Monday, March 19, 2012

The Booze Cause of the Economic Crisis

Everybody should believe in something; I believe I'll have another drink.
Author unknown

Appearing at Real Clear Politics today, Causes of the Crisis, wherein Robert Samuelson proclaims "Four years after the onset of the financial crisis -- in March 2008 Bear Stearns was rescued from failure -- we still lack a clear understanding of the underlying causes."

He makes note of the two competing theories; that Wall Street, unregulated, took too many risks, and that mortgage-lending standards created the housing bubble. He then examines the case for a root cause of both.
Actually, both theories are correct -- and neither is... But the fact that these theories are not mutually exclusive suggests that both were consequences of some larger cause. Just so. What ultimately explains the financial crisis and Great Recession is an old-fashioned boom and bust, of which the housing collapse was merely a part.
In this, Samuelson is correct. He then proceeds to give a history lesson, pointing out that the boom began with the decisive defeat of double-digit inflation in the early 1980s, (while failing to address the cause of, or cure for, that inflation, however). He points to two mild recessions in the ensuing years, and gives credit to the Federal Reserve for "defusing" those two threats. He then states "booms become busts because justifiable confidence becomes foolish optimism," and continues his history lesson by spreading the blame everywhere; on investment banks, households, lending standards, regulators, ethical standards, even criminals. But not one word of explanation as to how "justifiable confidence becomes foolish optimism."

Then he points out how lonely he is in his viewpoint.
Confession: I have written all this before. It is a lonely view. The latest issue of the academic Journal of Economic Literature has two review articles; one summarizes 21 books on the crisis by economists and journalists, and the other analyzes 16 scholarly papers and studies. None -- so far as I can tell -- suggests this long boom-bust crisis explanation. The only "boom" that matters is the housing boom. There is no sense of history: a recognition that today's events may ultimately result from events years or decades ago.
There's ample reason for his loneliness, he posits:
Among the public, the press and politicians, the disdain for historical explanations is no mystery. The crash was a crime against society; the public wants culprits. The press pursues wrongdoing. It's a good story. President Obama blames his predecessor's policies. It's good politics. A narrative rooted in mass and bipartisan delusion does not serve these purposes. Everyone wants blood.
I note that "rooted in mass and bipartisan delusion" begs the question, "caused by what?" But that critical question goes unasked, and unanswered.

He goes on to issue a disdainful word or two for orthodox economists, which could, if he thought about it, perhaps explain why he found no mention of root causes in the literature he reviewed.
The case of economists is more curious. They presumably crave truth; most aren't hankering for political appointments. But their blind spot is their self-identity. Modern economists portray their discipline as a "science" that can better manage the economy for growth and stability.
He then buttresses his case for the economic crisis having been caused by the reckless, hedonistic behavior of consumers and businesses by quoting, not from the work of an economist, but from a new economic history by the author of "A Beautiful Mind." (A book I'm going to have to read. Her website features a four-minute overview that hints she may have some realistic insight.)
In particular, this repudiates the fatalism of the 1920s that, as Sylvia Nasar describes in her book "Grand Pursuit: The Story of Economic Genius," saw business cycles as unavoidable and, in part, desirable:

"Judging by newspaper headlines of the early 1930s, popular wisdom viewed economics through a biblical lens: recessions were the wages of sin. When good times lasted too long, businesses and individuals threw caution to the wind and behaved badly. Recessions ... occurred when private businesses and households unwound past excesses, wrote off bad investments, and behaved with restraint once again. ... (Recessions) were regrettable but necessary correctives, like a detox program for a drunk."
As an aside, I find it curious that he believes that modern economists' blind spot, their portrayal of their discipline as a "science," repudiates the "fatalism" of the 1920s. Also note that in the piece he quoted, there's once again no mention of where businesses and individuals obtained the funding for that long-term binge from which they need detoxing.

His case having been proven by newspaper headlines of the early 1930s, he wraps up with more of the same, along with another dig at orthodox economists. Apparently the Causes of the Crisis were moral turpitude, bad habits and overconfidence, followed by repentance. This once again begs the question "caused by what?"
The problem for economists is that the crisis has, to some extent, reaffirmed this dour and previously discredited view. Prolonged prosperity from 1983 to 2007 bred bad habits and overconfidence. This does not mean that we know nothing or that we have no tools to combat savage recessions; after all, we did avoid a second Great Depression. But it does mean that one promise of modern economics -- to extend economic expansions and shorten slumps -- can create the conditions for its own failure. Although the conclusion is obvious, economists ignore it. The most likely reason is that it undermines their self-appointed role as agents of social progress.
Mine Gott! How can a Washington Post Opinion Writer, past columnist with Newsweek, who has been writing on economic issues since 1977, dance around an issue so convincingly and yet never mention the root cause he claims to be pursuing? How can he ignore the 1928 prediction and explanation of Ludwig von Mises?
It is clear that the crisis must come sooner or later. It is also clear that the crisis must always be caused, primarily and directly, by the change in the conduct of the banks. If we speak of error on the part of the banks, however, we must point to the wrong they do in encouraging the upswing. The fault lies, not with the policy of raising the interest rate, but only with the fact that it was raised too late. 1
Mises' work is at the core of Austrian Business Cycle Theory, which explains that "larger cause" in explicit detail. ABCT explains precisely where businesses and individuals obtained all the moolah for that "long-term binge from which they need detoxing."
As the founder of the "neo-Austrian School" of economics, Mises’s business cycle theory, which blamed inflation and depressions on inflationary bank credit encouraged by Central Banks, was adopted by most younger economists in England in the early 1930s as the best explanation of the Great Depression.
How can someone who has been writing on economic issues since 1977 be so blissfully unaware that only three years earlier, in 1974, Frederick A. Hayek received the 1974 Nobel Memorial Prize in Economic Science for his work on the Austrian Business Cycle? (Although the committee conflated his work and von Mises'.)

For those who don't want to bother with the thousands of pages of the collected works of Mises and Hayek and dozens of other respected economists of the Austrian school, the fine people at Econstories.TV have distilled the best of the work into two short musical videos (yeah, economics as musicals, who would have thought such a thing?) that I discussed and included for viewing in EconStories.TV - Economic Edutainment. Highly recommended.

And for those who don't care to invest even the 20 minutes it takes to read that essay and watch a couple of short videos, I can distill the lesson even farther.

If bartenders central banks would quit handing out booze funds like there's no tomorrow every time a drunk the GDP shows signs of DTs twitches, the tomorrow that comes won't find the gutters littered with millions of individuals and businesses who crashed and burned because they drank spent themselves into a stupor on cheap liquor money.

...and that's all I have to say about that.

1 Mises, Ludwig von. [1928] 1978. Geldwertstabilisierung and Konjunkturpolitik [Monetary stabilization and cyclical policy]. Jena: Gustav Fischer. English translation by Bettina Bien Greaves, On the Manipulation of Money and Credit. Dobbs Ferry, N.Y.: Free Market Books.


  1. Well look, I could take you to task for failing to credit Hobbes with a great majority of things when it comes to political theory, but I don't.

    Don't be angry. The point is that he knows the common explanations are deeply flawed. That's enough to be happy about, I should think.

  2. I think Samuelson's failure is in diagnosing symptoms as the disease, not in failing to credit Mises and Hayek. "Caused by what?" is the critical question he fails to answer. He only peeled one layer of the onion, and decided that was as far as he cared to go.