Let's say we have a very responsible government which taxes well, reinvests well in productive work, private markets that operate smoothly, why does the FED have to step in periodically to raise/lower interest rates (outside of very bad circumstances).
Another way of asking this question is, "What is a neutral rate?" or "What is an economy in equilibrium?"
Manipulating the supply of the dollar via interest rate adjustments, along with open market operations, is how the Fed attempts to control inflation.
One of the Fed's purposes is to moderate that cycle. And clearly it does not always succeed, but there is no reason to believe that the economy would reach some kind of equilibrium or neutral rate without it, because we know that didn't happen before the Fed existed.
I wonder if there's a better way to do this though. Maybe letting lenders fail, arresting bankers for not pricing risks in loans and setting an example is a better way to set up the money supply?
The busts are only painful if they affect non-speculators. Speculators (lenders and borrowers) should handle their own risk?
I'm sure it's not easy but the current system really really favors the rich with resources at the expense of retail retirement stock holders.
I'm not in favor of arresting people who did not break any laws, and it's not illegal to misjudge risk when making loans.
All it takes to stop boom/bust is full reserve banking and abolition of central bankers. Very simple, technically. After that to get yield on savings, people must invest in funds and be exposed to their relative lack of liquidity. Good bankers can keep things relatively liquid anyway, at least when times are stable, but you'd still have to wait to get your money back if you wanted out of investment funds. The underlying mechanics of finance are exposed: loans still occur, but investors see that their money is gone from their current accounts until the fund reaches maturity.
Now, will the citizens or politicians tolerate the long sucking sound as all the unstable credit is withdrawn from the economy? No, probably not. It's politically hard, not technically hard.
I don't expect economy to reach equilibrium, some mythical state of neverending growth. I want economy to stay dynamic, with boom periods interlaved with occasional, small crises.
Once you introduce Debt you get cycles. If I make $50k and can borrow $10k, I can spend $60k despite $10k of that $60k being "created from thin air". This creates an exponential growth curve whereby if I'm spending $60k, the sum of all the people who receive the $60k I spent could borrow $12k, allowing them to spend $72k. And so on.
When spending (and thus growth) is high, the central bank increases interest rates to slow it down, because too much spending leads to rising price of goods, which leads to inflation, which is not something anyone ever wants too much of. When spending is low, the central bank drops interest rates to ramp it back up.
Its easy to say "we should just get rid of debt", but the issue there is that we know debt works, when used well, even over the long run. Think about it: If I want to open a business, there's no way I can afford that without Debt. So I take out $100k. In five years, lets say I've made $500k total. I can repay that $100k, even with interest, and have a bunch of money left over. My productivity (ability to generate income) increased, and it was only possible because of Debt.
So we can get rid of debt, but we know that over the long term the economy will grow slower without it than with it. Its the job of the fed to try and keep as much equilibrium as possible, which is insanely difficult given the complexity of a 7 billion actor economy, many of whom do not treat debt with the respect it needs.
> Its easy to say "we should just get rid of debt", but the issue there is that we know debt works, when used well, even over the long run. Think about it: If I want to open a business, there's no way I can afford that without Debt. So I take out $100k. In five years, lets say I've made $500k total
This is the part where I fumble. In a society with 2 citizens and one bank, if citizen 1 borrows $100k, the maximum profit they can make = money borrowed by citizen 2.
Three cases in the above example with 10% interest:
1. Citizen 2 doesn't borrow but instead just lives by hunting deer. Citizen 1 and the bank will go bust
2.Citizen 2 borrows 200k and spends 100k on something citizen 1 provides. Citizen 1 makes 100k profit and repays the loan with interest, say total 110k. Now citizen 2 is still on the hook for 220k. How will Citizen 2 get 220k if he has only 100k left and the other citizen has only 90k left? The only way I see it is they produce another kid who takes another loan.
3. Citizen 1 takes 100k loan, Citizen 2 takes 5k loan. Citizen 2 pays 5k to Citizen 1. Citizen 1 did not make enough to repay the 10% interest. So bank sucks it up and gets back 105k. Citizen 2 absolutely doesn't have any money to repay that 5k loan they took. So both Citizen 1 and 2 are busted. What now? They have to take more loans infinitely? (Short of producing other citizens who take loans)
I would really appreciate your views.
But, reality isn't as simple as that example.
