The Financial Crisis

Many people are confused about what is going on in the economy right now. I thought I'd provide a post that describes how it would be viewed by adherents of the main branches of modern economics.

The two most credible strains of economics are the Monetarists and those of the Austrian School. Keynesians represent a third school.

Monetarist theory is associated with Milton Friedman and current Fed Chairman Ben Bernanke, among others. No politicians, to my knowledge, are associated with Monetarist theory.

The Austrian School is associated with economists Fredrick Hayek, Ludwig Von Meise, and Murray Rothbard, and politician Ron Paul, among others.

The work of both the Monetarists and the Austrians are clear expansions on the work of Adam Smith ("The Wealth Of Nations", well accepted arguments in favor of free trade and free association, and of the free market mechanisms that create wealth), and have few contradictions with it.

The Keynesians are associated with John Maynard Keynes, and by implication, Carl Marx and his contemporaries. The Keynesians would claim linage to Adam Smith, but their theories are inherently inconsistent with much of Smith's work, and directly contradict the theories of the Monetarists and the Austrians.

It should be noted that no respectable economist is now a pure Monetarist or Austrian. They are two competing theories that have many of the same underlying principles, and differ mainly on whether monetary policy can be used constructively. The Federal Reserve is a tool of Monetarism, and the Fed Chairman has no choice, under law, but to act like a Monetarist, attempting to use the printing of money promote economic growth.

It should also be noted that the current system, put in place by the government, is an attempt to use the (most controversial) aspect of Monetarism that theorizes that monetary policy can be used as a productive economic tool, in conjunction with Keynesian economic planning. This is somewhat ironic, in that any serious Monetarist will reject Keynesian planning in virtually any form. This is, in practice, why Federal Reserve Officials are constantly advising Congress to reduce government interventions, warning that there is only so much they can do to support the economy.

All current elected leaders (other than Ron Paul) subscribe to the Keynesian/Monetarist hybrid philosophy, whether they know it or not. (Pure Keynesians are extinct in serious economics circles).

So how would members of the various schools view the current financial crisis?

The Keynesian/Monetarists:
The Cause: It is a Keynesian style economic "planning" effort that the United States has employed since the beginning of the 20th Century. One would expect that they would attempt to explain the current crisis in terms of fixable shortcomings an otherwise good "plan" to improve on the free market's allocation of housing, as well as more Marxist explanations related to the greed of capitalists. This is exactly what we are seeing in the news. They assert that the aspect of the "plan" now causing trouble, i.e. an artificially high rate of housing development, followed by the bursting bubble, is only causing trouble due to a lack of proper regulations, and the resulting ability of greedy businessmen to run amok. (The relevant policies related to this part of the Keynsian "plan" include the home mortgage deduction, various direct subsidies for housing including the FHA and HUD, the creation of subsidized and government guaranteed mortgage insurance with Fannie Mae and Freddy Mac, and various "civil rights" type laws requiring banks to provide loans in poor areas such as the Community Reinvestment Act, along with the Federal Reserve policy of keeping interest rates artificially low).

The Solution: Fix the plan by outlawing certain behaviors that are incentivized under the structure created by the plan (such as uncreditworthy people buying houses, and investors taking high levels of financial risk). Massive government spending financed by printing money, and lower interest rates (more printing money) will create jobs and save the economy.

The Monetarists:

The Cause: The pure Monetarists believe that the problem was cause by a fundamentally flawed "plan," which would describe virtually any economic plan conceived by government. Their theories dictate that the unavoidable misallocation of resources caused by any large scale government planning effort would, as a mathematical certainty, eventually result in a major economic contraction. The plan, they would argue, turned the irresistible forces of economics toward a bad result. They would point out that the plan created an underlying structure in which people and lenders had a strong incentive to act just as they have acted. They would argue that more regulation (i.e. a less bad plan with more laws making it difficult or inconvenient for people to act in accordance with their structural incentives) could have slowed the progression of the unavoidable adverse economic effects of the plan, making them better able to mitigate the damage through activist monetary policy.

The Solution: Drastically alter the plan to slow the progress of it damaging effects. Better yet, eliminate government intervention in the economy completely. The resulting economic downturn can, to at least some degree, be mitigated by massive monetary expansion. Printing money and giving it to banks, and low interest rates.

The Austrians:

The Cause: The Austrians believe, like the Monetarists, that the problem was cause by a fundamentally flawed plan. But they would focus on the activities of the Federal Reserve, and would assert that excess money creation, artificially cheap credit (i.e. the primary tool of the Monetarists), would alone have caused the problem, regardless of the so-called "quality" of the plan. The combination of the flawed Keynesian plan and the flawed Monetarist monetary policy is the worst of all possible worlds.

