During the Republican Presidential primary campaign in 2007 and early 2008, Congressman Ron Paul (R-TX) insisted on talking about such outré topics as the dangers of the Federal Reserve System and fiat money, for which he was widely snickered at. Back then, everybody just knew that the geniuses at the Fed had solved all our fundamental economic problems. Now the only one that remained was (as Barack Obama kept pointing out) how to more equitably divvy up the endless stream of wealth.
Granted, when your kids would ask you why a dollar bill was worth a dollar, you'd start out confidently enough, but soon find yourself waving your hands around and answering their increasingly skeptical questions with "Because Daddy says so!"
Yet, even though you, yourself, might be a little hazy on the details, you could be confident that Alan Greenspan and his protégé Ben Bernanke had this money thing all figured out. So, why listen to Ron Paul talk about something as obviously obsolete as the gold standard?
Early 2008 sure seems like a long time ago now …
Perhaps not surprisingly then, one of the surprise bestsellers of 2009 is Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas E. Woods Jr., a historian with the Ludwig von Mises Institute. Despite almost no reviews in what Treasury Secretary Tim Geithner might euphemize as the "legacy press"— Woods's book (with its Foreword by Rep. Paul) has risen as high as #11 on the New York Times bestseller list.
Woods points to six main causes for the current economic travails, which began with the rise in mortgage defaults in 2007 (largely in the four Sand States). His assessment overlaps considerably with the under-reported aspects that I've emphasized:
"Fannie Mae and Freddie Mac": The government-sponsored thingamabobs encouraged lending to lower income and minority homebuyers of increasingly dubious creditworthiness
"The Federal Reserve and artificially cheap credit": Woods sees the low Fed interest rates that bottomed out at 1 percent in 2003-2004 as the worst culprit
The great sportswriter A. J. Liebling boasted: "I can write better than anybody who can write faster, and I can write faster than anybody who can write better," and Woods does a fine job of hitting Liebling's sweet spot in lucidly presenting an Austrian School of Economics analysis of our current troubles.
The "Austrians" (most of whom are American these days) have been waiting a long time for an opportunity to make their case.
"Austrian Economics" is one of the field's various schools, such as the Chicago School, Keynesianism, and Marxism. Its founders were U. of Vienna thinkers such as Ludwig von Mises and Friedrich Hayek, and its American champions include Henry Hazlitt and Murray N. Rothbard.
In recent decades, the Austrians have lost out on most of the economics professions' glittering prizes to neoclassical economists. Mainstream academics make the simplifying assumption that the economy will achieve "equilibrium," a simplification that allows them to engage in dazzling displays of mathematical complexification. These "proofs" have routinely impressed editors of academic journals and the Nobel Prize committee. During the years of apparent economic stability from 1983-2006, their assumption that "equilibrium" was a good assumption for modeling the real world economy came to seem reasonable.
The Austrians continued to eschew complicated mathematics as unrealistic in depicting an-ever changing economy, a stance which hurts them professionally in publish-or-perish universities.
Steve Keen, a non-Austrian economist at the U. of Western Sydney (and a leading figure in what I might call—to maximize confusion—the nascent Australian School), explained in his 2001 book Debunking Economics: The Naked Emperor of the Social Sciences:
"Far from arguing that capitalism is the best social system because of the conditions which pertain in equilibrium, Austrian economists argue that capitalism is the best social system because of how it responds to disequilibrium."
"Disequilibrium" is a fair description of the current state of the economy. Keen goes on:
"The Austrians emphasize the importance of uncertainty in analyzing capitalism, whereas neoclassical economists, as we have seen, either ignore uncertainty, or trivialize it by equating it to probabilistic risk."
As we've observed over the last 20 months, Wall Street "rocket scientists" marinated in mainstream economic assumptions badly underestimated the riskiness of complex mortgage-based assets. The math whizzes at AIG, Bear Stearns, and the like assumed that the risk of a borrower defaulting followed a normal probability distribution (a.k.a., a "bell curve") and thus randomness could be diversified away by bundling huge numbers of mortgages together. Assuaged by that comforting assumption, not enough Wall Street analysts paid attention to fundamental changes in the market, such as the diminishing capability of the rapidly changing population of marginal homebuyers in California, Arizona, Nevada, and Florida to pay back their huge loans.
Austrian Economics is subtle and sophisticated, especially in its depiction of "malinvestment" and the subsequent economic downturns, which is vastly more sophisticated than the muddled thinking on the subject of, say, Keynesian Nobel Laureate Paul Krugman.
