The book does two things. First, it lays bare the true fiscal position of the U.S. government, and shows why some kind of default is not merely possible but inevitable. But this is not a book full of numbers about the impending collapse. The collapse is merely the jumping-off point. By far the more central part of the book is this: the critical first step for reversing this mess and checking the seemingly unstoppable federal advance is to stick a dagger through the heart of the myths by which government has secured the confidence and consent of the people.

We know these myths by heart. Government acts on behalf of the public good. It keeps us safe. It protects us against monopolies. It provides indispensable services we could not provide for ourselves. Without it, America would be populated by illiterates, half of us would be dead from quack medicine or exploding consumer products, and the other half would lead a feudal existence under the iron fist of private firms that worked them to the bone for a dollar a week.

Thus Americans tolerate much government predation because they have bought into the myth that state intervention may be an irritant, but the alternative of a free society would be far worse. They have been conditioned to believe that despite whatever occasional corruption they may observe in politics, the government by and large has their well-being at heart. Schoolchildren in particular learn a version of history worthy of Pravda. Governments, they are convinced, abolished child labor, gave people good wages and decent working conditions; protect them from bad food, drugs, airplanes, and consumer products; have cleaned their air and water; and have done countless other things to improve their well-being. They truly cannot imagine how anyone who isn’t a stooge for industry could think differently, or how free people acting in the absence of compulsion and threats of violence – which is what government activity amounts to – might have figured out a way to solve these problems. The history of regulation is, in this fact-free version of events, a tale of righteous crusaders winning victories for the public against grasping and selfish private interests who care nothing for the common good.

But let’s suppose that the federal government has in fact been an enemy of the people’s welfare, and that the progress in our living standards has occurred quite in spite of its efforts. It pits individuals, firms, industries, regions, races, and age groups against each other in a zero-sum game of mutual plunder. It takes credit for improvements in material conditions that we in fact owe to the private sector, while refusing to accept responsibility for the countless failures and social ills to which its own programs have given rise. Rather than bringing about the “public good,” whatever that means, it governs us through a series of fiefdoms seeking bigger budgets and more power. Despite the veneer of public-interest rhetoric by which it camouflages its real nature, it is a mere parasite on productive activity and a net minus in the story of human welfare.

Now if this is a more accurate depiction of the federal government, we are likely to have a different view of the consequences of the coming fiscal collapse. So an institution that has seized our wealth, held back the rise in our standard of living, and deceived schoolchildren into honoring it as the source of all progress, will have to be cut back? What’s the catch? This is no calamity to be deplored. It is an opportunity to be seized. The primary purpose of the book, therefore, is to demonstrate that we would not only survive but even flourish in the absence of countless institutions we are routinely told we could not live without.

And with the exception of the final chapter, that’s what the rest of the book does. I wanted it to be a relentless presentation, such that even a skeptical reader would have to be impressed by the sheer number and force of the arguments.

Some of the topics covered include:

* Could we survive without the welfare state?
* Was the Industrial Revolution a disaster for workers, and evidence of the wickedness of the free market?
* The market vs. global poverty
* How the market, in spite (not because) of government, leads to higher living standards for everyone
* How the market leads to improved working conditions and does away with child labor
* Federal education programs: a critique
* Doesn’t Sweden prove a large welfare state is compatible with lasting prosperity?
* If government shrinks, won’t big business fill the void and oppress the public via predatory pricing?
* Why it’s impossible to design a wealth redistribution program that does not cause net harm
* The truth about “affordable housing” programs
* Iceland and the financial crisis: a case study of free markets run amok?
* California energy “deregulation” – proof that free markets don’t work?
* Is the Savings & Loan (S&L) crisis evidence of the failure of free markets?
* The real record of Sarbanes-Oxley
* OSHA and workplace safety
* The FDA
* Don’t we need to make an exception for government science funding?
* A primer on the War on Drugs
* Obamacare: the problems and the solution
* Why “stimulus” programs make things worse
* How prudential regulation contributed to the financial crisis
* Are some firms “too big to fail”?
* Did the “repeal” of Glass-Steagall contribute to the financial crisis?
* The real story of “deregulation” and the financial crisis
* Is Paul Krugman right to absolve Fannie Mae and Freddie Mac of blame?
* The Pentagon’s impact on the U.S. economy
* Has the Federal Reserve really made the U.S. economy more stable, as so many proponents try to claim?
* What caused the bank panics of the nineteenth century? Are they evidence of the need for a central bank?
* The separation of money and state
* Do we need the Fed to protect us from deflation?
* Regulation as an anti-competitive device
* Possible approaches: agorism, jury nullification, Free State Project, and more

One of the goals in writing my books has been to help get people up to speed on important issues as efficiently (and, I hope, enjoyably) as possible. (In fact, much of what I write comes down to this: what do I wish I myself had known 20 years ago, so that I wouldn’t have had to come by all this information so laboriously on my own?) That way people can more easily prepare themselves to answer many of the most common objections to their position they are likely to encounter.

