Global Liquidity To Combat The Secondary Contradiction Of Money – Adrián Ravier

Adrian Ravier

Degree in Economics (UBA, 2002), Master in Economics and Business Administration (ESEADE, 2004) and Doctor of Applied Economics from the King Juan Carlos University of Madrid (URJC, 2009).

Regular Professor of Introduction to Economics at the Faculty of Economic and Legal Sciences of the National University of La Pampa (UNLPam).

Contributes to the blog Punto de Vista Económico y en Libertad y Progreso.

ACTON – In their famous study on the Monetary History of the United States, Milton Friedman and Anna Schwartz argued that the Great Depression of the 1930s was due to errors by the Federal Reserve. The problem was not the monetary and credit expansion of the 1920s, they said, but rather the secondary contraction of the money supply produced between 1929 and 1933, which caused a large price deflation that destroyed a large part of the banking system (from of the 25,000 banks operating in 1929, only 12,000 remained in 1933).

What do we mean by “secondary contraction”? As Roger W. Garrison explains “a downward spiral of economic activity that is fueling and causing the deepest maritime recession and / or lasting longer than was necessary due to the need to liquidate bad investments.”

Right now we can see a similar situation. Firstly, as they were successful between 1924-28, and also between 2001-05 the Federal Reserve succeeded between 2008-16 a monetary policy that was too loose for too long (with negative real interest rates), with the aim of removing to the American economy from the previous recessions of 1921 and 2008; second, in both cases this credit expansion fueled a stock market bubble that sooner or later had to be corrected; thirdly, the panic of 1929 and 2008 is similar to the one we observed today in 2020, although here the trigger is another.

The current panic is unleashed by a deep fear in global society for the effects of the coronavirus, which have caused mandatory quarantines in almost all countries of the world, limiting the circulation of people, thereby reducing consumption, causing a strong hoarding which means a greater demand for money and, ultimately, a sharp drop in the speed of money circulation.

In their study on the crisis of the thirties, Friedman and Schwartz recommend that, in a situation similar to that of the Federal Reserve, it avoid the consequent crisis by reinflating the money supply.

Many will say that this is a Keynesian policy, due to the active role that the government and the Federal Reserve assume in the face of the crisis. However, we must note that expanding the monetary base when the money supply contracts an operation with some consensus in the academy.

Does this consensus include Austrian liberals? In a sense, yes. And it is that Friedrich Hayek, in his famous book Prices and Production (1931) affirms that the Federal Reserve must expand the monetary base to avoid this “secondary contraction”. In terms of the quantitative equation (MV = PY), Hayek proposes to keep MV constant. Already in trouble (due to the excess liquidity injected between 2008 and 2016 that generated a stock market bubble), Hayek proposed (ideally) that the Federal Reserve would allow the necessary market liquidation while the monetary authority avoids the secondary contraction (panic) by maintaining a constant stream of spending.

It is worth clarifying that the increase in the money supply (M) that Hayek proposed would not be of the magnitude, nor of the quality, that Bernanke offered after the 2008 crisis. On the one hand, at that stage it will be seen that the EDF doubled and tripled the monetary base, in an amount that is well above what the market might need to avoid the “secondary contraction”. On the other hand, instead of arbitrary and discretionary bailouts, Hayek may prefer an expansion of the money supply through open market operations, that is, buying bonds and without favoring “moral hazard.” In this way, some of the large companies that were rescued would have fallen and others would have been merged or restructured, leading to market adjustment.

In the coming months we will be able to see if we learned the lesson. While the profession of economists (including Keynesians, Monetarists, and Austrians) warrants an injection of global liquidity to deal with the secondary contraction caused by the coronavirus, the quality of the intervention may be different, depending on what the modern stock market bubble corrects and avoiding moral hazard with a selective bailout of companies that are regularly too big to fail.