Regulation: The Cause, Not the Cure, of the Financial Crisis
(posted by Roderick T. Long)
In my previous post I explained how Austrian price theory renders both state-socialist central planning and free-market plutocracy unworkable; in the present post, I explain how Austrian price theory applies to boom-bust cycles in general and the present financial crisis in particular, and why those who blame the crisis on the free market have things precisely backward.
Recall that market prices are the mechanism that allows consumer rankings of consumption goods to determine choices among production goods; if consumers rank goods made from steel higher than goods made from rubber, steel prices will rise relative to those of rubber, thus encouraging economising of existing steel and increased production of new steel. (This is incidentally why anti-gouging laws are such a bad idea; they prolong the very shortages whose effects they’re trying to mitigate, by suppressing the price signals that function to end the shortage. When prices are legally prevented from rising during a shortage, that’s like sending out a signal into the market saying “hey everybody, no shortage here, no reason to economise on this item, no reason to increase production of this item, feel free to focus your investment elsewhere” – which is obviously the worst possible message to send.)
Interest rates are a kind of price also; they signal the extent to which consumers are willing and able to defer present satisfactions for the sake of greater future satisfactions. To take the standard example, if Crusoe makes a net he’ll be able to catch far more fish than he can with his hands, but time making the net takes away from time catching fish; if Crusoe can afford to defer some present fish-catching in order to make the net, then it’s rational for him to make it, but if instead he’s on the edge of starvation and might not be able to survive on reduced rations long enough to finish the net, he’d better stick to catching fish with his hands for the moment and save the net project for another day. Whether it makes sense for him to divert time and effort from fish-catching to net-making thus depends on how urgently he needs fish now – in short, on his time-preference.
In a free market, low interest rates signal low time-preference and high interest rates, high time-preference. If your time-preference (i.e. the urgency of your preference for present over future satisfactions) is low, then I would only have to offer you slightly more than X a year from now in order to induce you to part with X today; if it is high, then I would have to offer you a lot more than X a year from now in exchange for X today. The prevailing interest rate thus guides investors in their choice between short-term, less productive projects and those that are more productive but whose benefits will take longer to achieve.
But when central banks, through their manipulation of the money supply, artificially lower the interest rate, then the signals get distorted; investors are led to act as though consumers have a lower time-preference than they actually do. Thus investors are led to invest in longer-term projects that are unsustainable, since the deferred consumption on which such projects depend is not actually going to get deferred, so that the goods that the investors are counting on in order to complete their long-term projects are not all going to be there when the investors need them. Such unsustainable investment is the boom or bubble; the bust comes when the unsustainability is recognised and a costly process of liquidation ensues.
The Austrian theory of the business cycle is sometimes called an “over-investment” theory, but that’s misleading. The problem is not that investors over-invest across the board, but that they over-invest in higher-yield longer-term projects and under-invest in lower-yield shorter-term. That’s why Austrians talk about “malinvestment” rather than over-investment. The prevailing mainstream tendency to treat capital as homogeneous ignores the difference between higher and lower levels of production goods and thus fails to appreciate the costs of having to switch from the high to the low when the bubble bursts.
In additional to the general misallocation of investment between lower-order and higher-order inputs, monetary inflation produces further imbalances. When the central bank creates money, the new money doesn’t propagate throughout the economy instantaneously; some sectors get the new money first, while they’re still facing the old, lower prices, while other sectors get the new money last, after they’ve already begun facing the higher prices. The result of such “Cantillon effects” is not only a systematic redistribution of wealth from those less to those more favoured by the banking-government complex, but an artificial stimulation of certain sectors of the economy, making them look more inherently profitable than they are and so directing economically unjustified levels of investment toward them.
Does the Austrian account, as is often claimed, underestimate the ability of investors and entrepreneurs to recognise the effects of government policies and compensate for them? No. Even if you know that a given price represents some mix of genuine market signals and governmental distortion, you may not know how much of the price represents which factor, so how can you compensate for the distorting factor? (Likewise, if you know there are magnetic anomalies in the area that are throwing off your compass, that’s not terribly helpful information unless you know exactly where the anomalies are and how strong they are compared with earth’s magnetic field; otherwise you have no way to correct for them. And given that the direction of your compass’s needle is at least partly responsive to true north, you’re better off trusting it, despite its distortions, than simply abandoning your compass and proceeding by coin-flip.)