The Solution: There is no solution. We are in for a major economic contraction. The more the government does to try to stop it, the deeper and longer it will be. If the government again attempts to use monetary policy to "bubble" our way out of economic trouble, it will either fail, leading to the immediate downfall of our society, or, if successful, create a bigger bubble which will cause a far more severe crash in the near future, one from which there will be no escape. The Austrians would state that the best option is to reform the monetary system, creating "sound money" and stopping the government from printing money, which will cause a very severe, but relatively short-lived (say 3-7 years), economic contraction, after which sustainable economic progress could resume. It would also be best to abandon the Keynesian plan in its entirety immediately. However, if Keynesian planning continued under a "real" money system, the damaging economic effects of the plan would be impossible to conceal.

It is an unfortunate fact that the Austrians are the only branch with any success in predicting macroeconomic trends. In early 1929, both Hayek and Von Meise predicted the then-coming depression. More recent Austrians predicted both the Internet Bubble and the current Housing Bubble. They have been warning of the current financial crisis. The Austrians also predict that, prior to the ultimate disintegration of our society, great institutions of the Keynesian system, thought invulnerable, will crumble spectacularly, like pillars of sand. That is one reason why the recent fall of all five venerable investment banks on Wall Street and the largest insurance company in the world are very concerning events to students of economics: They are late-stage predictions of the Austrians, events that occur shortly before a "death spiral".

It is worth noting that the increasing frequency with which the predictions of the Austrians were coming to pass was a central theme of Ron Paul's presidential campaign.

The Keynesian/Monetarists and the Monetarists would predict that we are in for a mere recession. Unfortunately, neither the Keynesian/Monetarists nor the pure Monetarists have any record of macroeconomic predictive success. Neither branch would have predicted the severity of the current crisis, and the Keynesian/Monetarists would have thought it utterly impossible. Further, Keynesian (and arguably some measure of Monetarist) "solutions" to the Great Depression were not successful, in terms of measurable macroeconomic effects.

Finally, it should be noted that there is much argument in serious economics circles about whether the Great Depression could have been avoided. The Keynesians are not serious participants, as it was Keynesian policies that were tried and unambiguously failed during the Depression. However, the Monetarists (notably current Fed Chairman Ben Bernanke in this PhD Thesis) argue that massive monetary expansion could have turned the Depression into a mere severe recession. The Austrians say that is rubbish, and that massive monetary expansion would have only aggravated the situation by causing hyperinflation, to go along with the economic contraction.

The current solution being attempted by the Government is a combination of Keynesian and Monetarist solutions. For us economics buffs, it will be interesting to see whether the Austrians or the Monetarists are right. Just a very bad recession, or a hyperinflationary depression? Oh well, at least its good to live in interesting times.

The Bailout

The Actual Truth About The Bailout: The basic purpose of the bailout is to allow banks to sell their toxic assets, mostly mortgage backed securities, for more than they are worth. I.e., to give free money to banks and financial companies.

The reason cited is that banks with lots of these assets cannot borrow money from each other, because one bank will not lend to another bank if the other bank has a bunch of toxic assets. This is because they don't know if that bank, the borrowing bank, will suddenly declare bankruptcy, wiping out the loan. The Bailout Plan will buy those assets. Thus, the banks will not have those toxic assets, and they will be willing to lend to each other again. This, in turn, is important, because banks usually have lots of their assets tied up in illiquid things, like business loans, so they need to be able to borrow cash when, for example, a bunch of people withdraw their money.

The bailout plan is not necessary because for several reasons.

First, most banks are not in trouble. They did not make the large returns that the now toxic bonds paid. They were conservative. There are enough banks to provide all the credit our economy needs. It should be noted that none of the major financial conglomerates are in trouble, e.g. BofA, Wells Fargo, JP Morgan.

The bailout is for $700 billion (it will ultimately be at least twice, maybe ten times that much). The argument is that only the government can come up with that much money. That is a specious argument. This $700 billion is not just one chunk of money, but a whole bunch of small chunks. The private market will provide capital to save the banks that can and should be saved. Private capital has already saved Morgan Stanly, Goldman Sachs, and saved the depositors of Washington Mutual. Without the bailout, the worst managed banks and financial companies, those that cannot raise capital, will fail. And guess what? They should fail

The only things the bailout accomplishes are(1) saving a group of recklessly managed banks and financial companies that made exorbitant profits for years by investing in risky securities, and (2) giving free money to strong banks, that don't really need it, but will happily take free money.

