The current financial crisis (in reality the correction of the bubble's malinvestments) which started over a year ago with the sub-prime meltdown spread like a wildfire throughout the financial industry last week with unprecedented central bank and government intervention and bailouts. Trillions of dollars, pounds, Euros and other currency were wiped off the value of share markets and the holdings of shareholders around the world in just one week (in addition to values wiped out since August 2007). Among all the chatter of politicians, bureaucrats and industry experts the Managing Director of the International Monetary Fund (IMF), Dominique Strauss-Kahn, offered his two cents. "The consequences of the financial crisis are not over but the root causes are far behind us,” Mr Strauss-Kahn told a news conference. This from the head of one of the major "root causes" of the crisis. With statements like this no wonder the news media continues to give Ron Paul coverage — he is one of the few in government or even in the financial community that makes any sense. He understands the root causes and has been trying to rid us of the root causes for many years.
What root causes is Mr Strauss-Kahn talking about? Does he mean all the government and central bank intervention in and the resultant distortion of the private market economy as a result of the malinvestments caused by such intervention? Of course this is not what he is talking about. Mr. Strauss-Kahn does not mean any of this for if he did he would resign immediately and urge the complete liquidation of the IMF, the central banks and all the other international government financial intermediaries and cartels. The utterings by Mr Strauss-Kahn about eliminating root causes of crisis and conflicts is just more nonsensical babbling by government politicians and bureaucrats attempting to absolve themselves of responsibility for this mess which they have created.
Ron Paul and the Austrian economists have been voices in the wilderness for many years — urging a return to a gold standard and 100% reserve banking, elimination of the Federal Reserve and other government agencies, elimination of the income tax and other repressive taxes, massive reduction in government spending and opposing government intervention including the military interventions of the Bush Administration in Iraq and Afghanistan to name just a few of the fundamental changes required. Until we rid ourselves of government intervention in the national and international economy and society and return to a private free market economy and a free society, the root causes of our crisis will remain. Until we rid ourselves of central banking and fractional reserve banking and return to private 100% reserve banking the root causes of our crisis will remain. Until we rid ourselves of fiat currency and return to an asset-based currency such as gold, silver or some other asset-based currency the root causes of our crisis will remain. Until we rid ourselves of taxes which punish production, savings and wealth generation the root causes of the crisis will remain.
Inflation (printing of money) by central banks creates malinvestments by sending false signals to business owners about future consumer demands. The business owners expand in anticipation of additional future consumer demand for goods and services that in fact does not exist. When the business owners realize that the anticipated consumer demand has not materialized the correction (recession or depression depending on the extent of the malinvestments) of this expansion begins. Markets re-order themselves to meet the real demand. Prices fall and malinvestments are liquidated. The sooner the correction process can be completed the sooner the recovery can begin. Intervention by government and central banks to prevent the correction only delays the inevitable, defers the completion of the correction process and in fact makes the correction worse by destroying more wealth.
As Frank Shostak, the eminent Austrian economist from Australia, pointed out in Mises Daily recently government and central bank intervention through taxation and inflation destroys savings (wealth) and shrinks the pool of savings available for real investment in real projects (versus the malinvestments created by central banks inflation) demanded by consumers. What is needed is more savings to create more wealth for more investment and the cessation of the theft of savings and wealth through government taxes and central bank depreciation of the currency. More savings and wealth is what is needed for a recovery to begin not more central bank and government intervention.
In early August 2007 when the correction to this latest bubble commenced (and before the Federal Reserve actively intervened) the markets began an immediate correction — commodity prices began to fall dramatically, the stock market began to fall and the value of some overvalued currencies such as the Australian dollar began to fall. We will never know how rapidly and in what form the unfettered real correction would have taken place since the Federal Reserve and then other central banks preempted the functioning of the market and actively intervened. The slide (correction) in stock markets, commodity prices and overvalued currencies stopped. What appeared to be a "recovery" for the financial community (but not for the consumer) took place. Commodity prices soared and the stock market went sideways. All the experts cheered but not the consumer. Oil reached new all-time highs as it approached US$150 (some predicted it would hit $200 per barrel or more) per barrel on international markets and gasoline topped $4 a gallon while hitting a high of A$1.65 per litre in Australia. The swift correction and real recovery demanded by the market was deferred and replaced by central bank and government intervention. Over the next 14 months the Federal Reserve lowered the target federal funds rate seven times, dramatically increased the money supply since September 2007 and intervened 34 times in the financial markets, primarily providing U.S. Treasury securities (for which there is a market) to investment banking firms in exchange for those firms' holdings of mortgage-backed securities (for which there is no market).
