it did not include mention of
the systematic consumption of home equity encouraged
for several years by the media and an
ignorant economics profession. Consistent with
the teachings of Keynesianism that consumer
spending is the foundation of prosperity, they
regarded the rise in home prices as a powerful
means for stimulating such spending. In increasing
homeowners' equity, they held, it enabled
homeowners to borrow money to finance additional
consumption and thus keep the economy
operating at a high level. As matters have turned
out, such consumption has served to saddle
many homeowners with mortgages that are now
greater than the value of their homes, which
would not have been the case had those mortgages
not been enlarged to finance additional
7 Joe Nocera, “Shouldn’t We Rescue Housing?, October 18, 2008,
p. B1.
Continues on Page 36
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