Tuesday, September 30, 2008

Bailout = Monetarism in Action

I wanted to make another note about the bailout package, and why Wall Street wants it so badly. The overriding principle behind the proposed bailout reflects Wall Street's blind belief in the economic theory of "monetarism." This theory calls for pumping money into the economy to make it better during bad times. There is a joke that explains monetarism. It refers to Ben Bernanke in a helicopter dropping bags of money to random people. Unfortunately, this joke falls into the "funny because it's true" category.

Richard Duncan, in Chapter 3 of his book, The Dollar Crisis: Causes, Consequences, Cures , Revised and Updated, says that monetarism is like pouring water over a drowning child. He states,

The failure of those [liquidity calibration] attempts will be the death of monetarism, which claims that any economic difficulty can be overcome simply by adjusting the money supply up or down depending on the circumstances. It will be death through drowning.

To continue the analogy, pouring money into a shallow pool to attract more people doesn't mean people will suddenly learn how to swim--some people will drown as the pool becomes more dangerous.

I am surprised more news stories haven't mentioned the term, "monetarism." The absence of the term in new stories shows either the mainstream media don't know much about economics, or they think their audience can't understand economic theory.

Update: In The Predator State, James Galbraith has a prescient line about America's "unlimited privilege of issuing never-to-be-paid chits" coming to an end. The book also contains a scathing rebuke of monetarism (surprisingly, all the book reviews I've read never once mention "monetarism"). Galbraith also writes that managing interest rates, not the money supply (M1, M2, etc.), stimulates the economy. In other words, even if the government hands down a billion dollars, it doesn't ensure that the money is spent; in contrast, if the government lowers interest rates, it makes it easier for money to be lent and spent and used optimally within the economy.

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