That’s what I’m trying to do in Rollback as well. The propaganda with which we are flooded regarding how indispensable the political class is – why, they are selflessly devoted to “public service”! – is unworthy of a fifth-grader. We would not die instantly in the absence of the Joe Bidens and Mitch McConnells. We would flourish. And here’s the proof.

Regards,

Thomas E. Woods
for The Daily Reckoning

P.S. You can purchase Rollback: Repealing Big Government Before the Coming Fiscal Collapse here, or receive a free chapter here.

Who’s Afraid of a Free Society? originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

It’s during an artificial, unsustainable boom like the one we’ve just lived through that, unbeknownst to most people, the real damage is done to the economy. But that’s when they’re least likely to listen or care.

Now that we’re living through the bust, on the other hand, many people are listening. That’s why it’s so important for economists of the Austrian School to redouble their efforts, whether in terms of writing, public speaking, media, or indeed whatever platform they can get, to promote a sound, free-market interpretation of what’s happening. The drones who exist to repeat clichés about market failure need a robust and energetic reply from people who know what they’re talking about.

Robert P. Murphy has done exactly this. His article archive at Mises.org has grown substantially during the crisis, and his blog is always a valuable read. In addition to all this, he managed to find time to write the recently released book The Politically Incorrect Guide to the Great Depression and the New Deal.

Murphy and I corresponded regularly late last year as we worked on our respective books. He got a kick out of the realization that he, the economist, was writing a work of history, and I, the historian, was writing a book (Meltdown) that gave the Austrian perspective on the current economic crisis. But he is a perfect fit for a study like this. Although many economists know little history, historians’ knowledge of economics is confined, with few exceptions, to a catalogue of primitive fallacies. This episode in American history has needed the careful, book-length attention of a good economist — that phrase, sadly, is practically an oxymoron in the Age of Krugman, is it not? — for a long time now.

And it isn’t just the court historians or the left-wing economists who need straightening out, either. Even otherwise free-market scholars of the Great Depression and the New Deal have a fatal soft spot for the Fed — whose failing, they tell us, was its failure to pump enough money into the system. Murphy will have none of this.

Thus, for example, the Chicago School has been critical of the Fed, but for the wrong reasons: the Fed supposedly failed to create enough money when the money supply began falling. This is not exactly a free-market criticism, but (surprise!) it’s the only one the mainstream has bothered to acknowledge. As a matter of fact, in the nearly two years following the 1929 stock-market crash the Fed engaged in what were at that time the most aggressive rate cuts in its history. (This is in contrast to the Fed’s rate increases during the 1920–1921 downturn, which was over quickly but which by Chicago’s reasoning ought to have been more severe and persistent.) Milton Friedman and Anna Schwartz, Murphy concludes, gave birth to,

“a myth, namely that the Federal Reserve sat idly back and allowed the economy to implode. That myth — like the myth that Herbert Hoover sat idly back and watched the Depression unfold — is continuing to drive misguided policies today.”

Murphy also includes in this chapter a very useful section on deflation, a subject nearly impossible to find treated without breathless hysteria. To blame the Depression on a decrease in the supply of money is to get the relationship exactly backward. Moreover, the money supply fell by the same percentage between 1839 and 1843 that it did between 1929 and 1933, but robust increases in real consumption and real GNP followed. Under the heat of Murphy’s magnifying glass throughout this much-needed chapter, the arguments of the deflationphobes melt away.

Naturally, Murphy devotes considerable attention to the interventionist program of Herbert Hoover, the president whom most Americans, if they have heard of him at all, associate with laissez-faire. According to Paul Krugman, for example, “the federal government tried to balance its budget in the face of a severe recession.” Murphy, in response, says “it would be difficult to render a more misleading account of Hoover’s policies without actually lying.” In Fiscal Year (FY) 1933, which ran from mid-1932 to mid-1933, the federal government ran a $2.6 billion deficit — at a time when it took in only $2 billion in tax receipts. So the deficit that Krugman represents as wild slash-and- burn budget cutting was in fact greater than the federal government’s entire tax haul that year. That would be equivalent, Murphy observes, to a $3.3 trillion deficit in FY 2007, as opposed to the actual figure of $162 billion.

