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Previously published on LewRockwell.com

The Federal Reserve and Productivity’s Boom-Bust Cycle

by Eric Englund

As stated in the Federal Reserve’s August 10, 2004 press release, "The Federal Open Market Committee decided to raise its target for the federal funds rate by 25 basis points to 1.5%." A fed funds rate of 1.5% is still extremely accommodative. Such aggressive accommodation came about due to the economic slowdown (as manifested by the dot.com, telecom, and NASDAQ busts) beginning in early 2000. What the FOMC members fail to understand is that the boom-times of the late 1990s emerged directly as a result of the Federal Reserve’s aggressive/easy monetary policies. When boom turned into bust beginning in 2000, the Fed eventually lowered the fed funds rate to an emergency-low level of 1%. The U.S. economy appeared to stabilize, yet robust job growth has not accompanied the economic "recovery." In turn, Alan Greenspan essentially claims that labor-productivity growth is hindering job growth. Ironically, it is the very boom-bust cycle brought on by the Federal Reserve itself that has lead to today’s productivity growth and it will be the Federal Reserve’s aggressive creation of money (out of thin air) that will eventually destroy the dollar (hyperinflation is not out of the question) and thus will correspondingly destroy productivity itself.

Let’s first deal with how the Federal Reserve has its hand in the productivity growth Alan Greenspan believes is resulting in poor job growth. For this I refer to the Mises Institute’s terrific book The Austrian Theory of the Trade Cycle. In a chapter written by Dr. Roger Garrison – titled "The Austrian Theory: A Summary" – he states the following:

Conventionally, business cycles are marked by changes in employment and in total output. The Austrian theory suggests that the boom and bust are more meaningfully identified with intertemporal misallocations of resources within the economy’s capital structure followed by liquidation and capital restructuring. Under extreme assumptions about labor mobility, an economy could undergo policy-induced intertemporal misallocations and the subsequent reallocation with no change in total employment. Actual market processes, however, involve adjustments in both capital and labor markets that translate capital-market misallocations into labor-market fluctuations. During the artificial boom, when workers are bid away from late stages of production into earlier stages, unemployment is low; when the boom ends, workers are simply released from failing businesses, and their absorption into new or surviving firms is time-consuming.

One could also add that workers are released from viable businesses that must downwardly adjust labor expenses, via layoffs, to meet the new economic reality (i.e., the economy has slowed significantly). Of course, at the very center of this boom-bust cycle is the Federal Reserve.

Paul Kasriel, chief economist at Northern Trust, has provided an excellent explanation as to why we have seen productivity growth after the 2000 bust – it fits well with Austrian theory of the trade cycle. Mr. Kasriel states the following in his September 18, 2003 essay titled Is Rising Productivity Resulting in Job Losses or Vice Versa?

Greenspan’s new complaint about productivity growth is that it is resulting in job layoffs. In this commentary, I again will attempt to refute Chairman Greenspan’s argument. In a nutshell, I believe the facts and theory support the notion that, rather than productivity growth resulting in job layoffs, just the opposite is at work here. To wit, job layoffs are resulting in productivity growth.

In reading Paul Kasriel’s essay, his argument is logical. When faced with an economic slowdown, businessmen must lay off workers to meet the new economic reality. In turn, the workers most likely to be laid off are the least productive workers. Therefore, on average, the output per worker will increase because the most productive workers are retained. If we take this line of thinking to its logical conclusion, it is the bust phase (of the boom-bust cycle) brought on by the Federal Reserve that forced the hands of employers to lay off the least productive workers. Thus, in essence, it is Alan Greenspan’s reckless monetary policy that has brought about today’s productivity growth.

There will come a time when the Federal Reserve’s unceasing depreciation of the dollar, via reckless monetary creation, will result in a marked all-around decline in worker productivity. Currently, the money supply – as measured by M3 – is growing at a rapid clip. As Doug Noland stated in his July 9, 2004 Credit Bubble Bulletin: "Year-to-date (26 weeks), broad money is up $469.6 billion, or 10.6% annualized." Moreover, he provided the following chart that conveys M3 money supply has grown from just under 8.6 trillion dollars to nearly 9.3 trillion dollars between April of 2003 and June of 2004.

Clearly, the Federal Reserve is doing everything it can to reflate the U.S. economy to reverse the bust that it had brought upon us. In looking at this chart, is it any wonder that prices at the grocery store and the gas pump have risen so dramatically – remember, internationally, oil is priced in dollars. Price inflation is back. However, with such an accommodative Federal Reserve, there is a distinct possibility that the dollar may soon begin to depreciate all the more rapidly – resulting in accelerating price inflation. Should inflation become heavy – with hyperinflation not being out of the question – the Federal Reserve will be directly responsible for destroying labor productivity.

How central banking decimates productivity was described in Costantino Bresciani-Turroni’s masterful book The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany. In his study, regarding Weimar Germany’s hyperinflation, it became clear to him that inflation negatively affected worker productivity. This is what he had to say:

…if the reduction of wages goes beyond a certain limit, or lasts too long, the physical energies of the working classes are affected. The lowering of the standard of living diminished the capacity for work, simply because wages were insufficient to provide the means of recuperation of worn-out human machines.

This had some important psychological consequences. They are less obvious but they probably had great influence on production. The continued depreciation of the currency and the uncertainty of the future, which it caused, produced a depression of working-class spirit, and the will to work declined.

The "dollar rate" was the theme of all the discussions among employees or workers. Their thoughts were concentrated on the problems of meeting their own needs with a money which lost value from hour to hour, and of spending their wages and salaries quickly in order to reduce their losses to a minimum. The productivity of labour suffered seriously from the psychological disturbance. Workers became less careful and materials such as coal and oils were wasted. The labourer’s energies were partly used in the dispute for an increase in his nominal wage. Even before the war it had been observed that the intensity of the labour of the workmen was reduced in the periods when they were negotiating with their employers for an increase in wages.

We have, unfortunately, few statistics regarding the average production per workman during the inflation. But these few, and more still the unanimous observations of employers, agree in suggesting that during the last phases of inflation, which were characterized by a rapid depreciation of the mark, the anxiety of the working classes made the average return per man decrease, and also lowered the standard of what work he did. Moreover, anyone could see in Germany at that period that a state of nervous irritation had taken possession of all classes of society.

Dr. Gerald Swanson’s research, of the affects of hyperinflation in South America, confirms Costantino Bresciani-Turroni’s conclusion regarding the direct correlation between rapid currency depreciation (i.e., inflation) and the decline in productivity (be it management or labor productivity). Dr. Swanson’s research can be found in The Hyperinflation Survival Guide: Strategies for American Businesses.

As the eminent Austrian economist Dr. Hans Sennholz has stated: "The ultimate destination of the present road of political fiat is hyperinflation with all its ominous economic, social, and political consequences. On this road, no federal plan, program, incomes policy, control, nationalization, threat, fine, or prison can prevent the continuous erosion and ultimate destruction of the dollar."* Considering Alan Greenspan’s reckless monetary policy, it certainly appears that Dr. Sennholz’ statement will hold true. In turn, the productivity "miracle" Alan Greenspan ruminates about today, will turn into a devastating productivity bust – once the dollar’s destruction enters its terminal stage. Irrefutably, the blame for the coming productivity bust will rest directly on the Federal Reserve and its inflationary policies.

*Source: The Inevitability of Runaway Inflation by James R. Cook.

August 23, 2004


The Hyperinflation Survival Guide, Published by Eric Englund.