On the Austrian understanding, governmental inflation of the money supply, thereby artificially lowering interest rates, was the chief cause of the Great Depression. (Mainstream economists dispute this, holding that the Fed’s policy could not have been genuinely inflationary, since prices were relatively stable during the period leading up to the crash. But for Austrians the crucial question is not whether prices were higher than they had previously been, but whether they were higher than they would have been in the absence of monetary inflation.) Likewise, for Austrians the housing bubble that precipitated the current crisis was the product of the Federal Reserve’s low-interest policies of recent years. (An aside to address a frequent misunderstanding: on the Austrian view there is nothing wrong with low interest rates per se; indeed, low interest rates are a symptom of a healthy economy, since the more prosperous people are, the likelier they are to be willing to defer present consumption. But one cannot make an economy healthy by artificially inducing symptoms of health in the absence of their underlying cause. By the same principle, absence of scabbing on one’s skin is a sign of physical health, but if there is scabbing, one does not promote health by ripping the scabs away; advocates of minimum wage laws, take note.)
In the 1920s, while mainstream economists were claiming that stock prices had reached a “permanently high plateau,” Mises and Hayek were predicting a crash (as incidentally was my grandfather Charles Roderick McKay, who as Deputy Governor of the Federal Reserve Bank of Chicago protested against the Fed’s policy of artificially lowered interest rates, kept the Chicago branch out of the easy-money policy until centrally overridden, foresaw the likely results, and got the hell out of the stock market well before the crash); likewise, in recent years Austrians kept warning of a housing bubble while folks like Greenspan and Bernanke blithely insisted that the housing market was sound.
Now everyone these days is saying, quite sensibly, that in the present crisis we need to avoid the mistakes that lengthened the Great Depression; the problem is that this advice is useless without an accurate understanding of what those mistakes were. By Austrian standards, the current plan to inject more “liquidity” into the economy is simply treating the disease with more of the poison that originally caused it. Attempting to cure an illness by artificially simulating symptoms of health is, literally, voodoo economics.
Of course the Federal Reserve is not solely to blame; there are still further government policies that encouraged riskier loans. There’s been some media attention paid to Clinton-era changes in the Community Reinvestment Act, for example, that encouraged laxer lending standards in order to attract minority borrowers. The claim that this explanation is “racist” is confusing the reason why a given loan is risky with the reason why the loan, despite its riskiness, gets made; all the same, focusing on this narrow example misses the wider picture, which is that when the federal government sponsors massive credit corporations like Freddie Mac and Fannie Mae, it creates an expectation (whether codified in law or not) that the government is guaranteeing their solvency. Just as with the S&L crisis of the 80s, the expectation of reimbursement in the case of failure encourages riskier loans because the risk is socialised. (And beyond this are the still deeper factors that stifle affluence for the vast majority and so make it necessary for them to borrow money to buy a home in the first place; taking that necessity for granted requires justification.)
Even George Bush, in his speech on the crisis, recognised (or read words written by people who recognised) that the expectation that a bailout would be forthcoming if needed had helped to encourage riskier loans – though he seemed to miss the further implication that by going on to urge a bailout he was confirming and reinforcing the very expectations that had helped fuel the crisis – thus setting the economy up for a repeat of the crisis in the future.
The grain of truth in the otherwise ludicrous statist mantra that the financial crisis was caused by “lack of regulation” is that when you pass regulation A granting a private or semi-private firm the right to play with other people’s money, but then repeal or fail to enact regulation B restricting the firm’s ability to take excessive risks with that money, the ensuing crisis is in a sense to be attributed in part to the absence of regulation B. But the fatal factor is not the absence of regulation B per se but the absence of B when combined with the presence of A; the absence of B would cause no problem if A were absent as well. So, sure, there was insufficient regulation, if by “insufficient regulation” you mean a failure on government’s part to rein in, via further regulations, the problems created by its initial regulations.
