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Posted by moneysage on August 21, 2007, 9:34 am
Central Banks' Inflation Monomania Amplifies Deflation Risk
more at http://money-sage.com
Collective neuroses among central bankers can be a very dangerous
thing. For those who doubt this, we direct their attention to the
mindset of the world's central bankers in the late 1920s and early
1930s, and the consequences thereof. During this period, the bankers
were obsessed with preserving the gold standard and crushing any
incipient signs of inflation. This led the FED and other cenral banks
to maintain ultra-tight monetary policies in the face of financial
market collapse. The consequence: collapse of the banking system,
underlined by the failure of many thousands of banks, loss of
depositor money, and the complete evaporation of liquidity. In the US
the money supply contracted by 35% between 1929 and 1933: the Federal
Reserve stood idly by. The money supply contraction, which occurred in
Europe as well, produced the most severe global depression in modern
history.
Make no mistake about it: a normal cyclical downturn was counter-
transmuted by central bank policy into an unprecedented global
depression. The economic misery and the political catastrophe which
followed in its wake are well known. Throughout the worst of the
deflationary collapse, the FED maintained a super-tight monetary
policy, at the very moment when it should have been flooding the
financial system with money. Its rationale: fear of .... INFLATION.
We have been assured by "modern" central bankers that this will never
be allowed to happen again. One of the principal assurers on this
score has been Dr. Bernanke himself, who is a well-known student of
the Great Depression. Bernanke publicly expressed his appreciation to
Milton Friedmann and Anna M. Schwartz, authors of that great classic:
"The Monetary History of the United States." In this highly detailed
analysis, Friedmann and Schwartz demonstrate precisely how the Federal
Reserve played THE DETERMINATIVE ROLE in the making of the Great
Depression.
Developments to date suggest that the admirers of Friedmann and
Schwartz have, thus far, lacked both the will and the daring to take
the actions needed to preculde the VERY REAL POSSIBILITY OF A GENERAL
DEFLATIONARY COLLAPSE.
Why is this? The answer seems to be: FEAR OF INFLATION. Hello 1929?
Let us hope not.
The real problem is that something happened on the way from 1932 to
2007. What happened was the Inflation of the 1970s. For largely
political reasons the FED printed a huge amount of money to counteract
-- ostensibly -- the decline in living standards and the depressive
economic threat created by the multiplication of oil prices. In plain
English, the FED made the exact opposite mistake it made in the '30s
-- it produced FAR MORE LIQUIDIY than was needed in the '70s, just as
it had created FAR TOO LITTLE in the 30s.
Now we appear to be paying for this most recent of the FED's two
colossal 20th century mistakes. With the looming commercial paper
crisis, on top of the sub-prime crisis, we confront, for the first
time, the possibility of massive corporate bankruptcy and collapse.
WE DO NOT BELIEVE THIS WILL OCCUR, because of the intense political
and market pressure on a spineless FED. The threat is very clear: if
businesses cannot roll over their paper, they are BANKRUPT. Massive
bankruptcy produces Depression.
We must acknowledge that we are surprised at the degree of
intellectual incompetence and administrative indecisiveness at the
central bank.
This does raise anew the question which some have long posed: would we
be better off without a central bank? It seems to us that JP Morgan
did a far, far better job in 1907 than the FED did in the late '20s,
the early '30s, the '70s, and currently.
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