The Austrian School and the Meltdown

At least one member of the U.S. House of Representatives is keeping his wits about him, our old friend Ron Paul.

The financial meltdown the economists of the Austrian School predicted has arrived.

We are in this crisis because of an excess of artificially created credit at the hands of the Federal Reserve System. The solution being proposed? More artificial credit by the Federal Reserve. No liquidation of bad debt and malinvestment is to be allowed. By doing more of the same, we will only continue and intensify the distortions in our economy – all the capital misallocation, all the malinvestment – and prevent the market’s attempt to re-establish rational pricing of houses and other assets.

[On September 25] the president addressed the nation about the financial crisis. There is no point in going through his remarks line by line, since I’d only be repeating what I’ve been saying over and over – not just for the past several days, but for years and even decades.

Still, at least a few observations are necessary.

The president assures us that his administration "is working with Congress to address the root cause behind much of the instability in our markets." Care to take a guess at whether the Federal Reserve and its money creation spree were even mentioned?

We are told that "low interest rates" led to excessive borrowing, but we are not told how these low interest rates came about. They were a deliberate policy of the Federal Reserve. As always, artificially low interest rates distort the market. Entrepreneurs engage in malinvestments – investments that do not make sense in light of current resource availability, that occur in more temporally remote stages of the capital structure than the pattern of consumer demand can support, and that would not have been made at all if the interest rate had been permitted to tell the truth instead of being toyed with by the Fed.

Not a word about any of that, of course, because Americans might then discover how the great wise men in Washington caused this great debacle. Better to keep scapegoating the mortgage industry or "wildcat capitalism" (as if we actually have a pure free market!).

Speaking about Fannie Mae and Freddie Mac, the president said: "Because these companies were chartered by Congress, many believed they were guaranteed by the federal government. This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk."

Doesn’t that prove the foolishness of chartering Fannie and Freddie in the first place? Doesn’t that suggest that maybe, just maybe, government may have contributed to this mess? And of course, by bailing out Fannie and Freddie, hasn’t the federal government shown that the "many" who "believed they were guaranteed by the federal government" were in fact correct?

Then come the scare tactics. If we don’t give dictatorial powers to the Treasury Secretary "the stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet." Left unsaid, naturally, is that with the bailout and all the money and credit that must be produced out of thin air to fund it, the value of your retirement account will drop anyway, because the value of the dollar will suffer a precipitous decline. As for home prices, they are obviously much too high, and supply and demand cannot equilibrate if government insists on propping them up.

It’s the same destructive strategy that government tried during the Great Depression: prop up prices at all costs. The Depression went on for over a decade. On the other hand, when liquidation was allowed to occur in the equally devastating downturn of 1921, the economy recovered within less than a year.

The president also tells us that Senators McCain and Obama will join him at the White House today in order to figure out how to get the bipartisan bailout passed. The two senators would do their country much more good if they stayed on the campaign trail debating who the bigger celebrity is, or whatever it is that occupies their attention these days.

F.A. Hayek won the Nobel Prize for showing how central banks’ manipulation of interest rates creates the boom-bust cycle with which we are sadly familiar. In 1932, in the depths of the Great Depression, he described the foolish policies being pursued in his day – and which are being proposed, just as destructively, in our own:

Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion.

To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection – a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end… It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression.

The only thing we learn from history, I am afraid, is that we do not learn from history.

The very people who have spent the past several years assuring us that the economy is fundamentally sound, and who themselves foolishly cheered the extension of all these novel kinds of mortgages, are the ones who now claim to be the experts who will restore prosperity! Just how spectacularly wrong, how utterly without a clue, does someone have to be before his expert status is called into question?

Oh, and did you notice that the bailout is now being called a "rescue plan"? I guess "bailout" wasn’t sitting too well with the American people.

The very people who with somber faces tell us of their deep concern for the spread of democracy around the world are the ones most insistent on forcing a bill through Congress that the American people overwhelmingly oppose. The very fact that some of you seem to think you’re supposed to have a voice in all this actually seems to annoy them.

I continue to urge you to contact your representatives and give them a piece of your mind. I myself am doing everything I can to promote the correct point of view on the crisis. Be sure also to educate yourselves on these subjects – the Campaign for Liberty blog is an excellent place to start. Read the posts, ask questions in the comment section, and learn.

H.G. Wells once said that civilization was in a race between education and catastrophe. Let us learn the truth and spread it as far and wide as our circumstances allow. For the truth is the greatest weapon we have.

In liberty,

Ron Paul
for The Daily Reckoning
October 02, 2008

Congressman Ron Paul of Texas enjoys a national reputation as the premier advocate for liberty in politics today. Dr. Paul is the leading spokesman in Washington for limited constitutional government, low taxes, free markets, and a return to sound monetary policies based on commodity-backed currency.

