What's Behind the Financial Market Crisis?

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The
financial crisis is not over. Neither tax rebates nor low interest
rates nor higher or lower exchange rates can do the job of reviving
an economy that is burdened by debt loads that are too high. On
the contrary: the policy measures that the US authorities have been
applying will prolong the agony. Be prepared for the challenges
of extended financial turmoil and economic stagnation.

Early this
year, the US central bank decided to manage the debt crisis in the
light-hearted belief that a few aggressive rate cuts would "unfreeze"
the banking system. Yet as of the end of the third quarter of 2008,
the arteries of the financial system are still cluttered, and the
financial system has moved even closer to total collapse.

Those banks
and brokerages that haven’t yet failed have been kept alive by emergency
monetary transfusions from the US central bank. The Fed has cast
away all restraints of economic rationality and is acting in a purely
political way. The Board of Governors of the US Federal Reserve
System is pursuing the goal of getting the financial system through
the mess – at least until the end of the year, no matter how
high the costs will be thereafter.

The American
central bank has adopted the financial equivalent of the military
strategy of scorched earth. The economic philosophy of the current
chairman of the US Federal Reserve System can be summarized in the
slogan, "No depression under my rule!" He resembles a
military leader who stubbornly declares, "No defeat under my
rule!" the more the chance of victory is slipping away, and
defeat can be denied no longer.

The current
economic disaster is the result of the combination of negligence,
hubris, and wrong economic theory. For decades, an economic and
monetary policy has been practiced based on the illusion of, "It
doesn’t matter." At first it was, "Deficits don’t matter."
From that, the policy of "it doesn’t matter" got extended
to money creation, the credit expansion, the stock-market bubble,
and the housing boom. Now, we’re being told that buying financial
junk by the central bank to beef up banks and brokerages also doesn’t
matter.

As a byproduct
of this mindless economic and monetary policy, financial market
operators, too, have lost their heads. Trusting the official cheerleaders,
investors hold on in the trenches until they will have lost their
last shirt. Economic weakness is spreading around the globe. There
is no new spurt of economic growth in sight. Yet many investors
stay put because they have been conditioned to believe that government
will bail them out.

The current
financial crisis is not of a cyclical nature. The financial turmoil
is the symptom of the structural imbalances in the real economy.
Over decades, expansive monetary policy has gone hand in hand with
implicit and explicit bailout guarantees, and this has distorted
the process of capital allocation. Under such perverted conditions,
those investors will win most who cast away the restraints of prudence.
It is a game that can go on for a long time – up to the point
when the irrationality has become systemic.

Read
the rest of the article

September
19, 2008

Antony
Mueller [send him mail]
is the founder of the Continental
Economics Institute
. He is an adjunct scholar of the Ludwig
von Mises Institute and academic director of the Instituto
Ludwig von Mises Brasil
. He maintains the blog Money,
Markets, and the Business Cycle
.

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