Now it is true that the FY 1933 budget included some minor budget cuts, but these relatively trivial cuts came only after Hoover’s dramatic spending increases of the previous several years had failed to show any results other than a deepening of the Depression. Murphy’s book has all the figures. By the time Hoover pulled back from what would later become standard Keynesian fiscal policy — a pullback that came in the form of minor spending cuts and major tax-rate increases — unemployment had already gone higher than 20 percent.

In a 1926 speech while secretary of commerce, Hoover had observed that Americans enjoyed both higher real wages and a higher standard of living than did people elsewhere. Like all too many others, though, Hoover drew the fallacious conclusion that the prosperity was the result of the high wages rather than the other way around. (This was the fallacy, exploded by Henry Hazlitt, that high wages promoted prosperity by providing workers with “enough to buy back the product.”) The high purchasing power of American wages reflected American workers’ productivity: because they were able to produce so much physical stuff, thanks to the amount of capital per worker in the United States, the resulting abundance made their paychecks stretch farther. “Unless workers have first physically produced the goods (and services),” Murphy writes,

“there will be nothing on the store shelves for them to buy when they attempt to spend their fat paychecks…. If more stuff is produced within America than within Mexico, obviously Americans are going to have a higher standard of living, regardless of ‘wages policy.’”

It was this fallacy that later informed Hoover’s disastrous high-wage policy, a policy FDR later codified with the National Industrial Recovery Act and that served to deprive countless Americans of employment.

On the New Deal itself, Murphy is just devastating. It’s been amusing to watch the likes of Brad DeLong tell us how super the government’s economic recovery efforts were. Let’s see: cartelizing American industry, restricting production, imposing extremely high minimum wages via the National Recovery Administration, destroying crops to prop up prices, paying farmers to reduce their acreage, blowing billions on arbitrary projects in the name of “creating jobs,” raising taxes — and that’s only a bit of it. That combination was supposed to make Americans rich — and don’t you try to say otherwise, you incorrigible extremist. Bob discusses all of this and much more (including Social Security and labor legislation), and raises evidence and arguments that, if the standard treatment of these subjects in every single American-history textbook is any indication, your delicate ears are not supposed to hear.

In addition to his merciless evisceration of the propaganda surrounding specific New Deal programs, Murphy assembles some suggestive evidence, in addition to the clear testimony of economic theory, regarding the destructive, growth- inhibiting nature of the New Deal in general. In particular, he lays to rest (to put it gently) the recent claim that FDR did make headway against the Depression, as indicated in the unemployment statistics, and that this progress resulted from his willingness to suck resources from the private sector and squander them on arbitrary things.

Readers will also enjoy Murphy’s treatment of the banking industry during the Depression, since we’re usually told that FDR’s alleged cure for that distressed sector was just super. It was no cure at all; it addressed none of the underlying problems, which continued to fester for decades thereafter. The state governments, for their part, had contributed to banks’ vulnerability by yielding to small institutions’ demands for “unit-banking” laws prohibiting branch banking. These laws made it more difficult for banks to manage risk by diversifying their portfolios. Most of the thousands of banks that failed during the Depression were in states with unit-banking laws. The number of bank failures during the same years in Canada, on the other hand, which had no unit- banking laws, was zero.

Although many readers will be able to name at least several important titles on the Depression and the New Deal, I cannot insist strongly enough that there is no book quite like this one. I am not aware of any other book on this subject that both carries the story from the 1920s through World War II and is economically sound throughout. Murray Rothbard’s America’s Great Depression, still indispensable, covers only through 1932; and books critical of the New Deal typically adopt, probably thoughtlessly, the Chicago position on the Fed.

In the midst of an economic crisis that ought to be causing people to rethink much of what they thought they knew about the economy (e.g., the Fed is a great stabilizing agent!), Bob Murphy has written an accessible and persuasive Austrian account of an essential period of American history that most people know only in propaganda form. He deserves to be richly rewarded. Read this book and promote it wherever you can.

Regards,

Thomas E. Woods
for The Daily Reckoning

Response to the “Market Failure” Drones originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Yes, you read that right. “Bubbles” just occur spontaneously. They have no cause or explanation. We need government to identify and destroy them.