The biggest thing that's missing there is Collateral. Lending isn't about just dollars; a bank is happy to loan you $100k if you've got $100k, or even say $50k, in assets to write on there. Because if you declare bankruptcy they can send their goons to your house and take everything you own.
Another way to think about collateral could be something like "intrinsic productivity"; its the things you own due to your own work and brain, not because a bank bought it for you. Everyone has something like this. Even back in 1200 BC, you were cutting down forests (with your hands) using an axe (which you built) to make a farm (which you run). That's collateral; it has value because human nature gives it value, not because it has a dollar sign attached to it. The bank can recognize that and assign a dollar sign to it. Hell, in civilizations past, you could be collateral; if you default, you get sold into slavery.
Another more minor thing that's missing is that the number of dollars in the world isn't a zero sum game. The fed is constantly printing more dollars. That's a job of a central bank. And its not just to replace bad ripped up dollars; they often increase the total amount of dollars in the world.
When they want to put more money out there, the Fed buys assets from the public using money that didn't even exist before the purchase. That right there is the power of the Central Bank. Normally this takes the form of buying Treasury Bonds back from the public, but I don't want to get too deep into the weeds of "where did these bonds come from in the first place"; conceptually they can buy any asset, and because the money they just bought it with didn't exist until right now, they've added dollars to the system without impacting the "net value" of goods in the world. Then in the future, if they feel there are too many dollars, they can sell those assets back to the public.
> Normally this takes the form of buying Treasury Bonds back from the public
This is the scary part though. The major way "new money" comes into existence is by the pledge of the government (and thus citizens) to pay the Fed back.
Extrapolating my earlier example, If citizen 1 is US Treasury and citizen 2 is a real person, the only way citizen 1's (US treasury) debt can be repaid is if citizen 2 (real person with no assets besides intrinsic productivity) borrows at least as much and pays to citizen 1 or produces a child who also takes a loan and pays to citizen 1(setting the debt into perpetuity for all US citizens).
The alternative to paying US dollar denominated debt seems to be taking all US citizens' intrinsic productivity (assuming all collateral is already taken away)
Is there any money that is not debt to the Fed? I'm not saying Fed is evil but I don't see the sustainability of this system unless there is a "constantly increasing supply" (not gold, land which are limited) of wealth that is not debt or falling back to some form of slavery.
Another way to look at this is: Even if I am prudent and don't take on any debt but bootstrapped myself into wealth, I'm subject to debt to the Fed simply because the treasury owes money to the Fed, simply because that's how money was created in the first place.
A Treasury Bond is more the opposite; its a debt where the treasury is the borrower. The simple goal of T-Bonds is such that the government makes an assumption: the rate of GDP growth (and thus taxes) will outpace the rate at which they have to pay back their interest. This has almost always been the case, including today.
> I don't see the sustainability of this system unless there is a "constantly increasing supply" of wealth
There is a constantly increasing supply of wealth (lets call it by its real term: Productivity). Our population is increasing. And we're getting better at building technology. These are the two primary sources of increased productivity. When Productivity goes up, GDP goes up, and taxes go up. Debts get repaid.
Maybe this isn't sustainable over the long term. But nothing is sustainable over the long term. That's not the point of an economy. If you like toilets, and iPhones, and $5 shirts from H&M, and HackerNews, then you have to respect that it works for us. And it'll probably work for our children too, because as long as we keep having children Productivity will increase.
Here's another way to think about it: We are on this planet for 80 years. That's it. We need to engineer systems that maximize those 80 years for every interval of 80 years every person has. That's why we have Debt; otherwise our only Wealth would come from (1) inheritances, and (2) our intrinsic Productivity. That doesn't sound like a great system to me.
But they are. The origin of fiat currency is exactly that. Historically, dollars were backed by something (gold, assets) held by central banks from citizen deposits.
But today, they are backed by nothing. Fiat dollars are simply loans taken by US govt and private citizens.
While that does keep the economic engine running, it's all running on debt. Debt by citizen 1 creates money. Citizen 2 sells them corn to get that money. Citizen 2 takes that money and more debt to buy a tractor from citizen 1. Then time comes to repay money and one of them defaults. Central bank seizes assets of the defaulter for not returning the money they printed out of thin air in the first place.
That system is great if there was some base backing so that savers are not disproportionaly affected. But todays massive boom busts take down the whole world except the 1%.
I mean, why should a newborn baby pay more taxes for the debt of Citizen 1 (US govt)?