Robert Murphy explains why the Federal Reserve has no more tricks up its sleeve, and it’s latest magic trick is doomed to failure.

What I love about the Austrian School’s take on economics is the way they look at wealth. People often confuse money and wealth–the two are definitely not the same thing. Money stands in for wealth; think of it as a placeholder for wealth.

The Austrian School views prices as signals to market actors. The interest rate is nothing more than a price, which tells us how much to charge for lending money. It’s the going rate set by supply and demand. The Fed cannot perform miracles–if it wants to affect this rate, it must either put more currency into circulation or take currency out. There is no shortcutting this process.  So when the interest rate goes down, that signals the market that there is more money to lend. However, when the Fed “prints” this money (more precisely, they increase their balance sheet by some keystrokes on a computer), it isn’t “real wealth.” That new money doesn’t have new wealth backing it up.

By increasing the money supply, but not new wealth, the same number of goods and services are chased around by new money, which causes prices to rise (yes, supply and demand apply to the money supply). However, the new money causes a boom, which crashes when reality catches up to the fantasy that the Fed has created–that there is lots of new wealth to be lent out. The crash is merely the natural result of the artificial boom created by the Fed.

The Fed is effectively lying to the market via this process. And they’ve done it for so long than they have no where to hide. Reality will catch up and expose the lies of the Fed–sadly we have to endure potentially painful corrections. The important thing is that, like a drug addict, the solution is not more of the drug you’re strung out on. The solution is kicking the habit.

Advertisements