So if the problem is caused by A without B, it might be objected, why must we adopt the libertarian solution of getting rid of A? Can’t we solve the problem just as well by keeping A but adding regulation B alongside it? The answer is no, because central planning doesn’t work; when one responds to bad regulations by adding new regs to counteract the old ones, rather than simply repealing the old ones, one adds more and more layers between decisions and the market, increasingly muffling price-system feedback and courting calculational chaos.
But, the objector may continue, what if we’re in a situation where we have regulation A but no regulation B, and where, further, repealing A is not politically possible but adding regulation B is – in that case, shouldn’t we push to add B? In some circumstances, depending on the details, maybe so; but the more important question, to my mind, is to which should we devote more of our time energy – tweaking the details of a fundamentally unsound system within the parameters of what is currently considered politically possible, or working to shift those parameters themselves? In Hayek’s words: “Those who have concerned themselves exclusively with what seemed practicable in the existing state of opinion have constantly found that even this had rapidly become politically impossible as the result of changes in a public opinion which they have done nothing to guide.”
Okay, some will say, maybe it was government, not laissez-faire, that got us into the mess; but now that we’re in it, don’t we need government to get us out? My answer is that government doesn’t have the ability to get us out. There’s just not much the government can do that will help (apart from repealing the laws, regulations, and subsidies that first created and then perpetuate the mess – but that would be less a doing than a ceasing-to-do, and anyway given the incentives acting on government decision-makers there’s no realistic chance of that happening). The bailout is just diverting resources from the productive poor and middle-class to the failed rich, which doesn’t seem like a very good idea one either ethical or economic grounds. The only good effect such a bailout could possibly have (at least if you prefer costly boondoggles without piles of dead bodies to costly boondoggles with them) is if it convinced the warmongers that they just can’t afford a global war on terror right now – but there’s no sign that they’re being convinced of anything of the sort.
If the price system were allowed to function fully, the crisis would right itself – not instantly or painlessly, to be sure, but far more quickly and with less dislocation than any government could manage. What the government should do is, in the final analysis, nothing.
But such a response would be politically impossible? Quite true; but what makes it politically impossible? Is it some corporatist bias on the part of the American people? Did Congress pass the bailout because the voters were clamouring for it? On the contrary, most of the voters seem to have been decidedly against it. The bailout passed because Congress is primarily accountable, not to the electorate, but to big business. And that’s a source of political impossibility that stems not from shiftable ideology but from the inherent nature of representative government. A government that was genuinely responsible to the people would hardly be a paradise (since the people are hardly free from ignorance and bias, and majority rule is all too often simply a mechanism for externalising the costs of majority preferences onto minorities) – but debating the merits of a government genuinely responsible to the people is purely academic, because such a government, whatever its merits or demerits, is impossible; you cannot make a monopoly responsive to the people. Other than the market itself, no political system has ever been devised or discovered that will subordinate the influence of concentrated interests to that of dispersed interests. Monopoly cannot be “reformed” it has to be abolished.
Now that is of course not to say that some governments can’t be less unresponsive than others, just as some forms of slavery can be less awful than others. One of the striking features of slavery in the antebellum American south, for example, is how much worse it was, on average, than most other historical forms of slavery; and if the abolitionists, despairing of the prospects of actually freeing the slaves, had focused their efforts on reforming American slavery to make it more like ancient Greco-Roman slavery or mediæval Scandinavian slavery, I’m not going to say that wouldn’t have been worth doing or wouldn’t have made a lot of people’s lives significantly better – but isn’t it setting on one’s political sights a tad low?
Further reading on Austrian business cycle theory and/or the current financial crisis:
Times Are Hard: On the Causes of the Business Cycle by Gene Callahan
The Economics of Housing Bubbles by Mark Thornton
Open Letter to My Friends on the Left by Steve Horwitz
Paulson’s Scheme by George Bragues
A Crisis of Political Economy by Chris Sciabarra
The Bailout Reader (a further collection of links from the Mises Institute)
October 10th, 2008 at 12:47 am
if consumers rank goods made from rubber higher than goods made from steel, rubber prices will rise relative to those of steel, thus encouraging economising of existing steel and increased production of new steel.
I think you mean: economising of existing rubber and increased production of new rubber.
October 10th, 2008 at 12:47 am
[...] The Austrian school of economics is in a permanent “We told you so” mode these days. In this very readable post, Roderick Long gives the Austrian economist viewpoint of the current financial [...]
