What Now Seems Unwise Could Be Rationalized Then
Readers suggested a topic on policy responses to recessions. “It seems to be an article of faith amongst many that if we had just ‘let it all fall’, then we’d be done with this economic crisis, or at least a lot further along, with less money spent, and moving on in a better direction. I’m curious what they base this on, since GD1 was essentially ‘allowed to happen’ at first, and it became a cascading worldwide crisis that seemed to never have an end until we had a devastating world war. I assume people will say the New Deal caused the crisis to continue, but how, specifically, which programs, and why?”
“In short, why would it be ‘different this time’? Because the last time we ‘let it all fall’ it turned into an unimaginable disaster.”
A reply, “That premise might have to be drilled into a bit. Leveraged high rollers got taken to the cleaners, and farmers in the midwest got busted by a weather event. I don’t think any of my family called it an unimaginable disaster. Half of them farmers and half steel mill workers. The horrors of WWI/WWII, that they called unimaginable. 25% unemployment, we’ve had that for six years now if taken by the same measure.”
“The problem I see with how we have responded so far to the economic problem, is that we have not made any progress at correcting the causes. If too much credit was a primary cause, we are only encouraging more credit. If banking rules was a primary cause, we have not reformed the banking rules. If globalization was a major cause, we are still pushing the globalization thing. If legislative capture by big money was a cause, we are further along down that path.”
“No one should wish for catastrophic crash, but continuing along the paths away from sustainability is going to make the payback only worse.”
One said, “The problem here is too much debt in the hands of too few people. The solution is to inflate the currency (more available dollars to pay the debt) and get that debt spread around across more people. I’m also not blind to the fact that with currency that has no backing value (gold), there’s no real ‘debt crisis’ possible on a national level. We can print as much as we want/need to pay off debts. The only question is how much pain will that cause the country/world and, right now, the answer is ‘more than letting the debt default.’”
A reply, “Well…. not really. When you hear some loon yammer ‘they’re printing money!’ the follow up question should always be, what are they doing with it??? What if they were stockpiling it in Fort Knox? Would there be any inflation? Not really. Inflation requires the $$$ get in the hands of people to spend and that’s not happening. Granted, it is clear the fed is targeting various commodities in order to support prices (housing and oil), presumably to continue chasing the fantasy of ‘jump starting the economy’. It might have worked if their media machine were able to convince the public to become debt junkies again but I don’t see the public buying into that lie again.”
“And always remember, when the Fed’s media machine invokes the word ‘confidence,’ they’re talking about the public ignoring risk and jumping on the debt train to hell.”
And I say, “The only ‘article of faith’ I see is the faulty recall of what happened in the 20’s and 30’s. Start from an imaginary point and recreate history to support a political policy. But all this talk about ‘what would have happened if we let it fail’ is just a set up to excuse the current economic disaster, and the sh*t-storm that’s coming. Because we went down the Keynesian road on this one, just like we did in the Great Depression. The United States and 14 other countries, at the same time. And we know who to blame for where we are and what’s to come.”
From Mises.org. “It has today been completely forgotten, even among economists, that the Misesian explanation and analysis of the depression gained great headway precisely during the Great Depression of the 1930s — the very depression that is always held up to advocates of the free-market economy as the greatest single and catastrophic failure of laissez-faire capitalism. It was no such thing. Nineteen twenty-nine was made inevitable by the vast bank credit expansion throughout the Western world during the 1920s: a policy deliberately adopted by the Western governments, and most importantly by the Federal Reserve System in the United States.”
“It was made possible by the failure of the Western world to return to a genuine gold standard after World War I, and thus allowing more room for inflationary policies by government. Everyone now thinks of President Coolidge as a believer in laissez-faire and an unhampered market economy; he was not, and tragically, nowhere less so than in the field of money and credit. Unfortunately, the sins and errors of the Coolidge intervention were laid to the door of a nonexistent free-market economy.”
“If Coolidge made 1929 inevitable, it was President Hoover who prolonged and deepened the depression, transforming it from a typically sharp but swiftly disappearing depression into a lingering and near-fatal malady, a malady ‘cured’ only by the holocaust of World War II. Hoover, not Franklin Roosevelt, was the founder of the policy of the ‘New Deal’: essentially the massive use of the State to do exactly what Misesian theory would most warn against — to prop up wage rates above their free-market levels, prop up prices, inflate credit, and lend money to shaky business positions. Roosevelt only advanced, to a greater degree, what Hoover had pioneered. The result for the first time in American history, was a nearly perpetual depression and nearly permanent mass unemployment. The Coolidge crisis had become the unprecedentedly prolonged Hoover-Roosevelt depression.”
