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Good Thing We Have No ‘Steel Policy’

Posted By Don Boudreaux On September 22, 2008 @ 3:46 pm In Financial Markets,Monetary Policy | Comments Disabled

Regarding the current financial turmoil….

Suppose Uncle Sam were the monopoly supplier of steel in the same way that he is the monopoly supplier of money.  A (largely) independent board of Very Smart People [1] meets monthly to determine the nation’s steel supply.  If this board gets matters correct, the resulting price of steel prompts producers and consumers to use steel wisely.  But if the board guesses wrongly and, say, increases the steel supply too much, the market will overuse steel.  Products that would have been better made with aluminum or plastic, or not made at all, will instead be made with steel.  And production plans made in anticipation of a continuing ‘easy steel’ policy will be disrupted if the board changes course.

Unless this steel board gets things right with superhuman regularity, the structure of the economy will be become grossly distorted over time.  In addition, producers and investors will be forever anxious about upcoming decisions of the steel board.

We avoid this fate because steel is supplied by markets, with competitive producers and consumers adjusting daily to new information about changing opportunities and costs of using and manufacturing steel.  No one worries about getting the steel supply right, for markets do that job remarkably well.

Unfortunately, the same isn’t true for money.  Its supply is determined consciously by a board.  Unable to know and adjust to changes in people’s demand for money – and subject always to political pressures to grease the economy with the snake oil of easy money – the Federal Reserve distorts the economy with its inevitably mistaken decisions on the supply of money.  Asset bubbles are part of the price we pay for this primitive way of supplying money.

Markets should supply money just as they supply steel – and experience (for example, Scotland and Canada in the 19th century [2]) shows that they do so when given the opportunity.

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[1] independent board of Very Smart People: http://www.federalreserve.gov/

[2] for example, Scotland and Canada in the 19th century: http://www.econlib.org/library/Features/feature3.html

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