Montreal, August 15, 2009 • No 269

 

Harry Valentine is a
free-marketeer living in Eastern Ontario.
 

 

 THE EMPEROR'S DERRIΘRE

The Vapour-locked and Flooded Engine:
An Analogy of Economic Downturn
 

by Harry Valentine
 

          Most people who have long-term knowledge of automobile engines have at some time encountered the phenomenon of the flooded engine. Usually, a cold engine becomes flooded after too much fuel enters the combustion chambers. Warm engines can also become flooded when excess fuel enters the combustion chambers, and the engine can stall. A hot engine can also become vapour-locked when excess fuel in the system vaporizes.

 

          Combustion usually occurs within a narrow range of the ratio between fuel and air that starts the engine. While automotive companies have been developing engines that can operate on very small amounts of fuel and large amounts of air, flooding the engine with excess fuel usually causes problems. An engine that burns excess fuel could produce less power and run at lower efficiency.

The Vapour-locked Economy

          The analogy of the flooded and vapour-locked automotive engine may be applied to the current economic situation. When too much monetary fuel is pumped into an economic engine, it can generate less real output while producing excess heat. The former chairman of the US Federal Reserve literally flooded the economy's engine with excess monetary fuel when he lowered interest rates to unprecedented levels that were far below natural free-market levels.

          Initially, the increase of monetary fuel brought about a perceived increase in economic performance in the high-tech sector during the 1990's. But the increase in easily available monetary fuel promoted reckless economic driving by new entrepreneurs eager to explore the new economic landscape. The additional fuel was used at lower efficiency in the economy and caused a boom of malinvestment in the high-tech sector.

          The high-tech sector overheated due to the inefficiency of massive malinvestment, just as an automotive engine can overheat due to inefficient use of excess fuel. The result was the dot-com bust and high-tech meltdown of 2000. The Federal Reserve and related financial institutions immediately attempted to restart the overheated and vapour-locked information sector of the economy by pumping in even more monetary fuel. The overheated high-tech sector responded no differently than an overheated and vapour-locked automotive engine when a so-called expert tries to restart the stalled engine by pumping in excess fuel. The so-called expert in this case who flooded the stalled and overheated engine of the high-tech sector was former Federal Reserve Chairman Alan Greenspan.

Overheated Housing

          Efforts by officials at the US Federal Reserve and other quasi-government agencies had little effect on restarting the high-tech boom. Market forces prevailed and forced the overheated North American high-tech sector to cool down. At the time, however, there was growing political support in Washington to encourage more Americans to become homeowners. Until then, the home building industry had weathered its ups and downs while undergoing moderate growth. State-sponsored programs aimed at increasing home ownership literally increased the volume of monetary fuel that was being pumped into the engine of the home building industry.
 

"The economic engine of the home building industry accelerated to spectacular and unprecedented levels of performance while the Federal Reserve disregarded warnings that the housing sector could overheat and become vapour-locked."


          The economic engine of the home building industry began to accelerate as the new monetary fuel entered the system. Various government agencies, along with banks that were being regulated by the Federal Reserve, initiated programs that made it easier for more people to acquire mortgages and become homeowners, irrespective of their previous long-term credit records. The economic engine of the home building industry accelerated to spectacular and unprecedented levels of performance while the Federal Reserve disregarded warnings that the housing sector could overheat and become vapour-locked.

          Even prior to the mortgage meltdown, the engine of the housing sector began to overheat and show signs of distress. That engine eventually did overheat and become vapour-locked on October 14, 2008. Some parts of that engine, including financial institutions such as Bear Stearns, literally seized up. One problem with the Federal Reserve is that when they pump out excess monetary fuel in order to stimulate growth in any one sector of the economy, the only control they really have is the fuel throttle. They have no gauges to provide them with accurate information about the conditions of the engine cooling system or the lubrication system.
 

More of the Same

          The US Federal Reserve and many other central banks around the world are now once again endeavouring to rebuild stalled economies by pumping more monetary fuel into an overheated engine that has stalled and become vapour-locked. The stalled economic engine may occasionally splutter during the restart exercise. Politicians and their advisors may misread these signals and proclaim that the economy is showing signs of recovery. But by pumping newly-printed monetary fuel into an overheated and vapour-locked economic engine, central bankers are just flooding that engine in their efforts to get it restarted. All that such action will ultimately achieve is to prolong the economic downturn, as is happening throughout most of the world.

          The United States experienced a severe economic downturn in 1920, but Presidents Wilson and Harding did what any sensible car owner would do when faced with an overheated and stalled engine. They cut government spending and allowed the overheated and vapour-locked economic engine to cool down on its own. By the end of 1921, economic recovery was well underway in the United States. In fact, few citizens at the time were even aware that they had lived through a very severe, but very short, economic downturn. Too bad this wisdom has been so thoroughly forgotten today.