October 10th, 2008 at 1:39 am
“The grain of truth in the otherwise ludicrous statist mantra that the financial crisis was caused by “lack of regulation” is that when you pass regulation A granting a private or semi-private firm the right to play with other people’s money, but then repeal or fail to enact regulation B restricting the firm’s ability to take excessive risks with that money, the ensuing crisis is in a sense to be attributed in part to the absence of regulation B. But the fatal factor is not the absence of regulation B per se but the absence of B when combined with the presence of A; the absence of B would cause no problem if A were absent as well. So, sure, there was insufficient regulation, if by “insufficient regulation” you mean a failure on government’s part to rein in, via further regulations, the problems created by its initial regulations.”
I think this is an important paragraph given that there is often so much confusion when people start referring to “deregulation” as if it means “lack of any regulation”. It should be obvious to anyone after a bit of reflection that government intervention is usually not an “all-or-nothing” affair, it tends to be a web of rules that often counteract each other in unpredictable ways.
October 10th, 2008 at 1:41 am
One again, out of the park. A couple of comments:
As a non-Austrian who appreciates Austrian ideas, I think it’s important to stress that “artificially low interest rates” don’t necessarily translate into low interest rates for ordinary borrowers. Those close to the spigot–the banks closely associated with the central banking system–get the money cheap. But this doesn’t translate into cheap money for the ultimate borrower, because the “last mile” of the financial system is subject to extremely powerful regulatory constraints on competition–the entry barriers William Greene talked about. If the “last mile” were a free market, it would be subject to the law that competition drives price toward cost. But since it is not a free market, it is able to price money according to what the market will bear, without regard to what it cost the supplier.
The Austrian theory of mal-investment still falls into a broader category of theories of over-investment, IMO, because the skewing of investment toward “roundabout” methods means that artificially capital-intensive methods of production and artificially highly capitalized firms tend to predominate. And one this state of affairs exists, regardless of whether the Marxists are right in how it came about, a lot of Marxist analysis of the crisis of overaccumulation is pretty useful. The way left-wing analysis of overaccumulation dovetails with Austrian thought was ably described by Joseph Stromberg in “State Monopoly Capitalism and Empire.”
Finally, IMHO a top priority in the anti-regulatory agenda should be repealing restraints on local currency and barter systems, because they may well be what takes up the slack (as in Argentina) during the clusterfuck to come. They have been extremely successful, in many cases, when money and credit have frozen up in the larger economy. I forget the name of the Austrian town that experimented with an alternative currency during the Depression, but it resulted in a fairly thriving local economy, with high rates of employment, when the “circuit of capital” was broken in the outside world.
When I can’t afford to hire a plumber, because I don’t have money, because the guy who needs my services doesn’t have any money, because the guy who needs his services doesn’t have any money, etc., a local currency system that lets me trade my services directly with others can grease things nicely. The idea behind the big barter networks in California during the Depression (which enrolled hundreds of thousands of people, btw) was that the people and their skills are there, and the tools are their, and the mutual need for each other’s services are there. If the food is rotting in the fields because the price is not worth taking to market, and meanwhile hungry laborers have skills for which there is no demand, why not work out a direct arrangement with the farmer to provide services he needs in return for the food?
October 10th, 2008 at 6:26 am
I love your post, but I think there is also another sense in which this crisis was the result of an absence of regulation. A free market severely regulates the behavior of businesses by producing losses to punish bad decisions. By protecting lenders and intermediaries from responsibility for losses, government intervention eliminated the natural regulation by the market.
October 10th, 2008 at 7:56 am
To martin: Oopsy! Fixed — thanks!!
October 10th, 2008 at 8:12 am
Good article, but a couple of quibbles/errata/whatever:
I think the one thing most “mainstream” Austrians seem to lose sight of is the point that Kevin makes and you recognize as a Cantillon effect - that the Fed doesn’t just affect the market-wide interest rate for everyone in the same way. Sure, they recognize it as an “effect”, but for a school based on the idea that people pursue their intentions, however irrationally they may perceive them, the mainstream Austrians have this curious notion of a political economy that operates independent of any of the desires of the main players. Perhaps it is some sort of conservative hold-over knee-jerk response in defending the rich, but they refuse to acknowledge that there is a ruling class that benefits enormously from the intervention, and that directs it to their benefit.