“Ludwig von Mises had predicted the depression during the heyday of the great boom of the 1920s — a time, just like today, when economists and politicians, armed with a ‘new economics’ of perpetual inflation, and with new ‘tools’ provided by the Federal Reserve System, proclaimed a perpetual ‘New Era’ of permanent prosperity guaranteed by our wise economic doctors in Washington.”
The Wilson Quarterly. “The great economic and financial crisis that began in 2007 has stimulated an outpouring of books, articles, and studies that describe what happened. What it hasn’t done is explain why all this happened.”
“People were conditioned by a quarter-century of good economic times to believe that we had moved into a new era of reliable economic growth. Homeowners, investors, bankers, and economists all suspended disbelief. Their heady assumptions fostered a get-rich-quick climate in which wishful thinking, exploitation, and illegality flourished. People took shortcuts and thought they would get away with them.”
“The most obvious explanation of why so many people did not see what was coming is that they’d lived through several decades of good economic times that made them optimistic. Prolonged prosperity seemed to signal that the economic world had become less risky. Of course, there were interruptions to prosperity. Indeed, for much of this period, Americans groused about the economy’s shortcomings. Incomes weren’t rising fast enough; there was too much inequality; unemployment was a shade too high. These were common complaints. Prosperity didn’t seem exceptional. It seemed flawed and imperfect.”
“That’s the point. Beneath the grumbling, people of all walks were coming to take a basic stability and state of well-being for granted. Though business cycles endured, the expectation was that recessions would be infrequent and mild. When large crises loomed, governments—mainly through their central banks, such as the Federal Reserve—seemed capable of preventing calamities. Economists generally concurred that the economy had entered a new era of relative calm. A whole generation of portfolio managers, investors, and financial strategists had profited from decades of exceptional returns on stocks and bonds. But what people didn’t realize then—and still don’t—is that almost all these favorable trends flowed in one way or another from the suppression of high inflation.”
“From 1981 to 1999, interest rates on 10-year Treasury bonds fell from almost 14 percent to less than six percent. Lower rates boosted stocks, which became more attractive compared with bonds or money market funds. Greater economic stability helped by making future profits more certain. Lower interest rates increased housing prices by enabling buyers to pay more for homes.”
“Millions of Americans grew richer. From 1980 to 2000, households’ mutual funds and stocks rose in value from $1.1 trillion to $10.9 trillion. The 10-fold increase outpaced that of median income, which roughly doubled during the same period, reaching $42,000. Over the same years, households’ real estate wealth jumped from $2.9 trillion to $12.2 trillion. Feeling richer and less vulnerable to recessions, Americans borrowed more (often against their higher home values). This borrowing helped fuel a consumption boom that sustained economic expansion. Disinflation had, it seemed, triggered a virtuous circle of steady economic and wealth growth.”
“Finally, government economic management seemed more skillful. The gravest threats to stability never materialized. Faith in the Fed grew; Greenspan was dubbed the ‘maestro.’ Well, if the real economy and financial markets were more stable and the government more adept, then once risky private behaviors would be perceived as less hazardous. People could assume larger debts, because their job and repayment prospects were better and their personal wealth was steadily increasing. Lenders could liberalize credit standards, because borrowers were more reliable. Investors could adopt riskier strategies, because markets were less frenetic. In particular, they could add ‘leverage’—i.e., borrow more—which, on any given trade, might enhance profits.”
“Bear Stearns, Lehman Brothers, and other financial institutions became heavily dependent on short-term loans (In effect, firms had $30 of loans for every $1 of shareholder capital.) Economists and government regulators became complacent and permissive. Optimism became self-fulfilling and self-reinforcing. Americans didn’t think they were behaving foolishly because so many people were doing the same thing.”
“What now seems unwise could be rationalized then. Although households borrowed more, their wealth expanded so rapidly that their net worth—the difference between what they owned and what they owed—increased. Their financial positions looked stronger. From 1982 to 2004, households’ net worth jumped from $11 trillion to $53 trillion. Ascending home prices justified easier credit standards, because if (heaven forbid) borrowers defaulted, loans could be recouped from higher home values. Because the rating agencies adopted similarly favorable price assumptions, their models concluded that the risks of mortgage-backed securities were low.”
“No less a figure than Greenspan himself dismissed the possibility of a nationwide housing collapse. People who sold a house usually had to buy another. They had to live somewhere. That process would sustain demand. ‘While local economies may experience significant speculative price imbalances,’ he said in 2004, ‘a national severe price distortion seems most unlikely.’”
“The great delusion of the boom was that we mistook the one-time benefits of disinflation for a permanent advance in the art of economic stabilization. We did so because it fulfilled our political wish. Ironically, the impulse to improve economic performance degraded economic performance.”