Dr. Paul is known among both his colleagues in Congress and his constituents for his consistent voting record in the House of Representatives. He never votes for legislation unless the proposed measure is expressly authorized by the Constitution. In the words of former Treasury Secretary William Simon, Dr. Paul is the "one exception to the Gang of 535" on Capitol Hill.

The fix is in!

Well…the hacks came through, just like Churchill said they would. At least the hacks in the U.S. Senate. The Senate voted last night to burden the entire nation with Wall Street’s mistakes. Only a handful of Senators dared oppose the measure, among them Bernie Sanders, a socialist from Vermont:

"The masters of the universe, those brilliant Wall Street insiders who have made more money than the average American can even dream of, have brought our financial system to the brink of collapse," Sanders said, and are demanding that the middle class "pick up the pieces that they broke."

Sanders must be delighted by the collapse of investment banking. But he says the way they’re going about imposing socialism is unfair to the proletariat. Oh well…you just can’t please everyone!

Over in the House, the hacks are taking up the measure today. They’re sure to want a few more lights on this tree – tax breaks for their big contributors, bridges, schools…an increase in Congressional salaries – but with the media looking so closely, they’ll probably go along with the Senate and pass the thing without further reflection. We say ‘further’ in the spirit of mischief. The whole project has been taken up with remarkably little real reflection of any kind. But we’ll come back to this in a minute…for the moment, the sky is falling…and the whole world turns its weary eyes on the U.S. House of Representatives for protection.

For example, a big chunk of blue hit the auto industry yesterday. Sales were down to levels not seen since 1993. Even the fuel-efficient Japanese models weren’t selling in September; sales at Toyota were down 32%. And those nice F-Series trucks – the most popular vehicles made by Ford – fell 42%. We used to own one. A nice dark-green pickup. We drove it to work. We drove it on vacations. It was roomy, comfortable…even fun to drive. It used a lot of fuel, but back in the early ’90s, gasoline was so cheap, we never thought about it.

But that was then…this is now. Back then, Ford and GM were still going concerns. Now they’re going out of business. Ford’s stock has only $4.55 cents left to go…and there will be nothing left. GM has $9.45 between it and zero.

"Pass this legislation," said a GM official. It’s the only way to break the "psychological cycle" that keeps people from buying cars and trucks, he believes.

So you see, dear reader, we are back to the ’30s…and we have nothing to fear but fear itself. It’s all in our minds! If people weren’t so ‘negative,’ they’d be more positive. And then, they’d start to buy things again and everything would be all right.

It’s all in our imaginations! We don’t really owe too much money. We didn’t really spend too much money. And those nifty CDOs, MBSs, CDSs…Lehman…Bear Stearns…Fannie, Freddie…Northern Rock – they’re all okay after all.

But bits of sky keep coming down.

Copper has collapsed. So has shipping. Both are telling us that they world’s economy is slowing down. Housing prices are falling faster. Job cuts are accelerating. Local governments are getting hit by lower revenues – they’re having to cut back. Households are cutting back too. Wal-Mart says it’s cutting prices for Christmas toys. Newspapers and magazines are cutting pages.

The sky is falling and anyone with any sense is running for cover…and protecting their portfolio at the same time. The meltdown is far from over, but you can still turn some nice profits…you just need to know where to look. Find all the resources your need to thrive in our Strategic Financial Library.

That leaves the politicians and the bureaucrats – right out in the open.

According to the theory – and here we flatter it, for there is no theory …just wishful thinking – the feds are keeping their heads while everyone else is panicking. The Wall Street boys now say prices for their assets "make no sense." They say Mr. Market has lost his nerve. That is how stalwart government employees are now supposed to be able to buy up Wall Street products at such large discounts they’re almost sure to make a profit.

It’s the fatal conceit…explained Friedrich Hayek in the ’30s…that somehow public employees are immune to the blandishments of power, money and the madness of crowds…that they alone are above it all, like a politician who is too rich to steal and too dumb to lie, or like a bureaucrat who can’t be bought, because he is priceless, and can’t be outwitted, because he is witless.

It ain’t necessarily so. (More below…)

But that is the way it goes. Humanity makes progress in science and technology. In politics, love and banking it merely rehearses the same dramas, tragedies and farces – over and over, forever and ever, amen.

*** Addison and Short Fuse report that today is the day they will be sending a copy of companion book to I.O.U.S.A. to every member of Congress. Many of our dear readers wrote in with…well, not necessarily words of encouragement. Turns out most think that the members of Congress (with a few notable exceptions – see today’s guest essay) don’t read anything at all. And to further prove that point, we got this note from Dan Denning, from the helm of the DR Australia:

"Of course, a spending Bill cannot originate in the Senate because as we know, Article 1, Section Seven of that useless piece of paper (the Constitution) says: ‘All bills for raising revenue shall originate in the House of Representatives; but the Senate may propose or concur with amendments as on other Bills.’

