Notes from the Publisher

December 20, 2008

Politics / The Economic Crisis and Money Shortages

JB

One thing that I learned from Thomas Sowell's book, Basic Economics, is that when you establish price contols, it invariably leads to shortages and rationing.  Rent control always led to a shortage of affordable housing, especially for the poor.  The reason is that price affects our usage of products.  If the cost of something goes down, we consume more of it, even if we didn't need to.  Thus, as the supply of something goes down, the price goes up, which discourages consumption of that product.  Thus, the process is self-limiting.  If the price of housing is very high, societies will tend to have more people in one house.  If the price of housing is very low, the same society will more likely have small families or even single individuals in a house.  Thus, if the price is kept artificially low, then the demand can easily exceed the supply.  If housing was free, every college student would want their own house.  If housing costs $1000/month, they will likely live with their parents.  Thus, price controls create shortages and rationing.

The current bailout is very much along these same lines.  Money is a product just like everything else.  Money also has a cost - normally called interest.  What the government is doing to "bail out" the economy is providing money below its normal cost.  The auto industry loans, the money to the banks, etc.  They are providing money below its normal cost.  I have a feeling that, rather than making the credit crunch smaller, this is going to make the credit crunch worse.  The reason is that the access to money is being given at a lower-than-normal rate.  Therefore, lots of people are going to be asking for the money even if they don't need it.  Instead of forcing companies to limit their consumption, they are keeping the price of money artificially low, which will prevent companies from engaging in good fiscal policy.  This is going to lead to an even greater money shortage, which will lead to either (1) unmanaged shortages, (2) rationing, or (3) printing more money.  All three of these are problematic.

#1 is obviously bad.
#2 is totalitarianism.  When the government controls the money, they control everything.
#3 will lead to massive inflation.  This is what many people don't understand - if you increase the money supply enough to fulfill the promises being made, that will make the money in your bank account and your salary worth about half what it is. 

This will hurt not only those businesses which had problems, but all of the ones which did not.  It's bad enough that the financial industry is having problems, if we print the money we need to fulfill our promises of low-cost credit, it will cause all of the industries that aren't having problems to suddenly start having problems.  And, because we are providing them money at below-market prices, the failing companies will have no incentive to reform their ways.

If there is anything which will cause the economy to plunge into a deep depression, it is the bailout.