Last time I checked, the debate on the efficacy of price controls was pretty much a done deal (remember these guys?). After trying it out in the ‘30s, we realized that central planning just doesn’t compare to the efficiency of letting market forces set our schedules. Unfortunately, this broader lesson has yet to be applied toward the ostensibly different but fundamentally identical matter of letting our central bank set the price of borrowing and lending.
Thanks to a cooperative Congress and an acquiescent public, the Federal Reserve’s latest round of quantitative easing will likely go unchallenged. (Meanwhile, niche movements are beginning to rediscover well-established Austrian School theories on why this is a bad idea.)
Bernanke’s rescue plan comes out of the same tattered playbook that got us into trouble in the first place: with consumption and borrowing at a present low, the central bank is moving to again artificially lower interest rates to stimulate new lending. Since savings have severely bottomed out, it makes sense that banks and other institutions are sluggish to lend out reserves. But will printing and lending hundred of billions of new dollars improve our situation?
By holding down the “price” of borrowing (i.e., interest rates), the Fed hopes to encourage short-term consumption and long-term investments. Consumers will increase consumption because the low interest rates seem to discourage saving, while long-term investors and entrepreneurs find it easier to begin new projects as the price of borrowing is held so fantastically low.
Sound familiar? Nearly a century after the passing of the 1913 Federal Reserve Act, and nearly four decades after the dismantling of Bretton Woods, it certainly should. The Fed’s current plans to instigate a “boom” echo its earlier machinations that led to the multi-decade boom we now associate with the 2000 dot com crash. The Fed’s response to that failure was to cut rates to an unprecedented low, buying the country an artificial last hurrah that, in turn, ended with the housing meltdown. The solution today is more of the same: print dollars, lower interest rates, and encourage more wild spending and borrowing.
To understand why the central planners have failed, one need only remember that our complex system of money and credit is not so fundamentally different from the economy at-large; both are ruled by market forces, which signify realities via a pricing mechanism that cannot be successfully manipulated through mandates of ceilings and floors. Just as we all know how poorly the economy functions when hobbled by price controls, the monetary system suffers when interest rates are kept lower than they would be by the free market. Our central bank chieftains suffer from the same Knowledge Problem that doomed the Soviets: no central entity can ever predict the true market rate, and deluded rate-setting deceives the public into acting out of accordance with market realities.
By depressing the interest rate, the Fed sends the miscue that savings are sufficient to fund long-term projects (e.g., housing construction and dot com ventures), and that consumers are consuming less in the short-term in favor of saving for the long term. However, since these artificial rates greatly overestimate the market’s real demand for long-term investment, a cresting point eventually arrives whereby entrepreneurial ventures begin to fail en masse. Thus comes the crash, better understood as the market’s natural purging of all the malinvestments encouraged by the Fed’s mismanagement of the printing press.
And so here we are, eagerly awaiting another $500 billion bailout from the Fed that will do nothing but bloat the overfed money supply with more new dollars, further suppressing interest rates to encourage another round of lousy investments.
As the central bankers again take their seats at the mahogany table to plan our economic recovery, the American people hunker down for a future plagued by the same economic maladies that have defined this century’s experiences thus far: bubbles, boom-bust cycles, inflation, and unsustainable trade imbalances. Let us hope that the mighty minds in charge of printing the world’s reserve currency have the wisdom to finally let go.
Search for Solid Ground 
Very informative article. First, is there a place where I can find more information on the argument against the Fed overall? I found your piece very interesting and would like to research it more. Secondly, I agree with your point that the $600 billion quantitative easing plan is artificially stimulating the economy and not reflecting true market forces. However, I have one resulting question that I am interested to see your position. Bernanke did this in large part because of sluggish economic growth and the fear of deflation. Would you worry that not resorting to such a policy would possibly make the US enter a double-dip recession (a deflationary period) as there are still so many without jobs and such a large number of foreclosures still being dealt with?
Glad I could engage you with my post! Americans face few matters more urgent or disastrous than the looming economic catastrophe. It is high time we begin seeing through the mainstream media’s (successful) attempts at deluding the public on the facts behind the economics, and begin to realize that the solutions we hear and read about so often are only going to prolong the (inevitable) bust period. Peter Schiff said it best when he criticized the use of the term “stimulus” as a deceptive way to say, “Just print money and stir”. Unfortunately, there is no stimulus the central planners can provide us that will prevent the onset of massive stagflation, driven by the U.S. economy’s need to correct for years of overconsumption and borrowing.
Your question, regarding the threat of a recession characterized by deflation, is incredibly relevant to most observers speculating on future troubles. If it’s alright with you, I’d like to hijack your comment as a jumping-off point for an in-depth post addressing this very matter.
While I work on that, I invite you to ask yourself: why should we fear deflation? And how does the printing of more fiat currency (which derives its value solely from its purchasing power, which in turn depends on the financial strength of the U.S. economy and how our central planners regulate the dollar supply) save us from recession? And finally, does the encouragement of continued consumer consumption and borrowing (which, I presume, inspire your desire for monetary stimulus) do anything but dig us deeper into the hole?
@jarededy
Told you I’d write up a post devoted to the inflation/deflation debate, and here it is: https://searchforsolidground.wordpress.com/2010/12/05/your-government-loves-inflation-and-so-should-you/
I’d love to engage you in a follow-up if you encounter matters you’d like to discuss.
You should totally take Sproul’s class in the ECON department called Money, Credit, and Banking. You would be all over it. He spends the whole coarse arguing against our current monetary policy and complaining about the Fed.