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If you believe what you read in the newspapers and hear from many of the talking heads on television, the current economic crisis spells the end of capitalism. Multitudes of fingers have pointed to business greed and short-sighted speculation, at mismanaged financial markets and irrational investment decisions as “proof” that it is the capitalist system that has gotten us into the fix we are in.
Long rejected theories from the Great Depression years of the 1930s are being resurrected to argue that only far-sighted and wise government interventions and regulations can save us from economic catastrophe and guarantee we never suffer from a similar calamity in the future. Not only is the capitalist system not responsible for the present economic crisis, but any attempt to severely hamstring or regulate the market economy out of existence would only succeed in undermining the greatest engine of economic progress and prosperity known to mankind. Without a doubt the current recession is rapidly turning into one of the worst in post-World War II history. The business slowdown and rising unemployment, now estimated to be more than 7.5 percent of the work force, is starting to affect a growing number of people around the country. But if we are to properly find a cure we have to make sure we understand the cause of the disease. The recession has its origin in years of monetary mismanagement by the Federal Reserve System and misguided policies emanating from Washington, D.C. For the five years between 2003 and 2008, the Federal Reserve flooded the financial markets with a huge amount of money, increasing it by 50 percent or more by some measures. The St. Louis Federal Reserve Bank has tracked the impact of this monetary expansion on interest rates. For most of those years key market rates of interest, when adjusted for inflation, were either zero or even negative. The banking system was awash in money to lend to all types of borrowers. To attract people to take out loans, these banks not only lowered interest rates (and therefore the cost of borrowing), they also lowered their standards for credit worthiness. To get the money, somehow, out the door, financial institutions found “creative” ways to bundle together mortgage loans into tradable packages that they could then pass on to other investors. It seemed to minimize the risk from issuing all those sub-prime home loans, which we now see were really the housing market’s version of high-risk junk bonds. The fears were soothed by the fact that housing prices kept climbing as home buyers pushed them higher and higher with all of that newly created Federal Reserve money. At the same time, government-created home-insurance agencies like Fannie Mae and Freddie Mac were guaranteeing a growing number of these wobbly mortgages, with the assurance that the “full faith and credit” of Uncle Same stood behind them. By the time the Federal government formally had to take over complete control of Fannie and Freddie last year, they were holding the guarantees for half of the $10 trillion American housing market. Low interest rates and reduced credit standards were also feeding a huge consumer-spending boom that that resulted in a 25 percent increase in consumer debt between 2003 and 2008, from $2 trillion to over $2.5 trillion. With interest rates so low, there was little incentive to save for tomorrow and big incentives to borrow and consume today. But, according to the U.S. Census Bureau, during this five-year period average real income only increased by at the most 2 percent. Peoples’ debt burdens, therefore, rose dramatically. The easy money and government-guaranteed house of cards all started to come tumbling down last year, and with a huge crash during the last six months. Now, the same people in Washington who produced the mess we are in say that they need more regulatory authority to repair the very financial and housing markets their earlier actions so severely undermined. And the same Federal Reserve System that produced the monetary excesses that generated the artificial bubbles that have now burst is busy flooding the financial markets with even more newly created money. Over the last five months they have increased the Monetary Base (cash in the system and bank reserves for loans) by 95 percent and M-1 (cash and checking deposits in banks) by almost 40 percent at an annualized rate. The concern, therefore, should not be deflation, but the likelihood of very serious price inflation over the next few years. It is as if Johnny went to the circus with his Uncle Sam and, while he was watching the elephants in the center ring and the trapeze artists high above, his Uncle Sam kept feeding him lots of cotton candy. Then when Johnny develops a tummy ach from all that sugar when he gets home, his Uncle Sam now says, “Oh, feeling bad, Johnny, here, have some more cotton candy.” The fact is, the U.S. economy and the American citizenry cannot escape a correction process after eating all that easy-money cotton candy. Housing prices were pushed far too high and have to settle down at a more realistic lower level; and some people who just cannot afford the homes they purchased during the bubble period will have to either cut back their spending to keep up their house payments or lose their homes. Companies that got over extended will have to dramatically downsize, and in some cases go out of business. Workers who were drawn into unsustainable jobs and wages due to all of that Federal Reserve money sloshing around the economy, and now find themselves temporarily unemployed, will have to search out and shift into more stable and sustainable employments as the dust begins to settle in the market in the months ahead. Trillion-dollar Federal bailouts and “stimulus” packages will only prolong the agony and delay any real economic recovery. Any government-created jobs will be at the expense of private sector employment opportunities, and will disappear as soon as the government projects come to an end. The capitalist system is a great engine of human prosperity. It creates the profit incentives for industry and innovation that over the last half century has literally raised hundreds of millions of people out of poverty around the world. The competitive process of supply and demand brings the productive activities of tens of thousands of businesses into balance with the demands of all of us as consumers, both here in America and around the globe. There is no economic system in all of history has had the same ability to do so much material and cultural good as the open, competitive free market. But the capitalist system cannot do its job if government interferes with its operation. Burdensome government taxes, heavy-handed government regulation, misguided government spending, and mismanagement of the monetary system only succeed in gumming up the works like so much sand in the machine. The best pro-active policy the Federal government can undertake right now is to accept that its own past policies have caused the economic crisis we are in, and leave the market alone to rebalance itself and reestablish the basis for sustainable growth and employment in the years ahead.
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