Monday, August 3, 2015

Credit Expansion, Economic Crisis, and War

"The dislocation of the monetary and credit system that is nowadays going on everywhere is not due . . . to any inadequacy of the gold standard. The thing for which the monetary system of our time is chiefly blamed, the fall in prices during the last five years, is not the fault of the gold standard, but the inevitable and ineluctable consequence of the expansion of credit, which was bound to lead eventually to a collapse. And the thing which is chiefly advocated as a remedy is nothing but another expansion of credit, such as certainly might lead to a transitory boom, but would be bound to end in a correspondingly severer crisis." 
"The difficulties of the monetary and credit system are only a part of the great economic difficulties under which the world is at present suffering. It is not only the monetary and credit system that is out of gear, but the whole economic system. For years past, the economic policy of all countries has been in conflict with the principles on which the nineteenth century built up the welfare of the nations. International division of labour is now regarded as an evil, and there is a demand for a return to the autarchy of remote antiquity. Every importation of foreign goods is heralded as a misfortune, to be averted at all costs. With prodigious ardour, mighty political parties proclaim the gospel that peace on earth is undesirable and that war alone means progress." 
(Source: Ludwig von Mises, The Theory of Money and Credit, 1953, pp.20-21) 

The role of the depreciation of local currency exerts big influence in an attempt of any nation to boost its export industry and to reduce importation of foreign products. Ludwig von Mises is clear at this point that this is one of the short-term effects of currency devaluation. However, such a stance is inimical to the interest of countries that rely more on their exports to strengthen their economy. If Mises' description therefore of the situation of global economy during his time is also appearing in our time particularly in relation to the way nations see the international division of labor and the importation of foregin goods, it is no wonder that we also have been hearing in our time the message that progress can only be obtained by means of war. In fact, not a few analysts are making a parallel between what's going on right now in global economy with the period prior to WW1 and WW2. 

The two paragraphs above tell us about the interlocking connection among the condition of money, credit, and the economy. In particular, Ludwig von Mises talks about the dislocation of money and credit due to credit expansion. He even told us that "It is not only the monetary and credit system that is out of gear, but the whole economic system" due to the abandonment by the policy makers of his time of the principles that made capital formation and growth possible during the 19th century. Reading this, I see Mises as prescient as if he is also describing our time. 

And then Mises proceeds to defend the gold standard that those who blame it for falling prices were actually mistaken. It was not the fault of the gold standard that prices fall. Instead, he identified credit expansion as the primary culprit. 

What is tragic is that further credit expansion is perceived as the solution while ignoring the fact that it was the source of economic malaise in the first place. For majority of policy makers today, this faulty idea still remains. Yes, as we've seen in the formation of two recent bubbles (tech bubble and housing bubble in periods prior to 2000 and 2008 respectively), this credit expansion have resulted into "transitory boom," which will unavoidably lead to an economic collapse far worse than the two previous ones.