The overall effect of the bailout will be negative for Main Street. The positive effects of the $700 billion of printed money pumped into the banks will be more than offset by the negative effects of a declining dollar, increased inflation, and the structural effects of keeping all of the bad financial institutions in business.

And, of course, can there be any doubt that there will be wholesale corruption? This $700 billion is likely to be little more than a piggy bank for the administration and its friends. Do you think a bank with shareholders that are enemies of the administration will be getting loans? Fat chance. So the other result will be that the Administration will be able to give its friends a huge business advantage over its enemies.

Frankly, we'd be better off funding increased amounts of insurance deposits (the FDIC) to make sure that depositors don't lose their money, (even over $100,000). That would prevent bank runs.

Then, the government could handle crisis individually, as they come up. But it the private market will not come in to save an institution, there is no conceivable reason that the government should.

Post to Wired Website

The American Revolution represented the expulsion of religion from government.

So, those who had forever held power on the basis of divine right needed a new religion that would avoid the new rules.

The answer: Socialism. The priests of social engineering.

Their proposition: We will give you Heaven on Earth. You need need only give us control of your government.

Our only defense to this attack was reason.

So they perpetrated the lie that social engineering is something that can be accomplished by the ignorant through the whims of the heart. Reason is not relevant in matters of social engineering, they said. They told you that your opinion is what really matters, your innate spiritual sense of right and wrong, and you believed it. They told you that those greatest of economic minds, Hayek, Von Meise, Friedman, Smith, were false prophets. Their mathematics were false. Their empirical data corrupted. The engineers were the priests, and the priests the engineers.

They told you to just do what feels good. Just believe. They said: "Know that if we are your rulers, you are righteous, moral, true, good. But if we are not your rulers, you prove yourself greedy, base, inhuman."

So I ask you, if you have persuasive counterarguments against the great libertarian economists (most are Nobel laureates), why have you not yet received prizes and accolades recognizing your transcendent insights?

If you have discovered the secret of centrally planned social engineering that will not lead to civilizational collapse, as the true economists all predict (their predications are coming to pass as I write), publish it. You'll be the most famous economist in human history.

The answer is that you are the worst kind of fools. You are the modern day armies of inquisition. You have brought our society to the edge of the abyss by your determination to impose your religion on society by force. You are no different than all the tyrants, and their ignorant minions, before you.

Obama is the Great Prophet of the Socialists, though he cannot call himself this. The great Priest of Social Engineering. His blank-eyed minions, entranced baying mobs, worship every word he utters.

We are doomed.

(By the way, McCain is merely a lesser priest of the same sect. Ron Paul was our last hope, and, though unable to defeat his arguments, you rejected him and the great economists whose views he advanced, as would an Evangelical an atheist).

Sacramento Bee Response

One Kevin Yamamura wrote this article in the Sacramento Bee about Ron Paul. I sent him this email response:

Why do you insist on misrepresenting Paul's positions?

He does not advocate a "return to the gold standard." I doubt you have any understanding whatsoever of monetary policy, so to even address this subject is irresponsible. However, I'm sure you know that saying somebody advocates "a return to the gold standard" makes them sound crazy, like saying he believes in UFOs (same with calling them an "isolationist", see below).

At any rate, Paul advocates legalizing transactions in instruments other than federal reserve notes. Such transactions are currently illegal. If I want to pay you for your services in gold or stock or bonds, we both go to prison (unless we comply with IRS regulations and pay lots of taxes on the transaction). The reason he advocates this is because printing money causes asset bubbles and inflation.

"Isolationist beliefs?" Why not just call him a "child molester"? It would be just as accurate.

And why do we get so angry? Because we are trying to save our country from becoming a third-world slum. This isn't "feel good" politics. We are running out of time. The regulatory/socialist state has run up at least $60 Trillion in debt and unfunded liabilities, at the Federal level alone. That is more than $500,000 for an average American family. That is a CURRENT LIABILITY. That's not: we need to pay $500,000 over the next 50 years. That's: each family would need to come up with $500,000 NOW and put it in an interest bearing account to have enough to pay the debt and unfunded liabilities that are about to start coming due. If that sounds unlikely to you, I'd ask you to do some research. Try googling statements by the Comptroller of the Currency of the United States.

Ever ask yourself why your readers are generally totally oblivious to this most important of facts?

The only, ONLY solution is to stop this disasterous experiment NOW, and return to a free society. That's not my opinion, that the opinion of lots of Nobel Lauriets.

I have a three year old kid who is going to be inheriting a society in collapse, and I'm not happy about it.

Do you know what happened after the Collapse of the Roman Empire? Look into it. Hint: Try wikipedia on "Dark Ages."

If you don't want to help us, at least don't misrepresent our positions, please.