The lesson from the events of 2007-2008 should have been clear: Boosting
GDP with loose money – as the Greenspan Fed did repeatedly between 1987 and
2005 and most damagingly between 2001 and 2005 when in order to shorten a minor
recession it inflated a massive housing bubble – can only lead to short term
booms followed by severe busts. A policy of artificially cheapened credit
cannot but cause mispricing of risk, misallocation of capital and a deeply
dislocated financial infrastructure, all of which will ultimately conspire to
bring the fake boom to a screeching halt. The ‘good times’ of the cheap money
expansion, largely characterized by windfall profits for the financial industry
and the faux prosperity of propped-up financial assets and real estate (largely
to be enjoyed by the ‘1 percent’), necessarily end in an almighty hangover.
The crisis that commenced in 2007 was therefore a massive opportunity: An
opportunity to allow the market to liquidate the accumulated dislocations and
to bring the economy back into balance; an opportunity to reflect on the
inherent instability that central bank activism and manipulation of interest
rates must generate; an opportunity to cut off a bloated financial industry
from the subsidy of cheap money; and an opportunity to return to sound money
and, well, to capitalism. Because for all the thoughtless talk of this being a
‘crisis of capitalism’, a nonsense concocted on the facile assumption that
anything that is noisily supported by bankers must be representative of free
market ideology, the modern system of ‘bubble finance’, cheap fiat money and
excessive debt has precious little to do with true free-market capitalism.
That opportunity was not taken and is now lost – maybe until the next
crisis comes along, which won’t be long. It has become clear in recent years –
and even more so in recent months and weeks – that we are moving with
increasing speed in the opposite direction: ever more money, cheaper credit,
and manipulated markets (there is one notable exception to which I come later).
Policy makers have learned nothing. The same mistakes are being repeated and
the consequences are going to make 2007/8 look like a picnic.
From ‘saving the world’ to blowing new bubbles
Of course, I was never very optimistic that the route back to the free
market and sound money would be taken. At the time I left my job in finance in
2009 and began to write Paper Money Collapse, the authorities had already
decided that to deal with the consequences of easy-money-induced bubbles we
needed more easy money. ‘Quantitative easing’, massive bank bailouts, deficit
spending and ultra-low policy rates had become the policy of choice globally.
But at least the pretense was upheld for a while that these were temporary
measures – ugly and unprincipled but required under the dreadful conditions of
2008 to safe ‘the system’. The first round of debt monetization after the
Lehman collapse – the exchange of $1 trillion of mortgage-backed securities on
bloated bank balance sheets for freshly minted bank reserves from Bernanke’s
printing press under ‘quantitative easing 1.0’ (QE1) – was presented as an
emergency measure to avoid bank collapses and a systemic crisis.
I never thought that this was a convincing rationale as it was clear to me
that whatever the accumulated dislocations were, there was ultimately no
alternative to allowing the market to identify and liquidate them. Aborting,
delaying and sabotaging this essential process of economic cleansing and
rebalancing would only cause new problems. Even on the assumption that these
were measures to deal with extreme ‘tail events’, I could not then and cannot
now support them. But it is becoming abundantly clear that these measures are
neither temporary nor restricted to avoiding bank runs or systemic chaos but
that now, after the public has become sufficiently accustomed to them and a cheap-money-addicted
financial industry has begun to incorporate them into their business models,
they constitute the ‘new normal’, that they are now the accepted ‘modern’ tool
kit of central bankers. Zero interest rates, trillion-dollar open-market
operations to manipulate asset prices and to ‘manage’ the yield curve are now
just another day in the modern fiat money economy. Nobody talks of restraining
central bank activism. Rather, the temptation is growing to use these tools to
kick-start another artificial boom.
In his excellent new book The Great Deformation – The Corruption of
Capitalism in America, David Stockman provides a fascinating account of how the
principles of sound money, balanced budgets and small government have
progressively been weakened, betrayed, undermined and ultimately completely
abandoned in American politics (often by Republican politicians and even some
of the alleged ‘free market heroes’ of Republican folklore), and how today’s
cocktail of bubble finance and trillion-dollar deficits represents the delayed
but inevitable blossoming of destructive seeds that were sown with Roosevelt’s
New Deal and Nixon’s default on the Bretton Woods gold exchange standard. In a
chapter on the recent crisis, Stockman argues convincingly that the shameful
bailout of Wall Street in 2008, in particular of Goldman Sachs, Morgan Stanley,
and a few other highly leveraged entities via the bailout of ‘insurance’ giant
AIG, were sold to Congress and the wider public with exaggerated claims that
the nation’s real economy was at imminent risk of collapse. From my position as
an economist and a market participant at the time of these events, Stockman’s
analysis and interpretation strike me as entirely consistent and correct. But
even if we were willing to give more credit to the claims of the ‘bailsters’
and interventionists that the fallout for Main Street would have been
substantial, that would only further underline how far the Fed’s preceding easy
money policies had destabilized the economy, and the question would still
remain whether it could ever be a reasonable objective of policy to sustain
these large-scale dislocations against market forces.
.jpg)
