submitted by jwithrow.
One of the most important elements of free market capitalism is the price system. The capitalist price system provides information on supply and demand in the marketplace and individuals make business and investment decisions based on this information.
The economic system that America now employs is not free market capitalism and there are legions of regulations in place that distort the market pricing system every step of the way.
The most insidious price distortion is the suppression of interest rates.
Interest rates are simply the price of money. Like everything else in the market economy, interest rates are self-regulated by the forces of supply and demand. If there is a high quantity of capital in the system available for lending then interest rates will naturally be low. Low interest rates will entice borrowers to engage in long term financing – purchasing homes, expanding businesses, etc. Interest rates will then naturally rise as the capital available for lending diminishes. High interest rates are not attractive to borrowers so individuals and businesses will focus more on short term projects. This will lead to increased capital formation within the system which will gradually trigger falling interest rates.
But what happens when a central bank suppresses interest rates and keeps them near zero for an extended period of time? Well, this destroys the entire pricing system and distorts the entire market system.
Artificially suppressed interest rates send a false signal – which is exactly why they were suppressed in the first place. Artificially suppressed rates still entice borrowers to take engage in long term financing but this is a Keynesian trap. The problem is that there is not sufficient capital formation in the economy to warrant the low interest rates and thus there is not a true demand for all of the long term projects undertaken.
This is called mal-investment.
“If you build it, they will come” is a great catch phrase in the movies but it’s just not how the real world works.
Despite what the economics textbook says, there is no such thing as a ‘mixed economic system’. There is simply no room for the suppression of interest rates or the distortion of prices in a capitalist system.
There are only two choices:
- Free markets
- Central planning
Free market capitalism presumes an honest and functional price system that is not manipulated by a central bank.
Oh, we should probably mention how interest rates are suppressed.
The Federal Reserve creates currency units out of thin air and uses them to buy long term Treasury bonds at low rates. What could possibly go wrong?
By the way, you can read more on this topic here, here, and here.