If you believe, as I do, that the U.S. economy is due for a severe beating, then you will agree we are also in for a heated debate over who is responsible for the fiasco. Fingers will be pointed. The usual suspects will be lined up: crazy investors, corrupt lenders, and crooked accountants.

How are you going to sort out the blame game?

Have you heard this one: "It's not the fall that kills you; it's the sudden stop at the end"?

Most economic analysis is like this popular pearl of wisdom: it is often technically correct, but fails to give all the factors their due consideration. Yes, it is the sudden stop at the end that kills you, but your downward velocity immediately preceding the stop is the result of the fall itself. There would be no fatal stop without something close to terminal velocity preceding it. The fall and the stop are inseparable parts of a whole. Can we let that old saying go now?[1]

Probably not. We are too attached to our popular wisdom. Even when it's refuted, we eventually forget the refutation and start repeating the proverb again.

There will, no doubt, be a solid lineup of crazy investors, corrupt lenders, and crooked accountants to take the heat for the inevitable financial downturn. There always is.

How many of these have you heard before?

The textbooks always start with crazy 17th century Dutchmen going nuts for tulips. In the following century, John Law is given credit as an extraordinary, if dishonest, marketer of the Mississippi scheme in France. The Panic of 1819 had corrupt U.S. bankers and land speculators to blame. The end of the last century had eager fools riding on the promise of making millions in stock options overnight, creating the Dot-Com bubble.

These are just a few of the usual suspects -- there are many more, but the lineup always gives the impression that bubbles are a matter of irrational exuberance and individual corruption. This is, at best, a half truth.

These perpetrators were part of the sudden stop at the end of the fall. Wild speculation is a symptom, not a cause. You don't blame the cause of influenza on the fever. You blame the virus. Fever is a natural response to the infection.

We all respond to the promise of financial gain, but by itself, this will not result in unsustainable market speculation. Without an excess of money and credit, speculation requires a long-term sacrifice in the investor's standard of living. It requires savings. Very few people willingly endure the hardship of saving to invest in long shots and murky schemes.

When a bubble gets going, many people, regardless of their credit worthiness, are willing to risk their assets to speculate blindly. The promise of short-term gains incites people to take greater risks with whatever they have or whatever they can get. The apparent promise is based on the rapid rise in the nominal value of the bubble fueled by an excess of money and credit. The ability to act on the apparent promise is also fueled by an excess of money and credit.

If we look closer at the famous bubbles mentioned above, we see these monetary infections preceding each one.

Tulipmania was not simply an irrational desire for infected flowers. Holland attracted an inordinate supply of coin and bullion from around the world because of its free coinage laws and the occasional seizure of Spanish ships. This increased the supply of money beyond the demand for it.[2] To add to the frenzy, the Dutch burgomasters, in favor of their financial self-interests, reduced the buyer's risk of tulip futures contracts by converting them to options in early 1637.[3] Mania was fueled by an excess of money and exacerbated by legislatively diminishing the buyer's risk.

The Mississippi Scheme was not just about John Law's marketing prowess. It was made possible by his paper money policy, by which Phillip II, Duc d'Orleans, inflated France's money supply exponentially.[4] Bestowing the Banque Royale with a monopoly on refining gold and silver, the Duc inflated the money supply 16 times its previous amount.[5] This monetary excess subsequently spilled over the channel to England and provided the fuel for the South Sea Bubble as well.

Sometimes identified as the first failure of the American market economy, the Panic of 1819 was preceded by the suspension of specie payments in 1814. The government granted this special privilege to banks that had been willing to help fund the War of 1812 with worthless bank notes. Emboldened by a guarantee of protection, the banks began issuing notes well in excess of their reserves.[6] This was the precedent, not only for the Panic of 1819, but also the Panic of 1837 and the Panic of 1857.

Never mind the high tech fever of the Dot-Com bubble, look at the orgy of money and credit pumped into the markets between 1995 and 2000.[7] This chart is worth a thousand words.

The above chart shows what was going on during the tech bubble, but you might notice the line continues going up until March 2006 when the Fed stopped reporting M3. The lack of reporting doesn't hide the fact that our money supply is inflating at an astounding rate thanks to the Fed's power to create money out of thin air. This month alone started with a $41 billion injection following a cut in the discount rate to 4.5% on Halloween.

You might also notice the upward slope of the line before 1995 is not too modest either. If we had M3 before 1959, the line would tell the same story. The Fed has inflated the money supply such that today's dollar has less than 5% of the purchasing power of a dollar in 1913, when the Fed went into operation.

The Fed ran its printing presses through WWI and most of the 1920s. Then Boom. Crash. The Great Depression.[8] Mainstream pundits will say things like "the cause of the Great Depression was not the expansion of the money supply, but the result of a monetary contraction forced on them by the gold standard." This is like saying "it's not the fall that kills you; it's the sudden stop at the end." It also doesn't square with the facts.

FDR took the American citizens' right to own gold in 1933.[9] Since 1938, the total supply of money has not decreased, not even for a moment.[10] Nevertheless, we had several recessions even before we had the stagflation of the 1970s. In 1971, the world lost its right to redeem gold with U.S. dollars. By then we were completely off the gold standard, but that didn't prevent the S&L crisis, Black Tuesday of October 1987, the "it's the economy, stupid" slowdown in the early 90s, or the turn of the century recession that started well before 9/11.

Theory can be brought in to establish the lesson more firmly, but historical examples are a persuasive tool to show the crowd that monetary inflation is the root cause of bubbles and their subsequent busts. The crowd bought tech stocks at hundreds of times over earnings based on a really good story. We need to tell some new and better stories.

When the U.S. economy crashes, we will have a unique opportunity to put an end to the madness of fiat currency, fractional reserve banking, or any monetary legerdemain that allows powerful individuals or governing agencies to manipulate the money supply independently of the market.

The crowd does not change its collective mind when it's in a relatively stable environment. The prevailing wisdom has been that central banks can control inflation and guarantee stable prices with an "elastic" (pronounced "inherently inflationary") currency. The next crash is going to prove that wisdom wrong. This will be an opportunity for those who have invested in sound economic ideas.

Go over the other bubbles in history. Rehearse the data and the stories. Have it at the ready whenever someone asks. If enough fingers of blame point to the source instead of the symptoms, change is possible.

[1] Most people say "it's not the fall that kills you" for humorous purposes. Like most humor, it has just enough truth to draw you in, but then twists the frame of reference, which makes you laugh. As long as mainstream economic analysis makes us laugh, I see no problem with it.
[2] Doug French, The Dutch Monetary Environment During Tulipmania, p. 12.
[3] Earl Thompson and Jonathan Treussard, The Tulipmania: Fact or Artifact, p. 3. Thompson and Treussard's analysis is important to advocates of the free market because it shows that legislative tampering caused the worst of the irrational speculation.
[4] William Bonner and Addison Wiggin, Financial Reckoning Day, pp. 72-74.
[5] Ibid. p. 81.
[6] Murray Rothbard, The Panic of 1819, pp. 3-4.
[7] Roger Garrison and Gene Callahan, Does Austrian Business Cycle Theory Help Explain The Dot-Com Boom and Bust?, p. ?
[8] Murray Rothbard, America's Great Depression.
[9] FDR's Executive Order 6102, which banned the ownership of gold, was repealed in 1974, but Americans are still prohibited from making contracts stipulating payment in gold.
[10] Anna J. Schwartz, Money Supply