Posted tagged ‘Artifically Low Interest Rates’

Real Savings = True Credit. Printed Savings = False Credit

March 12, 2015

In this article titled, Understanding True Credit And False Credit, by Frank Shostak at mises.org, explains the difference between real credit that is backed by savings from real production, and counterfeit credit that is created by the printing press.

Don’t think of money when we talk in terms of real credit, think in terms of real things that are first produced, then saved and finally loaned as credit. Money is how we facilitate the exchange of goods and services either in the present or at some time in the future because of saving. Credit is a part of this future exchange.

Here are some excerpts from the article.

“Banks cannot expand true credit as such. All that they can do in reality is to facilitate the transfer of a given pool of savings from savers (i.e., those lending to the bank) to borrowers.

“Consider the case of a baker who bakes ten loaves of bread. Out of his stock of real wealth (ten loaves of bread), the baker consumes two loaves and saves eight. He lends his eight remaining loaves to the shoemaker in return for a pair of shoes in one-week’s time. Note that credit here is the transfer of ”real stuff,” i.e., eight saved loaves of bread from the baker to the shoemaker in exchange for a future pair of shoes….Note that the saved loaves of bread provide support to the shoemaker. That is, the bread sustains the shoemaker while he is busy making shoes. This means that credit, by sustaining the shoemaker, gives rise to the production of shoes and therefore to the formation of more real wealth. This is the path to real economic growth.

“The introduction of money does not alter the essence of what credit is. Instead of lending his eight loaves of bread to the shoemaker, the baker can now exchange his saved eight loaves of bread for eight dollars and then lend them to the shoemaker….Money fulfills the role of a medium of exchange. Thus, when the baker exchanges his eight loaves for eight dollars he retains his real savings, so to speak, by means of the eight dollars. The money in his possession will enable him, when he deems it necessary, to reclaim his eight loaves of bread or to secure any other goods and services.”

“The existence of banks does not alter the essence of credit. Instead of the baker lending his money directly to the shoemaker, the baker lends his money to the bank, which in turn lends it to the shoemaker. In the process the baker earns interest for his loan, while the bank earns a commission for facilitating the transfer of money between the baker and the shoemaker….Despite the apparent complexity that the banking system introduces, the essence of credit remains the transfer of saved real stuff from lender to borrower.

“Trouble emerges when instead of lending fully backed money, a bank engages in issuing empty money (fractional reserve banking) that is backed by nothing….When unbacked money is created, it masquerades as genuine money that is supposedly supported by real stuff. In reality however, nothing has been saved. So when such money is issued, it cannot help the shoemaker since the pieces of empty paper cannot support him in producing shoes — what he needs instead is bread. Since the printed money masquerades as proper money it can be used to divert bread from some other activities and thereby weaken those activities. This is what the diversion of real wealth by means of money out of “thin air” is all about.”

“We can thus conclude that as long as the increase in lending is fully backed by real savings it must be regarded as good news since it promotes the formation of real wealth. False credit, which is generated out of “thin air,” is bad news since credit which is unbacked by real savings is an agent of economic destruction.

Here is a previous post titled, Printed Money Doesn’t Represent More Savings, in which we talk about how electronically printing counterfeit money doesn’t produce any good or service, it is just the creation of a piece of paper that allows who ever receives it the legal right to demand someones production.

Related ArticleWhat Comes First, Production Or Consumption, at austrianaddict.com.

Related ArticleCapital Consumption aka Eating Our Seed Corn, at austrianaddict.com.

Related ArticleThe Role Of Interest Rates In A Market Economy, at austrianaddict.com.

Charles Hugh Smith – After 6 Years Of Unprecedented Central Planning, The Economy Is More Fragile Than Ever

June 23, 2014

File:Organiztion of the Federal Reserve System.jpg

Charles Hugh Smith does another brilliant analysis of how central planning, by the Federal Reserve, has markets completely distorted to the point that nobody knows what is real or fake, in this article, After 6 Years Of Central Planning, The Economy Is More Fragile Than Ever.

Artificially holding interest rates lower than they would be in an unhampered market, distorts the production process. It brings about economic activities that wouldn’t have existed if the market was left to decide what the interest rate should be. Interest rates “coordinate production across time”.  Any interference with the knowledge that passes through the production process, because the interest rate is distorted by the Fed, consumes scarce resources, scarce capital, and scarce labor. As we talked about in this article Capital Consumption, aka, Eating Our Seed Corn, and this article, A Look Over The Horizon At What Lies Ahead If We Continue Down The Central Planning Road.

Here are some excerpts from CHS’s article.

“Here are the key characteristics of Central Planning:”

1. “The central bank/state intervene in the economy in a dominant fashion, controlling functions such as interest rates…”

2. “The central bank/state pick winners and losers: ….. The central bank/state bailed out the too big to fail banks private losses with public-taxpayer money. In effect, the central state/bank enrich cronies at the expense of everyone else.”

3. “The central bank/state manipulate the nominally “free” market to boost asset valuations as a way of enriching cronies who own most of the financial assets and as a public-relations charade to mask the failure of their picking winners and losers.”

“In other words, in centrally planned economies, markets are not allowed to discover price–they exist only to reflect positively on Central Planners.”

4. “The central bank/state use the power of the printing press to create as much money as they need to reward cronies and cram their decisions down the throat of the economy.”

5. “The central bank/state use the power of their public policy announcements to manipulate behavior and the financial markets while keeping programs that might attract scrutiny secret.”

“Central planning fails for intrinsic reasons unrelated to the specific policies. The decentralized, self-organizing market is like the immune system for the economy; it keeps the system healthy by burning off the deadwood of failed bets and failed investments and distributing credit and risk on performance rather than cronyism.”

“By eliminating the economy’s immune system, Central Planning dramatically increases vulnerability and guarantees systemic crises down the road…”

“The economy becomes dependent on the The central bank/state intervention and loses the ability to function in the real world. When the real world finally intrudes, the weakened, strung-out addict, no longer capable of responding to reality in a positive fashion, expires.”

The damage done by Central Planning has yet to come home to roost. Six years into the Grand Experiment–that Central Planners can pick winners who just happen to be their cronies–the chickens of consequence are still making their way home.”

CHS  has some great charts that show the results of the Feds interventions, which are hard to see let alone understand. As J.M. Keynes wrote, “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

In order to understand what Keynes was talking about concerning counterfeiting by central banks, you first have to understand this quote by his rival F. A. Hayek, “The coordination of mens activities through central planning or through voluntary cooperation are roads going in very different directions, the first to serfdom and poverty the second to freedom and plenty.”

Voluntary cooperation through free markets brings about individual freedom and a higher standard of living, while its opposite, central planning, brings about coercion by the state and a lower standard of living.

Related Article/VideoKeynesianism vs. The Austrian School, by austrianaddict.com.

Related Article/VideoKeynes vs. Hayek Round II, The Fight Of The Century, by austrianaddict.com.