We are headed in the wrong direction. The bailout is a “fix” for our financial troubles in the same way that taking more drugs is a “fix” for an addict’s addiction. Injecting more fiat money into our economic blood stream may give us a temporary sense of relief, but only at the price of a more severe withdrawal reaction in the future.
Analysts have offered a plethora of causes for the current down turn: greedy bankers, the unregulated shadow market, securitization and complex derivatives, predatory lenders, deadbeat borrowers, housing speculators, Fannie and Freddie, the CRA and ACORN, adjustable mortgage rates, low interest rates, preferential tax treatment of mortgage interest, and so on. The large number of “explanations” in and of itself should serve as a signal that the fundamentals are not understood. Clearly, all those listed contributed. Underlying these factors, isn't there a more fundamental primary driver?
Examined more closely, you will see that most of these “causes” simply tell us why this boom-and-bust is in the housing market. They don’t really address why the boom-bubble-bust occurred in the first place. Eight years ago, it was the dot-com bubble. And before that, there was the Asian financial crisis. And what about the recession back in the early 1980’s? Might there be something which could explain the phenomena of bubbles and the business cycle in general? And if we "fix" the housing bubble bust now without identifying the primary cause, what's to prevent another bubble in some other sector in the future?
The best answers look at fundamental principles. We see this in the scientific process which takes an immense number of concrete specifics and integrates them into a law or theory. Like Einstein’s E=mc2. Or the ideal gas law, PV=nRT. Or Dalton’s atomic theory, or Bassi’s germ theory. Each of these took a set of diverse, previously unexplained occurrences and discovered the underlying principle which connected and explained them all. The new, deeper understanding then triggered an explosion of progress, both in further theoretical research and in the efficacy of its application.
To find long-term efficacious solutions to extreme financial volatility, we must understand the fundamental economic principles which are operating. Since the early 1900’s, our banking, financial and monetary policies have been heavily influenced by two major schools of thought: Keynesian economics and monetarism. These theories are flawed. The policies they justified have failed, along with the banks and other businesses which were required to try and exist within their flawed system.
Two key economic principles must be understood in order to untangle the Gordian knot of today’s financial crisis. The first is the difference between commodity and fiat money and the effect they each have on the market. The second is the instability of a mixed economy.
In future posts I will address the role that each of these has played leading up to today’s down turn, and why we won’t have a permanent turn around until we return to a true free market.