Second, (and this may come as some surprise) I do believe that government *could* do something to mitigate the disaster it has caused. As Rothbard noted in his ideas on how to return to a gold standard - destroying money is not necessary, and probably harmful to some extent. So I think, in a utopian world where a centralized government is responsive to the common good, it could help by re-flating through localized landbanks or some other de-centralizing scheme, whereby the wealth stolen from the people is returned to them. Granted, I agree with you that the centralized government can’t help but be run by special interests, so I don’t think it would ever work that way, but technically the government *could* do something to mitigate the disaster.
Finally, I’d amplify Less’s point, which is one I’ve made all along (and which, it seems to me, you agree with, but it stands to be focused on a bit) - if there is Fannie, Ginnie and Freddie in the first place, there is no “market” to regulate, since the real market regulated it just fine by not creating it. People in the free market knew that this garbage was just too opaque and risky to buy. That is, in fact, the market regulating itself perfectly. It took the government intervention to “de-regulate” the market.
October 10th, 2008 at 8:59 am
I agree with all of the above comments, except that I don’t think it’s true that Austrians are ignoring Cantillon effects and the beneficiaries thereof; look at the commentary that’s been going on lately at Mises.org.
October 10th, 2008 at 10:21 am
the mainstream Austrians have this curious notion of a political economy that operates independent of any of the desires of the main players.
I’m curious to know which “mainstream Austrians” you’re referring to. The Austrians I’ve read on this subject seem to me to be well aware that it doesn’t.
October 10th, 2008 at 11:32 am
Martin,
You can start with Kinsella, Reisman, and their retinue.
Others, like Block, will acknowledge it when pressed, but their analysis of the economy doesn’t demonstrate any actual awareness of it.
They all tend to subscribe to the “big business is the most persecuted minority” school of thought, and it shows in pretty much everything they write. Ignorant masses besiege the talented CEOs and multi-millionaires at every step of the way, layering impediments in their quest to make this a better world for all. The only hope for us all is if these John Galts all move away and leave us to our own devices.
Actually, I tend to agree with them on that last sentence, but with a different outcome in mind.
October 10th, 2008 at 11:46 am
Ha!
Took me all of two seconds at mises to find an article that fits my description to a T:
http://www.mises.org/story/3135
Note that the author could rightly claim that his article describes one half of the problem - the “Baptist” side. If he recognized that there are also “Bootleggers”, but that he’s going to focus on the other part, he’d have done enough to be painting a realistic picture.
Instead, his villain is solely the “ignorant” masses, who have created this machine through their ignorance, and nothing else. Noone actually intended it to work the way it does - the masses are just too stupid to realize what they’re doing.
October 10th, 2008 at 12:05 pm
They all tend to subscribe to the “big business is the most persecuted minority” school of thought, and it shows in pretty much everything they write.
Well, Reisman called Block a commie because Block keeps quoting Kolko and making fun of the idea that big business is a persecuted minority — and Jeff Tucker was attacked for celebrating the downfall of Wall Street bankers ….
October 10th, 2008 at 12:11 pm
I should add that in a recent dust-up on the Mises listserv over whether big business was mostly a victim or mostly predatory, the mostly-a-victim view (defended by Reisman and a couple of other people) was vastly outnumbered by the mostly-predatory view (of which the most vocal defenders were Block and DiLorenzo).
Yes, I know Block and DiLorenzo are not completely consistent on this — but that’s the side they took in that particular fight.
October 10th, 2008 at 1:17 pm
Roderick,
Could you post a link to that listserv here? I’d like to check out that debate!
October 10th, 2008 at 1:46 pm
Great post - comprehensive and defensively written.
I would be interested to hear your thoughts specifically on the wisdom of inflation rate targeting, because that has been the official primary objective of many putatively independent central banks. Are they still just creating money thereby distorting the system and favouring the few over the many?
October 10th, 2008 at 9:38 pm
[...] and Cures October 10, 2008, 8:38 pm Filed under: economics, government Roderick T. Long explains how the free market did not cause the present financial crisis. Here’s what I take to be the [...]
