Americans are once again hoping for an economic recovery. If recovery comes, can it be sustained? Or will it soon collapse, as have recent upturns?
The answer depends on how the recovery is financed. If economic recovery is financed from the real savings of the American people, a sustained period of economic growth may occur. But if the recovery is induced by an artificial expansion of banking credit, any upturn will .quickly abort.
To see this, we need to understand the difference between saving and credit expansion. Perhaps a simple example will make the distinction clear.
A businessman has been thinking about building a new factory. But every time he adds up the costs—construction, equipment, wages, interest on the needed loan—he decides that the factory is too expensive.
Suppose, however, more savings become available for investment. The rise in real savings may result from a tax reduction which removes some of the penalties placed on savers. Or more savings may become available due to reduced borrowing by the various levels of government. In either case, interest rates decline, not because more money is added to the economy, but because existing funds are shifted from consumption to saving.
This shift, in the long run, benefits all Americans.
The businessman benefits because lower interest rates mean he can now afford to build his factory. The construction company and suppliers benefit because they receive new orders. And workers benefit because the factory creates new jobs.
But the real beneficiary is the buying public. The businessman builds his factory because he thinks he can produce goods that consumers will prefer to those being offered on the market. He takes a financial risk because he thinks it will enable him to satisfy consumers better than his competitors. If he fails, the loss is his. If he succeeds, consumers get more of what they want and thus enjoy a higher standard of living. The consumer—each and every one of us—is the final judge and ultimate winner.
The key to real growth, therefore, is to increase the amount of savings available for productive investment. If the savings pool is allowed to grow—without being choked by tax increases, government borrowing, or other hindrances—a sustained economic recovery can get under way.
Unfortunately, in previous recessions the savings pool hasn’t been permitted to grow. Taxes haven’t been cut and government borrowing hasn’t been reduced. Instead, the Federal Reserve System has resorted to credit expansion. It has tried to induce artificial recoveries by injecting new paper money into the banking system.
To the casual observer, these new funds seem no different from money that has been saved. Businessmen borrow these dollars, use them to expand their operations, and hire more workers. For a while, the economy appears to recover.
But there is a fatal difference. The Federal Reserve action does not shift funds from consumption to saving. Instead, new money has been created. As the new money works its way through the economy, prices are bid to higher levels. Rising prices cause long-term interest rates to climb, as lenders come to anticipate a depreciating dollar.
With inflation heating up and interest rates on the rise, the Federal Reserve finds itself in a vicious spiral. Credit expansion causes prices to rise, and the only way to stay ahead of rising prices is to pump more and more credit into the banking system.
Before long, prices are rising at double-digit levels, interest rates are soaring, and the banking system is overextended. The Federal Reserve has little choice now but to tighten credit, break the “inflationary psychology,” and plunge the economy into another recession.
This, then, is the decision we face. Do we reduce taxes and cut government borrowing, thereby expanding the savings pool and permitting a sustained economic recovery? Or do we try to induce yet another artificial recovery through credit expansion, and reap the whirlwind when it collapses?