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"Austrian" Investment Themes, Commentary and Opinion, Economics

Professor Plum, With the Revolver, in the Library: Who Caused the Financial Crisis and How Did They Do It?

Right up until that fateful week in September of 2008 when Lehman Brothers, Fannie Mae, Freddie Mac,Merrill Lynch and AIG all imploded; most media, government and financial professionals, either could not, or would not acknowledge the economic disaster that was unfolding before their eyes.

Of course, now that the horse has escaped the barn, these same visionaries have a lot of ideas on how to best close the door. 

 A casual stroll through your local book store leaves one practically assaulted from the sheer volume of explanations and witch hunts.

The whole exercise is reminiscent of the classic mystery board game Clue, in which the participants, via a process of elimination try to deduct who was responsible for the murder of “Mr. Boddy”, how it was accomplished, and in what room of Mr. Boddy’s mansion the murder took place.

Not surprisingly, the chic answer to the 2009 edition of “Financial Crisis Clue” is greedy businessmen, with a lack of regulation, in a failed free-market.

Yet there is a nagging question that arises when listening to all of these explanations.

After all would you listen to a lecture of how a hurricane is formed from a weatherman who stood in the middle New Orleans during Katrina and issued a forecast proclaiming it to be partly cloudy with a chance of afternoon showers?

The socially conscious critics who seem so eager to please their peers by pronouncing the death of capitalism have proven that they have no understanding of how free markets work. In their defense, who can blame them for their ignorance?

The reality is that when it comes to banking and money in the United States, we have nothing that even resembles a free market. Our most prestigious Universities teach economic theory that proclaims economic growth to have occurred when a perfectly good window is broken and then fixed. Or, for that matter, a city is flattened by a hurricane and later partly rebuilt.

Contrary to what most in the media, government, and financial industry would have you believe, the economic crisis was foreseeable.

Economists and followers from the “Austrian School” of Economic thought have long understood and warned of the growing instability and threat that a massive credit expansion posed to the global financial system and in particular government’s role in creating such a bubble.

For a look at the financial crisis through the eyes of those who saw it coming there is no better place to start than the book  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.

Woods provides a concise and compelling explanation of the crisis as well as “Austrian” theory that is easily accessible to the laymen. A look at the table of contents provides a glimpse into the discussion:

• Chapter 1 – The Elephant in the Living Room

• Chapter 2 – How Government Created the Housing Bubble

• Chapter 3 – The Great Wall Street Bailout

• Chapter 4 – How Government Causes the Boom-Bust Business Cycle

• Chapter 5 – Great Myths About the Great Depression

• Chapter 6 – Money

• Chapter 7 – What Now?

Woods is at his best in Chapter Four, where among other things, he breaks down the Austrian Business Cycle Theory into seven easy to understand steps (with examples) in the space of a page and a half.

Chapter Six is also a gem. Here, Woods uses an example of Robinson Crusoe Economics to demonstrate the folly of believing that the Federal Reserve can save us by injecting more credit and money into the financial system.

This is important to investors and savers as it is crucial to understand how the unintended consequences of the government’s response to this crisis will affect the purchasing power of one’s savings and the “real” value of one’s investments.

It would be nice to say that the story has a happy ending. Unfortunately, it looks like it might only be the first of an epic series. As Woods states at the conclusion of Chapter Three:

“There is no shortcut to creating wealth. We cannot become prosperous by pushing interest rates lower than the market would have set them. There is no monetary magic wand that can make everyone rich. The interest rate was at the level the market established for a reason. When governments and their central banks artificially interfere with it, they mislead investors into destructive courses of action, that they would not otherwise have taken. They encourage consumption at a time when investors are starved for capital. [real]

Meanwhile, the free-market takes the blame when these artificially encouraged lines of investment and production go belly up. But the free market has nothing to do with it. It is the interference with the free market, the refusal to allow the market to coordinate production and consumption, that causes the problem.

F.A. Hayek won the Nobel Prize in Economics for showing how central banks – which are creatures of government, not the free market – set the boom-bust cycle in motion when they try to take shortcuts to prosperity. There are no such shortcuts, and central bank’s attempts to pretend otherwise are destined to end in disaster. That is what happened in our case: artificially low-interest rates, thanks to the Federal Reserve, encourage lines of production that made no sense and could not be sustained in the long run..”

In other words, the winning, if unpopular answer to the Financial Crisis edition of Clue is:

Central banking, with massive credit creation, in nearly every corner of the globe.








Central banking, with massive credit creation, in nearly every corner of the globe.

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DISCLAIMER: Nothing in this article should  be construed as a personal recommendation or advice. Nor should anything in this article be construed as an offer, or a solicitation of an offer, to sell or buy any investment security.  Barnhart Investment Advisory clients and principals may hold positions in any securities mentioned in this article. Investors should conduct their own due diligence and seek the advice of a financial and/or investment  professional before making any investment decisions.


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