Sometimes I wish our overlords would get their stories straight. First, Alan Greenspan – whom the New York Times once described, in its typical toadying, totalitarian fashion, as “the infallible maestro of our financial system” – told us it was impossible to tell if a bubble existed at any given time. Now we have Barack Obama insisting that not only can we detect bubbles, but we can also deflate them with sufficient dispatch to prevent them from causing any serious economic disturbances.

How are we peons to decide between the competing views of our infallible maestro on the one hand and the man who would be FDR on the other?

I shouldn’t be so cynical. It is not for us to question how our overlords intend to distinguish between genuine growth in some industry on the one hand and bubble conditions on the other. Just to be safe they may have to quash all rapid growth wherever it occurs. Perhaps they can cut off credit to an entire sector of the economy, or levy industry-specific taxation. (Anyone who thinks this type of discretion and micromanagement might be exercised with political motivations in mind, or for any purpose other than the common good, is almost surely a good candidate for surveillance in our progressive commonwealth.)

In their quest to free us from economic instability, our betters may find it necessary to institute new rules. It is our job to accept these new rules with docility and thanks. These rules might have to be kind of sweeping, perhaps on the order of nobody may do anything. In liberal times that could perhaps be modified to nobody may do anything without asking permission. True, we could then wind up with a lengthy debate about whether asking permission itself counted as doing something, such that we’d need to ask permission in order to ask permission, in an endless regress. We’d then be back to the original nobody may do anything, which is probably the safest place to be anyway.

Or perhaps our rulers could shut down the electrical grid from time to time. I’d like to see those greedy fat cats inflate a bubble without any electricity!

Now the possibility that the government itself could be the primary culprit in the generation of asset bubbles is of course not merely rejected; the very idea cannot even be entertained. The great progressive institutions of government and central banking the causes rather than the solutions to our problems? Impossible!

Everyone knows Bad Things happen in the economy because of wicked speculators and grasping businessmen. If someone were to ask whether the Federal Reserve’s creation of $8 billion out of thin air every week on average for four solid years might have had a tiny bit to do with the housing bubble, well, we’d have to remind such a cynic that the Fed was created in order to give us macroeconomic stability. Our present crisis was caused by excessive “leverage,” you see – though we won’t bother asking where major economic actors managed to get all this credit in the first place. That might lead people to ask hard questions about the Fed yet again, and as we’ve seen, the Fed is our Wonderful, Stabilizing Friend.

It is true that Anna Schwartz, the famous monetarist (and not an Austrian economist), recently observed that asset bubbles cannot form without loose monetary policy by the central bank to fund them.

“If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses.”

(Schwartz also rejects former Fed chairman Alan Greenspan’s “attempt to exculpate himself” for the housing bubble.)

Schwartz is here echoing what Austrian economist Ludwig von Mises said decades earlier. A sudden drive for a particular kind of investment will raise the prices of complementary factors of production as well as the interest rate itself. In order for a mania-driven boom to persist, there would have to be an increasing supply of credit in order to fund it, since investments in that sector would grow steadily more costly over time. That could not occur in the absence of credit expansion. The dot-com and housing bubbles can both be explained by artificial credit expansion, say such economists.

If we are to believe these economists, the best way to prevent future asset bubbles would be to stop the Fed from creating so much money out of thin air in the first place. Better still, we should abolish the Fed altogether, since in the view of these economists it is entirely superfluous to a market economy.

Again, though, our trust should be in princes. After all, Austin Goolsbee, an economic adviser to the president, assures us that Obama will be on the lookout for both bubbles and busts.

The president, Politico notes, is

“…prepared to intervene to make sure that kind of red-hot growth doesn’t occur. And he’s willing to do it with added government regulation if needed to prevent any one sector of the economy from getting out of balance – the way the dot-com boom did in the 1990s and the real-estate market did earlier this decade.”

See, those things just happened! No cause. They just happened. And government will protect us from them.

Mark Zandi, a former economic adviser to John McCain, adds that “policymakers always intervene in a downturn. So it is necessary for policy makers to take action against bubbles. You’ve got to be symmetrical in your policy.” What we need, says Zandi, is a “systemic regulator” who will decide whether or not bubbles exist and then take appropriate action. (See how much different a McCain administration would have been on the economy?)

Naysayers may point out that the Fed’s own economists denied that a housing bubble existed, and that, as we observed earlier, Greenspan himself believes it’s impossible to detect bubbles at all. But surely one more regulator, a big, giant, super-duper regulator, should be able to get things right.