October 10th, 2008 at 11:51 pm
To Roderick:
This is one of the best short explanations of the Austrian business cycle theory I’ve ever seen. It’s all too easy to boil down the theory too much such that it loses its elegance and becomes merely a “hangover” analogy.
To Kevin:
Regarding high interest rates for the masses, I’m skeptical of that being caused by barriers to entry into the banking sector. I think that the phenomenon of large spreads between risky and trusted borrowers has to do with the large degree to which the trusted borrowers are cushioned from competitive forces. I.e. they are so much safer to lend to because they are protected by the State.
That’s not to say that barriers to entry in banking are not important. In fact, its not even competition from other banks that the capitalist banking sector needs protection from, it’s protection from substitute products — other types of lending institutions. The worst part of the type of financial regulations that get imposed in crises is that they tend to prevent alternatives from arising. So many of our monetary rules are about protecting the money system, singular.
October 11th, 2008 at 1:17 am
RTL, you also have “now” for “not”, in “…for Austrians the crucial question is now…”.
There’s an important issue missing in this analysis, namely someting arising from just how close the analogy is between this financial meltdown and the similar thing in nuclear reactors. In a reactor, you rely on two things: each fission neutron sets off the release of more than one neutron (supercriticality), so that fission keeps going, but you have enough damping that you don’t get more than one neutron straight away (prompt criticality), which would lead to a run away reaction and meltdown. You get the difference from some neutrons that are released after a lag, by fission products. The lag is enough that you can control an unstable reactor just as you can an unstable bicycle, because you can respond fast enough (and some reactors have inherent stabilising features so that they do part or all of this without outside control).
Back to the financial meltdown. The idiots have let things get prompt critical, but it could get even worse if the lagged stuff starts coming in. Some sort of bailout is necessary to head this off, because it is the lack of “symptoms of health” that set those lagged failures off. In other words, they need to buy time, just as a diver needs to decompress slowly to avoid the bends, or giving a patient ethanol is the antidote for poisoning from other alcohols. However, it is also necessary to use the time, or you just defer the problem - the diver must still come up, and the patient must still sober up.
So the ideal lies in a combined strategy: some of the stuff discussed by Brad Delong, bailers out rolling over debts at penal rates plus supplying new equity, and then decompressing in an Austrian sort of way, only slowly so old toxic stuff can wash out. The final situation would include improving ordinary people’s situation as Paul Craig Roberts just described. That can work through from accumulated effects of inflation, but ideally would involve improving people’s real situations by putting the rest of the economy right. See also how Britain phased out rationing without shocks (intervals of surging and crashing pent up demand causing harmful transient shortages), by gradually raising ration levels until there was slack before removing the system from each rationed thing in turn.
Sadly, as things are now, only governments can do any putting right on any of these time scales (because of their past encroachments, of course, so there’s moral hazard getting them to provide the help - but there it is).
October 11th, 2008 at 5:12 am
Mike G-
If you want to learn more about why inflation targeting is popular amongst central bankers, google “downward wage rigidity”. You’ll find several academic documents detailing the “problem” of people not accepting lower pay for their labor in stable or deflationary environments, and how inflation targeting is useful in changing the terms of these contracts after the fact to the detriment of these stubborn workers.
It’s one of the things the bankers do to build a political coalition to support their agenda.
October 12th, 2008 at 3:56 pm
I thought he was just giving an example of the sort of resource allocation errors that central planners make
October 13th, 2008 at 8:24 am
[...] Long liefert die in meinen Augen bisher beste, fundierteste und ausgeglichenste Analyse der aktuellen Finanzkrise. Ja, der Artikel beginnt recht theoretisch und ist länger als der [...]
October 13th, 2008 at 8:58 am
Your puzzle says it all. I am dumbing down inorder to be ready for my social society government provider of my needs. At 77 I am tired of trying to provide for all seven kids, It’’s their turn. I’ll lay back and not worry any more about reagonimics, As a delegate for Ronnie in 1980, I was pretty serious about his rescue
coming to save me from beaurecrats depriving me of providing for my family. But now, who cares. Right? Only Ron Paul shows the correct leadership.
October 13th, 2008 at 2:54 pm
Incidentally, for some Austrian replies to Nobel laureate (giggle) Paul Krugman’s muddled critique of Austrian business cycle theory, see here.
