Smiling Dave usually doesn’t read Hayek. He has been warned that Hayek was a little weird. But the latest imbroglio about Hayek and Sraffa got him curious, and he found an amazing quote from Prices and Production. The good professor Hayek wrote the book in 1932, and every last word could be talking about 2012.
BTW, it turns out everything he wrote before 1941, or after he got his Nobel Prize in 1974, is kosher. The interim period is when he went Socialist, poor fellow.
The quote, without further ado. As always he gets the italicized font, and Smiling Dave will comment in regular font.
To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection…
First, let’s explain a technical term. Forced Credit Expansion means lending people money that isn’t really there. Banks do this all the time, writing checks to people when their vaults don’t actually have the cash to cover the check. It’s legal, sadly, and called Fractional Reserve Banking. The Federal Reserve Bank does this a bit differently, printing money. In Hayek’s time when there was a gold standard, this would mean printing paper money redeemable for gold when the Fed didn’t have the gold to cover the paper money. Nowadays, when there is no gold standard, it’s just plain old printing money, paper or digital. Another phrase that is used instead of forced credit expansion is increasing the money supply.
Important stuff here. Hayek is saying that the inflation of the money supply in the 1920’s caused people to waste valuable resources on idiotic projects, which is what caused the Great Depression. Followers of AE are familiar with this, and it is all laid out like a Greek tragedy in Rothbard’s book, America’s Great Depression.
Let’s look at how prophetic Hayek was about 2012. Allan Greenspan printed tons of money [after the crash of the NASDAC bubble], causing the housing bubble, and the housing bubble collapsed and caused our current Great Recession. Same pattern exactly. Forced credit expansion causing misdirection of production, meaning building more houses than people could actually afford to buy. And sure enough, Bernanke went ahead and tried to cure the evil by the very means which brought it about, giving his digital money printing the Orwellian name of Quantitative Easing. And as Hayek pointed out so correctly, because we are suffering from a misdirection of production [=housing bubble] we want to create [by QEs] further misdirection.
And now Hayek says something very important:
—a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end.
In other words, the QEs will work, sort of, as long as they keep on going. Think about it. Peter Schiff says we are now in a govt bubble. The politicians are “creating jobs” by having people work for the govt. A good example is govt ownership of GM, giving jobs to people who are making cars at a loss, to the tune of $50,000 per car. That’s right, every Chevy Volt means a net loss of 50,000 bucks for GM. Other examples of parasitic jobs on a huge scale are all our military spending, all the money wasted on the TSA and the department of Homeland Security in general, on govt schools and teachers, and all the vast bureaucracy of govt. Another waste is just giving money for not working at all, meaning all those welfare and unemployment checks and food stamps.
Of course, such jobs are parasitic jobs, since they do not create anything useful. And how are these people paid? By printing digital money to pay them, that’s how. So all that labor, which could be doing something useful, is misdirected into being parasitic, and the credit expansion is what pays for it all.
Hayek is telling us this insane system will work, until the govt stops printing money to pay all these people. What he doesn’t mention here is why the govt should ever stop. But the answer is well known, and Mises spelled it out in Human Action, that if they keep it up long enough the dollar will lose all value, and we will become Zimbabwe.
It would not be the first experiment of this kind that has been made. We should merely be repeating, on a much larger scale, the course followed by the Federal Reserve System in 1927, an experiment that Mr. A.C. Miller, the only economist on the Federal Reserve Board and at the same time its oldest member, has rightly characterized as “the greatest and boldest operation ever undertaken by the Federal Reserve System,” an operation that “resulted in one of the most costly errors committed by it or any other banking system in the last 75 years.”
2012 minus 75 is 1937. Again, it took about 75 years for the Fed to get up the sheer arrogance to try a new “experiment”. Bernanke admitted that the QE he is unleashing on the USA has never been done before, and he himself is not sure what will happen. Never has so much money been printed in the US on such a massive scale, and boy is that error proving costly.
It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression.
Once again, Hayek is telling us something incredibly important for today. All that money printing, what he calls “the experiment”, is awful indeed. It’s what caused the exceptional severity of the recession we are in right now. But depressions don’t usually last for years and years. For that you need the govt’s bumbling attempts to “fix things”, what Hayek describes as “the attempts to prevent liquidation once the crisis had come”. In Hayek’s time, it was the Hoover dam and FDR’s many ridiculous programs. Today, it’s what we know as the bailouts. The bailout of the big banks, of the auto industry, of the unemployed, all the things the govt brags about as having saved the world from disaster, are responsible for the exceptional duration of our 2012 depression. If you are reading this and don’t have a good job, or any job, now you know why.
We must not forget that, for the last six or eight years, monetary policy all over the world has followed the advice of the stabilizers.
The stabilizers back then saw that prices might fall due to increased productivity from technological advances, and wanted to make sure prices stayed the same. Their method was lots and lots of credit expansion. We too, have these guys around nowadays. They are the central bankers here and in Europe, who warn us of the terrors of deflation, and promise us that they will print mountains of money to make sure prices never go down, God forbid. And Hayek speaks to us from across the years, advising us what to do with these guys:
It is high time that their influence, which has already done harm enough, should be overthrown.
This means you, Ben Bernanke, and all of your ilk.
We cannot hope for the overthrow of this alluringly simple theory until its theoretical basis is definitely refuted and something better substituted for it.
In other words, until everyone out there reads Smiling Dave’s humble blog and understands Austrian Economics, we can’t do anything.
Hayek goes on to be rather pessimistic about our chances. People want a quick fix, and there is none:
The opponents of the stabilization program still labor—and probably always will labor—under the disadvantage that they have no equally simple and clear-cut rule to propose; perhaps no rule at all that will satisfy the eagerness of those who hope to cure all evils by authoritative action.
This too, is prophetic. The govt has created a whole class of people who can only live by being parasites. What will we do with all those people who live on Social Security checks, who rely on Medicare and Medicaid and welfare and unemployment checks, who have nowhere to go but to Iraq and Afghanistan to kill people for money? The govt has made it very difficult for them to get real jobs, and for anyone to save for their old age. We are in a big big mess. There is no simple and clear cut way out of this. All we know for sure is that we have to avoid anything that will make things worse, like exactly what Obama has done and wants to keep on doing.
But whatever may be our hope for the future, the one thing of which we must be painfully aware at the present time—a fact that no writer on these problems should fail to impress upon his readers—is how little we really know of the forces that we are trying to influence by deliberate management; so little indeed that it must remain an open question whether we would try if we knew more.
This is truer than ever. Obama has no clue. Bernanke has no clue. All the economists but the Austrians [a small, uninfluential minority] have no clue. Those fools think they can “manage” the economy with zero understanding of what makes it tick.
Rock on, Hayek. You deserved that Nobel Prize.