The View From 1776

The Fed’s Latest Bubble Creation

The Wall Street Journal reports that the Fed’s continuing policy of artificially depressing interest rates is creating yet another asset bubble, this time in exploration and production (E&P) of petroleum and natural gas.

The Fed’s loose money policy, expressed in very low borrowing costs and highly inflated securities prices in the stock market, is fomenting an over-expansion of business investment in hydro-fracking.  This same process created the over-expansion and collapse of the housing market leading up to the collapse of our financial market in 2007 - 2008.  Lending institutions already are struggling to collect on bad loans to over-expanded petroleum exploration and production companies.

The repeated economic pattern since the start of the Federal Reserve system in 1913 has been loose money that artificially stimulates sectors of the economy, leading to expansion of production facilities in excess of sustainable longer-term demand.  The mischief lies, not in temporary blips of consumer demand, but in over-building basic production facilities that take long periods of time to come into production and which can’t be quickly and temporarily shut down when projected demand fails to materialize. 

Producers and sellers of consumer goods can quickly curtail production and liquidate excessive inventories.  But home building companies acquire large tracts of land and increase their borrowing in anticipation of continued or rising demand for new housing.  When consumers finally are tapped out by rising debt (encouraged by the Fed’s policies), home builders are stuck with non-productive land and unsold houses, leaving no way to service the debt undertaken to acquire the land and to expand their operations.

The Wall Street Journal notes that, “Rising U.S. oil supply is the big factor weighing on prices. And that supply is largely a function of exploration-and-production companies enjoying access to capital to fund drilling budgets that frequently outpace cash flow. 

“Witness the rush by several E&P firms to issue shares, especially during the brief rally in oil prices during February. So far this year, the sector has accounted for almost 12% of U.S. equity issuance, the highest proportion by far in at least two decades, according to Dealogic. Even on the debt side, E&P issuance to date is running at the same pace as the past five years.”

Keynesian economics, the secular, socialistic religious doctrine to which the Fed adheres, treats the economy as a series of monolithic blocks that will react in computer-model, predictable ways to spur the economy.  The Fed and Keynesian economics deal with aggregate demand, making no allowance for unpredictable reactions and actions by the hundreds of million of individuals who comprise the nation’s economy.  In the Keynesian religion the Fed has only to create billions of dollars of fiat money via bookkeeping entries, and the economy, responding like a theoretical socialistic machine, will automatically recover lost economic momentum. As the stock market rises, consumers will be duped into resumed spending, thinking that they are again wealthy (Fed chairman Bernanke’s “wealth effect”).

Unfortunately for the Fed and for liberal-progressive-socialists everywhere, once again Keynesian economic doctrine has disappointed expectations.  Our economy, in the real, non-Keynesian world, has suffered the slowest economic recovery in modern times.  The only big beneficiaries of the Fed’s Keynesian policies have been stock market speculators, take-over artists, bankers, hedge fund operators, and private equity groups.  Being able to borrow unlimited amounts of phony dollars at historically low interest rates, these financial sector players have made a killing in the stock market since 2009.  Meanwhile, the average citizen has been left to pick up the scraps.  Wage rates and employment, in some areas of the nation, are lower than they were in 2009.  Factoring in consumer price inflation, consumers below the level of stock market speculators are in worse economic shape than before the financial collapse.

In sharp contrast, the Austrian school of economics focuses almost entirely on the real-world actions and reactions of individuals, rather than on the theoretical aggregates of Keynesianism.  The Fed’s Keynesian economists failed to anticipate severe sectoral dislocations of the sort that occurred in the 1990s stock market boom, or in the vast over-expansion that occurred in the housing market and the fatal decline in lending standards employed by mortgage lenders. 

The Fed’s record, in fact, is abysmal.  Only a couple of months before the financial collapse of 2007 - 2008, Fed chairman Ben Bernanke opined that the economy was in good shape and that the only real problem was an excess of saving (at a time when governmental, corporate, and individual debt was soaring to all-time highs).

Given the intuitively and pragmatically established fact that no small groups of experts anywhere can manage an economy as large and complex as that of the United States, Austrian economics is the only sensible approach to policy-making.  Austrian economics is aimed, not at managing the economy, but a preventing over-expansions such as the housing market, the stock market, and the now levered-up investment in petroleum E&P.  Outside a command economy like the USSR, individual consumers and business executives will always try to game the system to their own advantage.  The only effective policy for the Fed is to maintain a stable value for the dollar and to allow interest rates to seek a real balance between demand for money and the real supply of money (savings by businesses and individuals, not fiat money created by the Fed).

Under Austrian economic policies, increased demand (in excess of real savings) for debt or equity to finance basic production would drive up interest rates and force businesses to examine more closely the long-term feasibility of their capital asset investment plans.  Without a flood of fiat money sloshing around the economy, banks would again be turned toward realistic evaluations of business and consumer creditworthiness.