Tuesday, January 31, 2012

Cause of depressions in a nutshell

From an e-mail exchange with my cousin-in-law:
What if Bernanke would write, from time to time, checks of fiat money to Honda dealers to buy some Honda cars and keep them in some FED garage? That would drive Honda prices up. But would the increased price of Hondas represent the increased demand of American public for Hondas? Surely not.

But to investors it would look this way (and not because they are stupid, but because that's how things normally happen — investors look for signs of companies doing better on the market, and usually, when the government does not intervene, they are correct), and they would invest extra money in Honda. So, Honda would expand its operations, hire more workers, buy more machinery, produce more cars, and then... American public would not buy all those extra cars. Not because they are evil or don't have money to spend, but because their interest in Hondas does not match the increased price and supply of Honda cars.

So, Honda would have to go bankrupt, or at least sell off its assets. The painful, but inevitable bust phase of the cycle would start.

Except in the case of artificially manipulating the price of money (the interest rate), it's the economy on the whole that's being misrepresented. And, following the above example, what Bernanke is doing now, is buying some more Honda cars, because Honda is supposedly "too big to fail" and that by buying them, he will somehow help the crisis.
The above argument was taken from various talks and articles by Mises Institute's Robert P. Murphy.

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