Some people say the market is the best regulator. After all, the free market doesn’t pump up the money supply and push interest rates down to levels that promote unsustainable bubbles. The free market punishes reckless risk takers, while it is government that bails them out (and thereby encourages them to take greater risks in the future). It was the Fed, not the free market, from which the “Greenspan put” – the implicit promise to bail out major Wall Street players – emerged. The Financial Times warned that these guarantees were encouraging dangerously risky investments. The free market makes no such guarantees, and thereby cultivates a more cautious class of entrepreneur.

But enough with these naysayers. I for one welcome our new overlords. Every American citizen could stand to learn from that model of filial piety, Britney Spears, who urged, “I think we should just trust our president in every decision he makes and should just support that, you know, and be faithful in what happens.”

Amen.

Thomas E. Woods, Jr.
for The Daily Reckoning

Obama’s Magic Bubble Deflator originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Then, all of a sudden, things were so bad that without a $700 billion congressional appropriation, the whole thing would collapse.

In the wake of this change of heart on the part of our leaders, Americans found themselves bombarded with a predictable and relentless refrain: the free market economy has failed. The alleged remedies were equally predictable: more regulation, more government intervention, more spending, more money creation, and more debt. To add insult to injury, the very people who had been responsible for the policies that created the mess were posing as the wise public servants who would show us the way out. And following a now-familiar pattern, government failure would not only be blamed on anyone and everyone but the government itself, but it would also be used to justify additional grants of government power.

The truth of the matter is that intervention in the market, rather than the market economy itself, was the driving factor behind the bust.

F.A. Hayek won the Nobel Prize for his work showing how the central bank’s intervention into the economy gives rise to the boom-bust cycle, making us feel prosperous until we suffer the inevitable crash. Most Americans know nothing about Hayek’s theory (known as the Austrian theory of the business cycle), and are therefore easy prey for the quacks who blame the market for problems caused by the manipulation of money and credit. The artificial booms the Fed provokes, wrote economist Henry Hazlitt decades ago, must end “in a crisis and a slump, and…worse than the slump itself may be the public delusion that the slump has been caused, not by the previous inflation, but by the inherent defects of ‘capitalism.’”

Although my recently released book, Meltdown explains the process in more detail, an abbreviated version of Austrian business cycle theory might run as follows:

Government-established central banks can artificially lower interest rates by increasing the supply of money (and thus the funds banks have available to lend) through the banking system. This is supposed to stimulate the economy. What it actually does is mislead investors into embarking on an investment boom that the artificially low rates seem to validate but that in fact cannot be sustained under existing economic conditions. Investments that would have correctly been assessed as unprofitable are falsely appraised as profitable, and over time the result is the squandering of countless resources in lines of investment that should never have been begun.

If lower interest rates are the result of increased saving by the public, this increase in saved resources provides the material wherewithal to see the additional investment through to completion. The situation is very different when the lower interest rates result from the Fed’s creation of new money out of thin air. In that case, the lower rates do not reflect an increase in the pool of savings from which investors can draw. Fed tinkering, in other words, does not increase the real stuff in the economy. The additional investment that the lower rates encourage therefore leads the economy down a path that is not sustainable in the long run. Investment decisions are made that quantitatively and qualitatively diverge from what the economy can support. The bust must come, no matter how much new money the central bank creates in a vain attempt to stave off the inevitable day of reckoning.

The recession or depression is the necessary, if unfortunate, correction process by which the malinvestments of the boom period, having at last been brought to light, are finally liquidated. The diversion of resources into unsustainable investments out of conformity with consumer desires and resource availability comes to an end, with businesses failing and investment projects abandoned. Although painful for many people, the recession/depression phase of the cycle is not where the damage is done. The bust is the period in which the economy sloughs off the malinvestments and the capital misallocation, re-establishes the structure of production along sustainable lines, and restores itself to health. The damage is done during the boom phase, the period of false prosperity that precedes the bust. It is then that the artificial lowering of interest rates causes the squandering of capital and the initiation of unsustainable investments. It is then that resources that would genuinely have satisfied consumer demand are diverted into projects that make sense only in light of the temporary and artificial conditions of the boom.

