Chicago's irreverent financial commentator, Bill King, wrote last week in The King Report that, "The Fed's panic intervention yesterday -- rate cuts before the open -- is 'rank amateur' intervention." He goes on to observe that Bank of America economist, Mickey Levy, made one of the most astonishing comments he's heard in a long time: "The Fed knows its credibility would be damaged if the economy slipped into recession." King's response is: "When did recession become an abhorrent, avoid-at-all-costs phenomenon?"
Bull's-eye! When indeed did a recession become something that we absolutely must avoid? What is it that the Fed, for the past decade, has feared about a recession? Recessions have been common throughout our history, and the country has always ridden them out because its political and economic leaders understood that such a "riding out" was necessary to purge the system of its excesses and thus be able to return to real growth again. What is different about this time that would make the Fed so desperate to avoid going through this healthy purging?
Here is the difference. What is unfolding around us (and actually has been unfolding since 2000) is that the Keynesian chickens set loose in 1936 are coming home to roost. Long term consequences are upon us, and they are bad consequences that have their roots in the fallacy of Keynesianism as a legitimate doctrine of economic thought.
This illegitimacy of Keynesian thought is partly tied up in its irresponsibly truncated sense of history. It's intellectual and political leaders throughout the West have, for the past 72 years, defaulted upon the most important responsibility they possess as leaders -- the necessity to think long range. John Maynard Keynes set the tone for this terrible default in the 1930s. In response to his critics' concern over what effect his inflationary economics would have in the long run, he scornfully replied, "In the long run, we're all dead." And unfortunately such an outrageous irrationality sufficed for the modern punditry so in search of a world in which they could have their cake and eat it.
This Keynesian pseudo-wisdom allowed the pundits of the West to believe that shrinking one's sense of history and responsibility down to one's own lifespan was, in some way, now permissible. It allowed Western punditry to blank out on the future -- which is one of the perennial and predominant sins of humankind. As a result, we today have to suffer an ever-increasing boom-bust economy because, of course, we're not all dead. The Keynesian generation's children and their children ad infinitum continue on. There's a thing called posterity.
From its start in the 30s, Keynesian economics was a brazen, short range endeavor in seeking something for nothing mingled with embarrassing self-delusion. Why it all sounds absolutely marvelous, one can imagine FDR replying to his Brain Trust when informed of the wonders to be worked with Keynes' "new economics." If capitalism has reached its mature stage and can no longer produce enough purchasing power, then we in Washington must step in and get the system going again. If people don't have enough money, then all we have to do is print up more and our problems will be solved. It's really all very simple, isn't it? Our growth can actually be as great as we want it to be. Our wealth will be unlimited. We will usher in the millennium. Oh, happy day! How could we not have thought of this before?
Stripped of all the eloquent conceptualizations and slick technical jargon, this was the great "innovation," the great "revolutionary insight" of Keynes: If we want to become wealthier as a nation and avoid economic recessions, then all we need to do is print up more money.
Today's financial tremors erupting throughout the world's economies are trying to tell us that this Keynesian paradigm is, like all huckster schemes of "easy wealth," a fraud. Sadly only those discerning few, who understand that there are rules to the Universe and its bounty, are listening. Thus big trouble now lies ahead, and this coming trouble is a result of over 70 years of Keynes' disciples printing up more money to somehow make us all more "prosperous." As a result, the grand Keynesian theoretical flaw is now manifesting in our lives, which is as follows:
Central bank credit expansion ultimately leads to massive "debt saturation" and "malinvestment" throughout the economy, which reverses the boom that the credit expansion was meant to perpetuate. Ultimately, the system must not just disinflate via Fed interest rate maneuvering; it must go through a severe purging so as to eliminate the monster levels of debt and malinvestment before a genuine growth cycle can be reignited. Such a purging leads to a mega-crisis that brings on a depression, a runaway inflation, or a combination of the two that is called stagflation. Which one of the three occurs will depend upon how the political and monetary authorities in charge at the time react to the events that unfold.
Debt Saturation Is the Problem
This then is what is different this time, and it is what the Fed fears. In the early stages of all credit expansions, businesses flourish, and the Fed is able to manipulate the expansion's boom-bust nature in a tolerable way. But once an economy becomes "debt saturated" from the massive injections of credit over time, borrowing and confidence drop off. This causes the rate of money supply growth to decline by negating the central bank's power to pyramid credit, which brings severe disinflationary pressures no matter what the Fed does with interest rates. If the preceding build-up of debt is severe and the resultant decrease of confidence widespread, such pressures then morph into a far more serious crisis.
