Organized Crime

Monetary policy under the direction of the Federal Reserve Board has a history of creating and destroying jobs. The reason for this is that the Fed, like all other central banks, has always been a generator of boom-and-bust cycles in the economy. Why this is so is explained in three classic treatises in Austrian economics: The Theory of Money and Credit by Ludwig von Mises; Monetary Theory and the Trade Cycle by F.A. Hayek; and Prices and Production by Hayek. Murray Rothbard’s America’s Great Depression also contains a lucid exposition of the Austrian business cycle theory. Hayek was awarded the Nobel Prize in Economics in 1974 for this work, among other things.

When the Fed expands the money supply it not only is prone to creating price inflation, but it also sows the seeds of recession or depression by artificially lowering interest rates, which can ignite a false or unsustainable economic “boom period.” Lower interest rates induce people to consume more and save less. But increased savings and the subsequent business investment that it finances is what fuels economic growth and job creation.

Lowered interest rates and wider availability of credit caused by the Fed’s expansionary monetary policy causes businesses to invest more in (mostly long-term) capital projects, primarily in real estate in the early 2000s boom period. There is an accompanying expansion of employment in those industries. But since the lower interest rates are caused by the Fed’s expansion of the money supply and not an increase in savings by the public (i.e., in the free market), businesses that have invested in long-term capital projects eventually discover that there is not enough consumer demand to justify their investments. (The reduced savings in the past means that consumer demand is weaker in the future). This is when the “bust” occurs.

The economic damage done by the boom-and-bust policies of the Fed occur in the boom period when resources are misallocated in the ways described here. The “bust” period is actually a necessary cure for the economic miscalculations that have occurred, as businesses liquidate their unsound investments and begin to make decisions on realistic, market-based interest rates. Prices and wages must return to reality as well in order for a genuine economic recovery to occur.

Government policies that bail out businesses that have made these bad investment decisions will only delay or prohibit economic recovery while encouraging more of such behavior in the future (the “moral hazard problem”). This is how short recessions can be turned into much longer ones, or depressions. Worse yet is when the Fed creates even more monetary inflation in response to the problems it caused by inflating the money supply in the first place. In doing so it may set off another boom-and-bust cycle.

It is obvious that the artificially low interest rates that were the official policy of the Greenspan Fed beginning in 2000 created an unsustainable boom in the housing market. Thousands of new jobs were in fact created—and then destroyed—giving an updated meaning to economist Joseph Schumpeter’s phrase “creative destruction.” Many Americans who obtained jobs and pursued careers in housing construction and related industries realized that those jobs and careers were not sustainable after all. They were fooled by the Fed. Thus, the Fed was not only responsible for causing the high unemployment rates (officially as high as 10 percent, but as high as 17 percent if “discouraged workers” are counted as unemployed), but also a mismatch in labor markets. That is, the skills that all the people in these industries acquired were no longer in demand; they lost their jobs and were forced to retool and re-educate themselves, or languish in unemployment or on welfare.

The Fed has been generating boom-and-bust cycles from its inception in 1914. Total bank deposits more than doubled from 1914 to 1920 (thanks mostly to the Fed’s financing of U.S. participation in World War I) and created a false boom that turned into a bust with the Depression of 1920 where GDP fell by 24 percent from 1920 to 1921, and the number of unemployed Americans more than doubled, from 2.1 million to 4.9 million (as documented by Richard Vedder and Lowell Galloway in their book, Out of Work). This was a more severe depression than the first year of the Great Depression a decade later.

Murray Rothbard demonstrated in his book, America’s Great Depression, that it was not restrictive monetary policy from 1929 to 1932 that fueled the Great Depression, as Milton Friedman and Anna Schwartz argued in their treatise, A Monetary History of the United States. Rather, it was the expansionary monetary practice of the Fed during the 1920s that generated another boom-and-bust cycle, with the bust being the primary cause of the Great Depression.

Giving the Fed the responsibility of maintaining low unemployment makes as much sense as giving arsonists the responsibility of fighting and building house fires.