October 13th, 2008 at 6:13 pm
Keith Preston: Could you post a link to that listserv here? I’d like to check out that debate!
Alas, it doesn’t have a public archive.
Mike G: Are they still just creating money thereby distorting the system and favouring the few over the many?
Yes.
P. M. Lawrence: you also have “now” for “not”, in “…for Austrians the crucial question is now…”.
Thanks! Fixed.
October 14th, 2008 at 3:04 am
Hi Roderick. I’d be interested in your thoughs on a comment made on another blog in response to Austrian explanations for the current crisis:
“Before making recommendations for a return to the gold standard, abolition of central banks and so on, you might want to consider the Panic of 1873 and the subsequent Long Depression (see also Hungry Forties, Panic of 1893, Panic of 1907, Australia’s 1890 Depression and so on).
The idea that financial panics are a product of central banking and fiat money derives its plausibility only from the fact that no-one can now remember the panics of the pre-central bank era.”
October 14th, 2008 at 6:41 am
[...] The Full Piece… TheArtofthePossible.com [...]
October 14th, 2008 at 8:43 am
Smally,
I would argue that the comment gets it half right. Many Austrians (not all, by any stretch, and in this instance, usually only the ones who are “shallow” Austrians) obsess over the state based inflation of the money supply without understanding how inflation can occur outside of direct state control (which, incidentally, depending on your definition of state, we don’t have right now either).
The truth is that there were central banks before the Fed, and they do have some blame for the problems in the 18th century (realize that this current mess originated at least as far back as Ronnie Reagan’s presidency and you can see that central bank tinkering has long term effects). But, and this is the point that comment gets half right, increase in money supply can occur in a free market due to counterfeiters and fraudulent bankers who pay homage to unsound economic theories.
The reason why that system is better than the current one is that people can escape such inflationary systems (by refusing to deal in that currency if they don’t trust it) or hedge themselves against it by maintaining stocks of competing currencies. Currently, even if you reject the paper money completely and attempt to live in a barter economy, you will be assessed a tax that you must pay in paper money, forcing you to turn a profit somewhere in paper money sufficient to pay the assessments on your bartered “profits”. In other words, you must subject yourself to this rip-off, or they will take everything you own away from you.
There are other secondary reasons that led to those other recessions as well, just as there are other secondary causes of the current crises. But the real bust only occurs when imaginary wealth, in the form of an inflated money supply, disappears. That the part the comment gets half wrong.
October 14th, 2008 at 3:00 pm
[...] to net-making thus depends on how urgently he needs fish now
October 14th, 2008 at 6:01 pm
[...] Regulation: The Cause, Not the Cure, of the Financial Crisis [...]
October 15th, 2008 at 8:00 am
[...] The Art of the Possible — Regulation: The Cause, Not the Cure, of the Financial CrisisThanks, Paul.Tags: economy economics finance regulation [...]
October 15th, 2008 at 10:41 am
[...] And naturally, instead of finally letting the market do its thing and correct itself, officials want to impose further regulation on the financial industry. Austrian economists accurately predicted that this mess would occur as a result of such regulation. So naturally they’re the first to explain that given the current scenario, more regulation is the cause, not the cure. [...]
October 16th, 2008 at 3:36 am
[...] and government legislation interfering in the day-to-day transactions and whatnot, but it was government action that inevitably lead to the current crisis we see [...]
October 17th, 2008 at 10:31 am
[...] John Schwenkler excerpts this article on why band-aid regulations might wind up being at least as bad as ripping off the band-aids [...]
October 21st, 2008 at 9:39 am
[...] to net-making thus depends on how urgently he needs fish now
October 22nd, 2008 at 4:28 am
[...] to net-making thus depends on how urgently he needs fish now
November 8th, 2008 at 12:26 pm
[...] read more | digg story addthis_url = ‘http%3A%2F%2Fmorality101.net%2Fblog%2F2008%2F11%2Fregulation-the-cause-not-the-cure-of-the-financial-crisis%2F’; addthis_title = ‘Regulation%3A+The+Cause%2C+Not+the+Cure%2C+of+the+Financial+Crisis’; addthis_pub = ”; [...]