Down deep, the Fed and its circle of monetary bureaucrats fear that this time the fundamental buoys of the economy could indeed collapse and usher in a dreadful credit deflation that would suck America and the world into the vortex of Depression. It is this dread that is undoubtedly keeping Bernanke awake at night.
In all the recessions since World War II, the Fed has been able to maneuver economic forces in America to induce recovery. The prior inflationary booms were not outrageous, the nation was a solid creditor in the world, there was a substantial cache of savings among the people, etc. It was a matter only of squeezing the speculative excesses out of the system. Some prolonged pain was required, but nothing that could not be endured by men and women who had a "life is tough" philosophy instilled into them in their youth.
This time it is all very different. The prior boom has been quite egregious, America is no longer a creditor nation, there are no savings left in the mattresses of the people, and the Age of Aquarius generation is not very appreciative of the "life is tough" adages of its parents. It subscribes to the code of immediacy instead. "We want what we want, and we want it right now," is the popular phrasing.
In 1980, Paul Volker broke the back of the 70s stagflation by raising interest rates to 18%. This restored credibility to the dollar, choked off inflation, and threw the economy into a vicious recession. But it also allowed the economy to purge large amounts of the debt and malinvestment stultifying it, which allowed us to eventually return to health and REAL growth. This is the role of a recession. It is a beneficial housecleaning. Unfortunately Ben Bernanke will not be able to clean today's house as Volker did in 1980. Far too much debt and malinvestment have accumulated. Far too many other nations are implicated. Far too little savings and mental toughness remain.
This bodes very badly for us as a nation. As Bill King puts it, "Recession has become dreadful because of the amount of debt, dubious investments, derivatives and crappy paper that infests the U.S. financial system. Fear is high that any debt and consumer retrenchment, which are both natural and NECESSARY (for long-term health), will quickly chain react into the dreaded debt deflation and system implosion."
"System implosion!" This is what gnaws at the back of the brains of Bernanke's Boys. Our debt and derivatives monsters are gargantuan. The daisy chain of banks, caught up in becoming 21st century casinos instead of prudent portfolio managers, is ominous. There are thousands of explosive mines planted into our economy by seven decades of power lusting political regimes and corporate cavaliers brandishing a know-nothing regard for the next generation. Any one of these mines could begin the chain reaction into the vortex. So Bernanke's Boys are living life on the edge of their seats right now. Humans in these kinds of predicaments are prone to panic, and that is what it appears the Fed has just done, and will surely do again several times before the recessionary cycle of stagflation and pseudo-growth we are entering plays itself out.
Will a depression come? If it does, it will not be the kind of depression we have experienced in the past. The Fed does have the power to inject liquidity, and unlike in the 30s, it will do so lavishly. But such liquidity injections cannot solve the underlying problem, which is pervasive debt and malinvestment. Thus the Fed cannot avoid a severe crisis; it can only change the nature of the crisis with its intervention. In this writer's opinion, what is coming during the next 10-15 years is a highly exacerbated version of the 1970s -- escalating prices, diminishing real growth, more and more government manipulation, controls, wars, and taxation. Massive stagflation with no Volkerian rescue possible because no Fed Chairman and no political administration will have the courage to allow the necessary debt housecleaning to take place. And even if such men should arise, the virulent outrage from Wall Street and Main Street would quickly force a reassessment on their part as to what is needed for the economy.
The Soros "Answer"
What then is the answer to this wild and treacherous boom-bust system that Keynesianism has given us? If we are to believe George Soros, the answer is to bring about even more government intervention into the economy and its monetary system. In a recent Financial Times article on January 22, 2008, he castigates the political administrations of the eighties for their naïve belief in Ronald Reagan's "magic of the marketplace." This is what Soros calls market fundamentalism.
"Fundamentalists," he schools us, "believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest. It is an obvious misconception, because it was the intervention of the authorities that prevented financial markets from breaking down, not the markets themselves."
On the contrary, Soros is the victim of misconception here. And his error can be traced back to the original sin discussed above about not thinking long range. It is his revered "government intervention" that brings on the crisis in the first place when the Federal Reserve intervenes to manipulate interest rates lower, which then causes the inflationary boom, which then requires more intervention to fix. He is not carrying the cause and effect relationship back far enough. The bust period only comes about because there is first an inordinate boom period. And the boom period only becomes inordinate because government central banks intervene to inflate the currency of the country involved at a faster rate than goods and services are growing, which brings on chronic price inflation. This chronic price inflation becomes possible only because we have allowed the Federal Reserve to have arbitrary power over the money supply, which began in 1913, was furthered when FDR took us off the domestic gold standard, and then finalized in 1971 when Nixon took us off the international gold standard.
