It Is Dangerous to Be Right When the Government Is Wrong - Andrew P. Napolitano [119]
About thirty years after Jackson ended the Second Bank of the United States, the debt accumulated by the federal government during the Civil War made a return to a system of central banking extremely attractive to the Lincoln administration. This debt prompted Congress to pass and President Lincoln to sign the National Currency Act of 1863 and the National Bank Act of 1864. Although the American economy continued to grow despite being dominated by this third system of central banking, it nonetheless saw great turbulence with many boom-and-bust cycles, and bank panics. In 1873, 1893, 1901, and 1907, massive panics caused a series of bank failures, and proved how unstable this central system of fractional reserve banking was. The response to the 1907 bank panic, caused by the Morgan-Rockefeller–dominated fractional reserve banking industry, was the Federal Reserve Act of 1913, discussed in greater detail below.
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Hayek Busts the Bubble of Conventional Economic Wisdom
Austrian economist Friedrich A. Hayek did not accept the conventional view and foundational assumption of the Federal Reserve System, that the boom-and-bust cycle was inexplicable and unavoidable. Hayek provided an explanation of why there was a period with such a large cluster of entrepreneurial errors that led to the shrinking of businesses and increased bankruptcy, which in turn led to bank failures. His explanation of the boom-and-bust cycle laid the foundation for the Austrian Business Cycle Theory (ABCT) (later expanded upon by Ludwig von Mises, Murray Rothbard, Henry Hazlitt, and other very influential Austrian economists), and would eventually win Hayek the Nobel Prize in economics in 1974. (Austrian is the name of the economic school of thought, not the personal ancestry of those who espouse it.) But what exactly were Hayek’s findings?
In brief, this theory is centered on the time-coordinating feature that interest rates play in the economy. There are two ways in which interest rates can fall. The first way is when individuals save more of their money in banks. When the supply of money which banks have to lend rises, banks then compete for borrowers’ business in order to clear this increase in the money supply. At the same time, when people save more of their money in banks, they defer some of their consumption (i.e., demand) from the present to the future. This causes a shrinking of the retail sector of the economy. The three productive resources of land, labor, and capital that were being used in the retail sector are now freed up and can be purchased cheaper for use in other sectors of the economy such as mining, manufacturing, and technology. These projects are farther away from the consumer and take a longer time before they can start churning out profits, so these businesses will be taking out long-term loans to complete these projects. When the interest rate is low, it makes long-term borrowing and production cheaper, incentivizing investment.
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In sum, when consumers save more, interest rates decline. This will cause a net flow of capital from consumption to long-term investment projects necessary to sustain a healthy economy. You can see how interest rates play a very important role in coordinating the economy over time, by matching up the markets for goods and markets for capital.
The second way interest rates can fall is if a central bank with governmental authority commands lower interest rates, or through