Yet Woods tends to paint an overly rosy picture of the infallibility of the free market when he blames the boom-bust cycle entirely on the Federal Reserve. This needlessly detracts from his credibility.
To point out the central bank's culpability in business cycles, Woods asks rhetorically:
"But when a great many businesses, all at once, suffer losses or have to close, that should surprise us. … So why should businessmen, even those well established and who have passed the market test year after year, suddenly all make the same kind of error?"
Why? Because, among other reasons, businessmen are human beings, subject, like all of us, to extraordinary popular delusions and the madness of crowds.
This doesn't mean that the Federal Reserve is necessarily better at preventing booms and busts than the more free market alternatives advocated by the Austrians. It just means that the Austrians shouldn't overpromise on what free markets can deliver.
Having spent 18 years in the corporate world, I've seen (and helped make) plenty of mistakes.
Consider, for example, a small boom-bust circuit that I was involved in: the now almost-forgotten Initial Public Offering Bubble that reached a climax in March 1983. The start-up marketing research company where I went to work in 1982 decided to go public early the next spring at $16 per share. If we met our performance projections, that seemed like a reasonable price. I put in $2,000 to buys shares at the offering price.
A few days before our initial public offering (IPO), however, our investment bankers got wind of a growing mania for any and all IPOs that had anything even vaguely to do with technology. Therefore, the bosses raised our offering price to $23.
When the bell rang on the first day, to our astonishment, the trading price instantly shot up and stayed at $43 per share.
I had made $1,740 on my $2,000 investment in one day. Woo-hoo!
Soon, though, that IPO Bubble was kaput. Over the next couple of years, during which the firm largely lived up to our revenue and profit forecasts, our stock drifted back down to that $16-23 range that management had always figured was appropriate.
And yet, as bad as that loss on our stock was for investors who bought in at the peak of the March 1983 IPO bubble, we did much better by them than most of the other IPOs in that bubbly month. Within a few years, many of our vintage of IPOs had gone broke and been delisted by NASDAQ. The Stingy Investor blog recalls:
"In the 1977-1983 bubble, fully 61% of all IPOs were issued near the climax in 1983. Two years later a Forbes study found that between 1975 and 1985, IPOs on average gained a paltry 3% annually vs. 14.8% for the S&P 500."
Now, you could blame the silliness of the 1983 IPO Bubble on the Fed. After all, there was a lot of money suddenly sloshing around in the stock market because in August 1982, when the Dow Jones Average had dropped as low as 776, Paul Volcker's Fed had decided that it had finally broken the back of the inflation and could afford to ease up on interest rates.
And, yet, Volcker was right to loosen credit. The nasty recession of 1981-82 had done its job, and the country was ready for prosperity (even if its IPOs couldn't live up to euphoric expectations).
There are two relevant questions about that boom and bust:
Q. Why was there a lot of money available for investing in March 1983?
A. The Austrians, with their focus on the Fed, can answer that.
A. Well, markets can make mistakes.
We can ask similar questions for the vastly more catastrophic Housing Bubble:
Q. Why was there so much liquidity?
A. Woods' answer—Greenspan's policy of kicking the can down the road instead of wringing the excesses out of the system after the Tech Bubble burst in 2000—makes sense. (You could also point to other problems, such as our huge trade deficits with China, which they reinvested heavily in American paper.)
A. Here, both government and private actors are to blame. In his chapter "How Government Created the Housing Bubble," Woods summarizes well how political correctness biased the government toward insisting on more lending to minorities.
Yet it's worth remembering that political correctness infected the corporate world as well. The particular problem wasn't greed, which ye shall always have with you, but a lack of counterbalancing fear.
Hispanic immigration and high birthrates were driving up the population in states like California. Wall Street assumed this would automatically boost home prices … after all, everybody's the same on the inside, right? Few bothered to ask unpopular questions about how these new homebuyers in the Sand States could make enough to pay the mortgages back, or could find Greater Fools to buy into their bad school districts.
Bottom line: Woods' Meltdown is an important contribution to understanding the mortgage mess and the Diversity Depression. But we've only begun to unravel it.
[Steve Sailer (email him) is movie critic for The American Conservative. His website www.iSteve.blogspot.com features his daily blog. His new book, AMERICA'S HALF-BLOOD PRINCE: BARACK OBAMA'S "STORY OF RACE AND INHERITANCE", is available here.]