Wednesday, 20 June 2012

Why Bernanke and the Fed’s Keynesian ‘Paradox of Thrift’ is Bogus

Guest post by Doug French, contributing writer at Money Morning Australia 

U.S. Federal Reserve Chairman Ben Bernanke continues to stand on a stack of Lord Keynes’ General Theory and proclaim that the world needs low interest rates to “fill the gap” in aggregate demand and so bring prosperity to our times.

“The reason to keep rates low isn’t to accommodate congressional fiscal policy,” Bernanke responded during a recent congressional hearing. Consumers benefit from cheaper mortgages and lower interest rates which, claims the Fed head, helps to stimulate the economy,.

When Sen. Bernie Sanders launched into a stem-winding question about the “unequal distribution” of wealth in the U.S., Bernanke quipped, “It’s not so much a question about bringing down the 1%, but bringing up the middle class.”

Right. Only a guy who has spent a lifetime in academia and now government would think he’s smart enough to pull the right monetary levers and push the correct policy buttons to make the middle class richer. His economic worldview even doubts that a richer citizenry will get us out of the great recession.

A few of Dr. Bernanke’s legion of Ph.D. economists have turned out the June issue of the Federal Reserve Bulletin. Inside, you’ll find that the median net worth for Americans fell almost 39% from 2007 to 2010. Of course, “median” means the drop was worse for half the population and better for the other half.

Either way, most Americans are poorer. According to the Fed’s figures, Americans are right back where they were in 1992. GDP went up. Real wages did not. And family debt stayed the same. But what everyone thought were their personal ATM machines back in 2007 – their homes – plunged in value.

For all the hand-wringing and shocked faces this story has inspired, what everyone forgets is that for net worth to rise, people must save more, pay down debt or enjoy increases in the value of their assets.

To Save or Spend

But the good Keynesian Dr. Bernanke knows the central tenet of the Keynesian school is the paradox of thrift, which states that if everyone saves more money during a recession then “aggregate demand” for goods and services will fall. This will lead to more unemployment, which in turn will mean even lower savings.

In the end, the Keynesians believe that this great paradox unleashes a vicious spiral that will take us back to the Stone Age.

The last thing Dr. Bernanke wants is a mass outbreak of thriftiness. The Fed chair wants people to spend and borrow. To buy new TVs. Even bigger houses. New smartphones. Anything, really. And he wants government to do the same. That’s the ticket! That’s progress.

If Keynesians believe their own theory, they should take the fact that net worth has dropped as a positive sign that Americans are doing all they can to spend us all out of the recession.

Boobus Americanus hasn’t pulled in his spending horns. His house may have crashed in value, but he’s still doing his part. He’s keeping his debt level held high. His spending habits firm. Keynesian heroism in light of the fact that, according to the Fed survey, incomes fell from 2007 to 2010.

According to the Fed’s report, the proportion of families reporting that they had saved anything the previous year fell from 56.4% of families in 2007 to 52% in 2010. “That decrease pushed the fraction of families reporting saving to the lowest level since the SCF [Survey of Consumer Finances] began collecting such information in 1992.”

But the Fed’s zero interest rate policy has banks and the government offering mere basis points to savers. Sub-1% interest rates on accounts and CDs have many wondering what’s the point?

Life coach and author John Strelecky urges people to spend the money. To “live your bucket list now.” The interest you would have earned on the money you spend is not enough to compensate a person for the lifetime of memories missed.

“No matter when that two-minute warning ticks off, you could say you did what you wanted to do with your life,” Strelecky says. “Don’t wait until you’re 65 to start spending your money to live a rewarding life.”

James Livingston, author of Against Thrift: Why Consumer Culture Is Good for the Economy, the Environment and Your Soul, claims that under-consumption caused the 2008 meltdown, and that consumers aren’t spending enough to get us out of it. “I’m saying that we need to lighten up and spend more, for our own good,” writes Livingston, who teaches at Rutgers. “If we don’t, we sacrifice ourselves on the altar of productivity and meanwhile sentence our children to a future of pointless repression, denial and delay.”

Economists like CNBC’s Steve Liesman think there is too much saving going on. So does the Chicago Fed’s Charles Evans, who said not too long ago:

It seems to me if we could somehow get lower real interest rates so that the amount of excess savings that is taking place relative to investment is lowered, that would be one channel for stimulating the economy.

Of course, as F.A. Hayek showed, the paradox of thrift is nonsense. Savings provides capital. It is that capital that makes labor more efficient. As capital is accumulated, its cost falls. Entrepreneurs then reorganize capital into more productive capital-intensive uses.

In other words, as people save more and spend less, capital is shifted into building factories, rather than tennis shoes. Labor and prices shift accordingly. Instead of collapsing into depression, the entire system reaches a new equilibrium at a higher savings amount by means of adjustments in labor, capital, prices, quantities, production and consumption.

It is savings and capital (not borrowing and spending!) that create prosperity for both individuals and societies. Chairman Bernanke is doing all he can, and the banks are cooperating, to entice you into giving up on earning decent returns and just buying a new boat or big screen.

Don’t fall for it.

I urge you use your savings to grow (not reduce) your net worth.

Author Image for Douglas French

Doug French is president of the Mises Institute and senior editor of the Laissez Faire Club. He received his master's degree under the direction of Murray N. Rothbard at the University of Nevada, Las Vegas, after many years in the business of banking. He is the author of two books, “Early Speculative Bubbles and Increases in the Supply of Money,” the first major empirical study of the relationship between early bubbles and the money supply, and “Walk Away,” a monograph assessing the philosophy and morality of strategic default. This post posted by permission of Money Morning Australia.

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