Adding fuel to the fire of the most recent boom was the so-called Greenspan put, the unofficial policy of the Greenspan Fed that promised assistance to private firms in the event of risky investments gone bad. The Financial Times described it as the view that “when markets unravel, count on the Federal Reserve and its chairman Alan Greenspan (eventually) to come to the rescue.” According to economist Antony Mueller, “Since Alan Greenspan took office, financial markets in the U.S. have operated under a quasi-official charter, which says that the central bank will protect its major actors from the risk of bankruptcy. Consequently, the reasoning emerged that when you succeed, you will earn high profits and market share, and if you should fail, the authorities will save you anyway.” The Financial Times reported in 2000, in the wake of the dot-com boom, of an increasing concern that the Greenspan put was injecting into the economy “a destructive tendency toward excessively risky investment supported by hopes that the Fed will help if things go bad.”

When things do go bad, pumping more money into the banking system, thereby lowering interest rates once again, only exacerbates the problem, because it encourages the continued wasteful deployment of capital in unsustainable lines that will eventually have to be abandoned anyway, and it forces healthy, wealth-generating firms to have to go on competing with bubble firms for labor and capital. When interest rates are made artificially low, they encourage the kind of investment that would normally occur only if more saved resources existed to fund them than actually do. Continuing to force interest rates down only perpetuates the allocation of capital into outlets that the economy’s current resource base cannot sustain.

In response to the dot-com and NASDAQ collapses and the modest recession that accompanied them in 2000 and 2001 that Alan Greenspan and the Fed chose to embark on a robust policy of inflation, an approach that culminated in lowering the federal funds rate (the rate at which banks lend to each other) to a mere one percent from June 2003 to June 2004. Already by early 2001 the Fed had begun to ease once again. That year saw no fewer than 11 rate cuts. The unsustainable dot-com boom could not, in the end, be reignited, and thank goodness – the resource misallocations in that sector were unhealthy for the economy. But the Fed’s easy money and refusal to allow the recession of 2000 to take its course led to an even more perilous bubble elsewhere. That was the only recession on record in which housing starts did not decline. Not coincidentally, that was also the moment at which people began to conclude that house prices never fall, that a house is the best investment one can make, and so on. By intervening in the market then, the Fed prevented the market from making a full correction, thereby perpetuating unsustainable investment and consumption decisions. In so doing it merely postponed what it was trying to avoid, and made the crash worse when it finally came.

Fiscal stimulus, meanwhile, merely diverts resources from the productive sector in order to fund money-losing enterprises arbitrarily chosen by government. These artificial expenditures, moreover, interfere with the market’s attempt to sort out genuine demand from bubble demand. “Stimulus” spending can in fact keep firms (construction companies, for example) in business that for the sake of genuine economic health need to be liquidated so their resources can be more sensibly employed in more urgently demanded lines of production.

The claim that “stimulus” spending is necessary to bring “idle resources” back into use also misfires, since it fails to consider why so many entrepreneurs – who have survived as long as they have on the market because of their skill at anticipating consumer demand – should suddenly have become, all at once, such poor forecasters that they’re all saddled with idle resources.

The reason for the idle resources is, obviously, some prior act of miscalculation. And what could have created such systemic miscalculation? Could it be the Fed’s artificially low interest rates, that distort entrepreneurial forecasting and encourage the wrong kind of investments at the wrong time?

Consider a restaurant owner who mistakes the temporary demand for his product deriving from the presence of the Olympics in his city with real, sustainable demand. Suppose he opens a new location to accommodate all this new demand. When the Olympics are over, he’s left with idle resources – labor with nothing to do and empty restaurant space for starters. Should we want to “stimulate” these resources back into activity? Of course not. They shouldn’t have been allocated this way in the first place. We should want the market, guided by the price system, to redeploy them into sensible channels.

The problem, therefore, isn’t that we lack enough “spending” or “demand,” and that we need government to fill in the “missing demand.” The problem is that in the wake of Fed-induced misallocations of resources we wind up with structural imbalances, a mismatch between the capital structure and consumer demand. The recession is the period in which the economy repairs this mismatch by reallocating resources into lines of production that actually correspond to consumer demand. The modern preoccupation with levels of spending instead of patterns of spending obscures the most important aspects of the question.

Had the market been allowed to work before the collapse, there would have been no housing bubble and no crisis in the first place. Had the market been allowed to work when the crisis hit, recovery would have been swift – as it was in 1920-21, when an even worse depression came to a rapid end without any open-market operations by the Fed, and without any fiscal stimulus. (In fact, the federal budget was cut in half from 1920 to 1922.)

What, in short, should we do now? Exactly the opposite of what our so-called experts, who in a sane world would be forever discredited, urge upon us.

Regards,

Thomas E. Woods, Jr.
for The Daily Reckoning

No, the Free Market Did Not Cause the Financial Crisis originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.