While reading up on the War of 1812, a small fact caught my attention: Britain was the largest importer of American goods leading up to the war. Drawing a comparison to today, I was reminded that America is the largest importer of Chinese goods. In the meanwhile, our exports have dropped significantly, and we end up with an annual net loss in trade. We all know that Britain ruled the world at one point but their role has greatly diminished in the last century. America became, and today is, the most powerful country in the world. But are we following in Britain’s footsteps? I believe that the answer lies in the understanding of consumption economics, and the role of central banking in this phenomenon.
The consumption possibilities curve (above) shows us that investments increase only when consumption decreases, and vice versa. For a good portion of American history, the people believed in savings. They understood that savings grant investment opportunities, and investments lead to progress. This is where the banking system also came in. As savings increased, banks would lower interest rates and signal to the industry that if they build/produce, the savings will help in consumption. Conversely, when savings were low, the banks would increase interest rates, as the success of a company would be risky when people didn’t have the money to buy their products. This is how a free market works in terms of consumption and investment, and it’s something Americans experienced for a good portion of their history. However, this changed with the establishment of the Federal Reserve, America’s central bank.
Central banks were tried a few times before the Federal Reserve, but were highly opposed by the likes of Thomas Jefferson and Andrew Jackson, amongst others. Jefferson blasted James Madison for signing into law a central bank, as he saw it as one of the most corrupt organizations used by monarchists to subdue people. And he was right. Though they didn’t last long in the eighteenth and nineteenth century, the Federal Reserve is coming up on a hundred years, and has been responsible for every single recession since its inception, and, the kicker, the Great Depression. Even Ben Bernanke, the current Chairman of the Federal Reserve, admitted that Milton Friedman was right about the role the Fed played in the Great Depression. But of course, he’s not about to walk away from his cushy job with no oversight or accountability whatsoever. He just said they’ll get it right next time. Oy vey.
See, the problem with central banks is that they completely screw up the way free markets are supposed to work. The biggest way they do so is by artificially lowering and raising interest rates. Going back to the consumption-possibilities curve, when savings are low (either because consumption is high or productivity is low), investments disappear. There isn’t any money to lend, and so banks raise interest rates to signal the markets that it’s a risky time to start a new endeavor. However, the central bank decides that people must consume more to stimulate the economy, and so they extend lines of credits beyond what should be warranted. They either produce more money (printing or electronically), or they insure bad loans. The result is a confused market. The producers ramp up production, but the shelves are left stocked, and their goods never move. This throws the market in a tailspin until the politicians decide it’s time to give the people money, via tax breaks or incentives, to go buy the goods that shouldn’t have been produced in the first place. Unfortunately, that’s not enough, and another side-effect from the misunderstanding of this ever-booming economy takes place.
Credit cards. If production is constantly going, and people are supposed to keep buying to ‘stimulate the economy’, they will end up overextending themselves. It’s no wonder that in 2008, the average savings of an American was -10%. Yes that’s a minus sign. They spent ten percent more than they made. This only gets worse as the average family goes into debt for nearly four months out of the year to pay for Christmas gifts. The people end up working paycheck to paycheck just so they can consume. Instead of saving and building capital to do what they truly desire, they work thirty, forty, fifty years in a job they loathe. This has raised a generation of youth that look to the state to provide as much for them as possible. The recent Occupy Wall Street movement was an example of that. They wanted their student loans tossed so that they could spend their money elsewhere. In fact, it gets worse. Now, these very people believe the state should provide them with jobs. And young people, in droves, are starting to work for the government. On average, there are twice as many government employees in a state as there are workers in manufacturing or agriculture. And the numbers are growing. All the while, they don’t realize that the government isn’t self-sustaining, and that private industry is required to pay even those paychecks. But I digress.
The Fed has created an ever-consuming populous, and thus enslaved them to a perverted understanding of ‘the economy’. It’s become this unsatisfiable beast that must be fed constantly unless you want the world to collapse around you. But that couldn’t be further from the truth. The economy is the people. It’s the people who buy and sell. It’s the people who invest or consume. It’s the people, not a cog that needs fixing. People have hopes, they have dreams, and they have fears. When people are afraid, they will cut down consumption. But the government tells them that they must keep this up, unless they want things to get worse. The truth, however, is that there is no short-term solution to a dip in the economy. The world is constantly changing, and along with it so do the markets. Cutting consumption is an appropriate response to those changes, lest we find ourselves in a never-ending spiral. I believe that Britain’s strong central banking played its part in the decline of the empire, and I believe the same is happening in America today.
The sad thing is that the founding fathers fought against this - the oppression of the people. Yet today, we have an oppressed population that is deluded into believing it’s free. America is no longer the land of the brave and the home of the free. It’s the land of the timid, and the home to slaves. We’re heading down the same path Britain did, and unless we change our mindset about consumption economics, we will not be able to avert the coming fiscal disaster. The Fed must go, and we must return to competitive and sound money. We must restore unto Americans the freedoms they’ve lost, and to do that, we must elect people that understand economics, not simply a few catchwords here and there. A return to free markets will restore that freedom, and bring back the atmosphere that helped America rise to the top as Britain fell away.