Reasonable People Can Disagree

This post will be in regards to a conversation that Brooke and I had yesterday afternoon. Brooke asked me what I felt about the current economic situation, its causes, and possible solution. We then proceeded to exchange our mildly-educated opinions and the resources who led us down that particular path. Here, I am going to repeat my opinion and reference my sources, to which I can own credit for said opinion.

Let me start first, though, by addressing the post title and conceede that the adjective reasonable when applied to my brother and myself is somewhat dubious. That being established, let's proceed to the boredom.

My answer to Brooke was short and sweet, and something like the following: "The less the government tries to do, the better off everyone will be." This espouses a laizes-faire, free-market view and approach of the current situation. My opinion is that the less the government tries to bail-out, force lending, and stabilize prices the faster the economy will hit bottom and proceed to recovery. The economy is headed south as part of a predictable central-bank created business cycle (more on this later). When on the downswing like this, there will be a bottom, and government intervention will result in either a slowing of the downfall (delaying recovery) or, much worse, a time-delay in the downfall, making the inevitable fall that much worse when it does come. This is much like hitting the snooze bar; the time comes when you have to get out of bed. Your head still hurts and now you're ten minutes late.

The business cycle I refer to above is that described in the Austrian Business Cycle Theory, or ABCT. According to the ABCT, cheap credit created by Federal Reserve Bank policies are the primary factor in the booms and busts we see in the economy. The Fed lowers interest rates, banks lend, people and institutions borrow, the money supply is artificially expanded, and the economy gets "drunk" on this infusion of cash (that is not backed up by anything solid such as savings, much less anything more solid like precious metals). The Fed, ever wary of inflationary pressures, eventually has to pull the plug and raise interest rates. The music stops, the party is over, Wall Street gives a nice big vomit, and the hangover begins (lets all hope we don't pass out).

Great analogy, right? So what do I mean by "drunk." Well what I mean is this: When the economy gets a infusion of cheap-credit cash, it has to go somewhere. Where it eventually goes is to portions of the economy that are ONLY viable because of the cheap credit, i.e. ventures that are profitable when the Fed has the funds rate at 1%, but are not when that rate rises. This is what is called a bubble. In the 80's with the Savings & Loan crisis, what we had was a commercial real-estate bubble. Now we're seen the demise of a residential real-estate bubble. This is compounded by a financial bubble that was perched on the back of the housing bubble. And, as we will see in the comming weeks, further compounded by the personal debt bubble that was also perched on home values. Bubbles are inflationary. Home prices were rising faster that incomes. This is not sustainable. When reality sets in, home values adjust to true market levels and this should be expected. But this is the very thing the government wants to stop as soon as possible. They want to prop up inflated home values. This is not only insane, but also likely impossible.

The popular thought is that they just need to prime the financial pump and get money, huge sums of cash, flowing again. Somewhere. Anywhere. And we'll all be okay. Sustainable lending practices can ONLY be supported by savings. That is what a bank is supposed to do: Take savings and funnel it into borrowers who need capital. But banks are collapsing because they are taking loans to make loans, and the tip of the inverted pyramid, the real savings, are being eroding. Look at banks today. Everyone is all in a hussy because they are not lending. They're sitting on cash. This is obviously terrible. They should, rather, be shelling it out willy-nilly to the economic equivalent of crack-addicts. No. Consciously or not, banks are doing what they are supposed to be doing in a recession: accumulating savings.

Now a rebuttal to Brooke's response.
His reply was what we see all over the media and in the current political climate: more and better regulation. Like McPalin, the idea is that their either wasn't enough regulators or the regulators were sleeping at the wheel. Well this line of thinking pre-supposes a great deal. That regulators are smarter and better than industry. Just yesterday, Greenspan was on Capitol Hill saying he was shocked at the current crisis. If he didn't see it comming why do we think a few extra neck-ties in Washington will? If the CEO's of countless financial institutions didn't see it comming, how will borrowing a hand-full of their inferiors and placing them on a tax-funded payroll going to solve the problem? I can't see that it will.

And now, my source.
I've been spending time on the website of the Ludwig Von Mises institute at www.mises.org. This is a libertarian think tank, based out of Auburn, Alabama who primarily focus on economics, the Austrian School of economics to be presice, and also spill out into general libertarian mantra which I'm not as keen on. There is too much to read there in my lifetime, so I'll share a few highlights from their blog that I have come across recently:

• Economic Depressions: Their Cause and Cure - probably a more eloquent treatment of my thesis above.


• Did Joseph Wharton Cause The US Financial Meltdown? - a fun jab at elite universities and MBAs.

That's it for now. If I come across any more goodies I'll be sure to share.