How will asset-driven ?growth? eventually harm the economy?

November 27th, 2006

Share |

In Chapter 15, Section 2 of Human Action: A Treatise on Economics, Ludwig Von Mises wrote:

The economists were and are still today confronted with the superstitious belief that the scarcity of factors of production could be brushed away, either entirely or at least to some extent, by increasing the amount of money in circulation and by credit expansion.

Indeed, as we mentioned in our previous article, The Bubble Economy, this is exactly what the Federal Reserve is currently doing to the US economy. In 2001, when the US economy was faced with a threat of recession, the Federal Reserve embarked on an expansionary monetary policy (aka ?printing money?) in an attempt to prevent it from happening. We believe this policy does not prevent a recession?it merely postpones it, in which the upcoming one will be more severe instead.

When central banks expand the money supply artificially, it creates distortions in the economy which will eventually result in a recession, which is a correction to the distortion. In the case of the US (and the British and Australian as well) economy, the housing bubble was caused by the inflation of money supply. For the common people in the street, such inflation manifests itself in the form of ultra low interest rates, which in turn encouraged an increase in ?demand? for housing. As we explained in How is inflation sabotaging our ability to measure the value of things?, an expandable supply of money derail our ability to accurately assess the value of things. Thus, when housing prices increased due to the increase in ?demand? for housing, the common people are misled into thinking that the value of housing had increased as much as the increase in its prices. That collective error in judgement resulted in the economy misallocating scarce resources into housing sector?in the case of the US, a significant proportion of the jobs created during the asset-driven ?growth? was related (both directly and indirectly) to the housing boom. Since economic resources are always scarce, any misallocation of it implies an opportunity cost on the other sectors of the economy. The result is a structural damage to the economy that can only be corrected through a recession.

This is the reason why we believe a recession is on its way.

Tags: ,