"So the Senate lobotomized a Bill already passed by the House, which included, among other ridiculous spending provisions, Section 503 (EXEMPTION FROM EXCISE TAX FOR CERTAIN WOODEN ARROWS DESIGNED FOR USE BY CHILDREN.)

"According to Bloomberg: ‘Senators attached a provision repealing a 39-cent excise tax on wooden arrows designed for children to an historic $700 billion bank rescue that is likely to pass tonight. The provision, originally proposed by Oregon senators Ron Wyden and Gordon Smith, will save manufacturers such as Rose City Archery in Myrtle Point, Oregon, about $200,000 a year.’


"But…there are some other portions of the Bill that look surprisingly bold, perhaps even illegal. I wonder.

"First, the totally legal but absurd increase in the statutory limit on the public debt, from Section 122: Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting ‘$11,315,000,000,000’.


"Thank god for statutory law. If you don’t like it, you can just change it.

"Other sections you might want to have a gander at include section 115, detailing the Secretary’s ‘Graduated Authority to Purchase.’ Passage of the bill gives him $250b to play with. Then, if the President requests it and Congress approves, he can request as much as $350b. After that, it’s $700bn, again subject to a request by the President and approval by the Congress.

"Please note, however, that $700bn is not the ceiling on the Plan. The language says $700bn is the most the President and the Secretary can request…at any one time.

"So this is bailout by installments. But $700bn is not the end. It is just the beginning, provided Congress signs off.

"And the rest of the section makes it hard for them to not sign off by severely limiting debate on the requests submitted by the President. You don’t often see Congress agree on rules for floor behaviour in the House and the Senate in a Bill. The rules committee does that in the House and the Senate sort of makes it up as it goes along.

"But this bill specifies the entire process by which a request from the President (Bush or Obama) MUST be handled by the House and the Senate. No motions to reconsider. No debate.

"And Congress is even trying to cut out judicial review. That’s in Section 119.

"It starts out promisingly enough by saying that ‘Actions by the Secretary pursuant to the authority of this Act shall be subject to chapter 7 of title 5, United States Code, including chapter 7 of title 5, United States Code, that such final actions shall be held unlawful and set aside if found to be arbitrary, capricious, an abuse aside if found to be arbitrary, capricious, an abuse of discretion, or not in accordance with law.of discretion, or not in accordance with law.’

"But what is law anyway?

"Either way, Congress is severely limiting the circumstances under which the Treasury can be challenged. Is that legal? Just asking…not that it matters anymore."

*** American Empire – so long, we hardly knew you. But good riddance! We liked the old Republic much better.

Yes, our French editor told us yesterday that she is re-releasing our instant classic – Empire of Debt.

"You were right on target with that one," said she.

Yesterday’s BBC report told us that the United States was losing its place in the world:

"The financial crisis is likely to diminish the status of the United States as the world’s only superpower.

"On the practical level, the US is already stretched militarily, in Afghanistan and Iraq, and is now stretched financially. On the philosophical level, it will be harder for it to argue in favour of its free market ideas, if its own markets have collapsed.

"The political philosopher John Gray, who recently retired as a professor at the London School of Economics, wrote in the London paper The Observer: ‘Here is a historic geopolitical shift, in which the balance of power in the world is being altered irrevocably.

"’The era of American global leadership, reaching back to the Second World War, is over… The American free-market creed has self-destructed while countries that retained overall control of markets have been vindicated.’

"In a change as far-reaching in its implications as the fall of the Soviet Union, an entire model of government and the economy has collapsed.

"How symbolic that Chinese astronauts take a spacewalk while the US Treasury Secretary is on his knees."

Of course, not everyone agrees. The BBC reporter put the question to former UN ambassador John Bolton….

He replied: "If Professor Gray believes this, can he assure us that he is selling his US assets short? If so, where is he placing his money instead? And if he has no US assets, why should we be paying any attention to him?"

Herewith, we give a short list of people who had no U.S. assets, but whom readers might want to listen t Jesus Christ, Adam Smith, Emmanuel Kant, Marcus Aurelius, William Shakespeare, etc., etc… As to the question of what one should do with his money after selling the U.S. short, Mr. Bolton, similarly mistakes patriotism for thought. It’s a big world. And there are a lot of places you might want to put your money, where it is beyond the reach of U.S. asset prices – including the most obvious one, gold.

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. The price of gold is still sitting just under $900 an ounce – which is quite undervalued. Our advice? Get in on the dips…and buy the precious metal for just a penny per ounce.

The Daily Reckoning