What happens when banks print new money…and lend it to business? The new money pours forth on the loan market and lowers the loan rate of interest.
It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered.
Businessmen…are misled by the bank inflation into believing that the supply of saved funds is greater than it really is…
Soon the new money percolates downward from the business borrowers to the factors of production: in wages, rents, interest…
Capital goods industries will find that their investments have been in error: that what they thought profitable really fails for lack of demand by their entrepreneurial customers…the malinvestment must be liquidated.
Murray Rothbard wrote these words back in 1963 in his landmark study, America’s Great Depression. And he’s just as accurate and perceptive and incisive today as he was back then: when the Fed expands the money supply, it winds up destroying capital, which slows the economy and increases unemployment! These are counter-intuitive and against all that the Fed has been feeding us: “We must stimulate the economy by lowering interest rates!”
Actually, no. Gary North points out that the Fed’s attempts to lower interest rates have little effect on short term rates, at least at the moment. Interest rates are low because no one is borrowing and the banks aren’t lending. Everyone is in the “wait and see” mode.
But in the long run, Rothbard nails it: The Fed destroys capital and consequently increases unemployment. Here he is:
Unemployment will be aggravated by the numerous bankruptcies, and the large errors revealed…
Unemployment will…become really severe and lasting only if wage rates are kept artificially high and are prevented from falling. If wage rates are kept above the free-market level that clears the demand for and supply of labor, laborers will remain permanently unemployed.
Thanks, Obi-Wan Bernanke!