None of the "breakdown problems" that Soros attributes to the free-market are due to the nature of capitalism, or any of the forces that enable capitalism as a system to work. It is not the free-market, but government intervention into the free-market that has caused the economic instability and social turmoil we endure today. All the so called evils that are attributed to the system of capitalism actually belong to the system of "interventionism" that Soros advocates. Free enterprise works very nicely if left alone.
Not that a free-market is perfect. It is, however, the least imperfect of all political-economic forms of organization. But in order to understand this, one must think long range. This is why the most grievous sin of all socialists and Keynesians is the shrinking of their sense of time and history. As the economist Henry Hazlitt observed long ago, "The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
Soros is not digging deep enough, not tracing back far enough. He is observing only the immediate events, and therefore cannot grasp that it is his intervention in the first place that brings on the breakdown that he then uses as an excuse for further intervention. Because all government interventions cause economic dislocations that demand further interventions, we then become embroiled in a continual chain of interventions until the system is so mangled in manipulatory controls that it collapses into stultification. Enter the socialist then to prescribe total control.
The answer to all this is not to enter into the process of "intervention" at all. When Jean Baptiste Colbert, the finance minister for King Louis XIV of France in the 17th century (who was a fanatic government intervener under the Mercantilist economic philosophy), asked a group of businessmen of his day what he and the King could do for them and their industries, they vehemently replied, "Laissez-nous faire!" Leave us alone!
This advice is just as appropriate today. True, as Soros claims, a laissez-faire economy does not tend toward equilibrium. But then no economy ever does. Such a thing exists only in textbooks, never in the real world. What a free-market economy does tend toward is relentless growth through what Joseph Schumpeter called "creative destruction." Because Keynesians and socialists believe that this creative process is nefarious, they insist that we must use government to control and manipulate it. They thus fall prey to the error that a utopian economy can be planned into being that will give us growth and prosperity absent the requisites of growth and prosperity (which are freedom and non-interventionist government).
This type of utopian thinking must be rejected. Smooth and pleasant growth does not exist in any society, and it never will. The free-market is not nefarious as Ludwig von Mises masterfully demonstrates in Human Action, for it has many natural laws (such as supply and demand, action and reaction, etc.) that always work to bring about realignment when things get out of whack. And they do so far better than any gaggle of bureaucrats in Washington ever could. A free-marketis, however, messy. And it requires self-reliant toughness. But if it is left free from government manipulation, it will produce a spectacular tide of wealth that will lift all its boats into prosperity. Not equal prosperity, but certainly definitive prosperity for all.
Bernanke's Worst Nightmare
What is the lesson to be learned here? Those who hop onto the monetary inflation tiger in pursuit of more wealth than they are willing to "produce" must pay for their indiscretion eventually with a severe and protracted economic crisis, i.e., depression, runaway inflation, or stagflation.
Mountainous loads of debt and malinvestment are now overwhelming us. Much of this burden must be liquidated before genuine demand and growth can be restored, which will require extensive, radical reform if we are to minimize the hardship.
As the renowned Mises warned us decades ago, "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
This is Bernanke's worst nightmare -- that Mises ends up just as right in his analysis of expansionary credit policy by a government's central bank as he was in his analysis of the inevitable collapse of socialism as an economic system.
The sun is now setting on the Keynesian / Soros / Bernanke paradigm. But it has a way to go yet. Major paradigms of history change laboriously over long stretches of time. And this one will be no different. People like Soros and the statist entourage around them still maintain much power over our lives. But it is a fading power, and the next 10-15 years hopefully will pound the final nails into their ideological coffin. The Fed will be injecting massive liquidity into the economy in an effort to avoid the debt purge necessary to heal the economy, which will create heavy stagflation and pseudo-growth. If enough of the country's intelligentsia can be reached during this time with the truth about how the Fed's use of fiat money is the cause of the boom-bust cycle and the immense stagflation stultifying the country, then we may have a chance to restore a free and stable country again -- based upon gold money and objective law.
If such a restoration is to come about, it will be because small groups of contrarian thinkers have (during the latter half of the 20th century and into the first decades of the 21st) persisted heroically in the face of relentless ridicule and ostracism to hammer home the eternal truths of gold, human nature, and government power lust. This is the true role of any man who claims the mantle of "intellectual" -- to think long range, to fight for objective law, to insist on real money, to pass on to his children a system of freedom, order and justice. The collectivists have defaulted on this role. We in the freedom movement are the only ones who can assume it.