Despite the intervention the market was not to be denied the correction it demanded and soon the first major steps toward unwinding of the malinvestments began to occur — the correction was underway. Events unfolded like a chapter out of Ayn Rand's popular novel, Atlas Shrugged. Countrywide Financial was taken over by Bank of America and Bear Stearns was taken over by J P Morgan in March 2008 with some help from their friends at the Federal Reserve Bank. Bear Stearns was a major participant in the private derivatives market (the risk market) of credit default swaps (referred to in the industry as CDS, private contracts "insuring" against the defaults of securities). When it became apparent that Bear Stearns could not cover the risk it insured and that its default would thereby bring down the house of cards the Federal Reserve stepped in and pushed Bear Stearns into the arms of J P Morgan. The politicians and bureaucrats as well as their organs of propaganda, the establishment's news media, told us not to worry. Congress passed a new housing bill to provide relief to hundreds of thousands of mortgagees thereby raising the debt ceiling $800 billion to $10.6 trillion. Then in early September Freddie Mac and Fannie Mae were hastily restructured from being quasi-nationalized to being completely nationalized in what appears to be a government sponsored bankruptcy in which the United States taxpayer will have to stand behind more than US$1 trillion of obligations of Freddie Mac and Fannie Mae.
Then last week Lehman Brothers was allowed to fail and go into bankruptcy (a government created procedure for reorganizing companies) and by the end of the week the bankruptcy court allowed Barclays Bank to acquire the core assets of the 158-year-old Lehman Brothers. Merrill Lynch an icon of the American financial industry for 94 years was taken over by Bank of America. On Monday American International Group (AIG) also in the business of insuring against defaults similar to Bear Stearns pleaded for a lifeline of $40 billion from the Federal Reserve to save it from bankruptcy. On Tuesday the Federal Reserve generously loaned AIG not $40 billion but $85 billion in exchange for the Fed owning 80% of AIG (effectively nationalizing AIG, some say it is in reality a controlled bankruptcy of AIG). To prove that this was not isolated to the US Halifax Bank of Scotland (HBOS) is pushed by the British government (Prime Minister Gordon Brown personally intervened) into the arms of Lloyds TSB as HBOS' stock crashed. In reaction to the AIG bailout Goldman Sachs whose stock was in free fall issued a note to its clients indicating that "The rescue package for AIG could mean that systemic concerns are going to moderate from very elevated levels." But the Federal Reserve and the US Treasury were only getting warmed up.
The Federal Reserve and its central bank partners organized a consortium of 10 international banks to each contribute $7 billion toward stabilizing financial markets (where do these firms come up with $7 billion — from the central banks of course). Then on Thursday the Federal Reserve and the central banks of Britain, Canada, Switzerland, the European Central Bank and the Bank of Japan pumped $200 billion into the system to provide more liquidity since banks were refusing to provide short-term lending to other banks over concerns as to the solvency of their own cartel members. Wachovia Corp. is set to take Morgan Stanley into its corporate organization and Washington Mutual is set to bankrupt the Federal Deposit Insurance Corporation if it is not taken over by Citicorp. Then the Securities and Exchange Commission slapped a ban on short selling of nearly 800 financial stocks. British authorities issued a ban on short selling and on Friday the Germans followed the British and banned short selling of financial stocks. We expect this from the Brits, who have a history of socialism but can you imagine this in "the land of the free and the home of the brave"? Then over the weekend the Treasury Secretary and Chairman of the Fed conspired with Congress to create yet another government agency similar to the Resolution Trust Corporation created to handle the US savings and loan crisis of the 1980s.
Resolution Trust II will have $800 billion available for the purchase of "toxic" debt and the Federal Deposit Insurance Corporation (FDIC) will receive an additional $400 billion for a total rescue package of $1.2 trillion — does anyone believe that this will be the final number? The CDS (credit default swaps) exposure alone is estimated to be $62 trillion that is in addition to more than $1 trillion of Fannie Mae and Freddie Mac exposure, the nearly $1 trillion in mortgage relief by Congress's housing bill and the billions of bailout dollars all of which are to be saddled on the taxpayers. This reminds one of the late Everett Dirksen (Republican Senator from Illinois) who once quipped "a billion here, and a billion there, and pretty soon you're talking about real money". Now we are talking trillions. If we keep this up soon we will need a wheelbarrow to carry all the dollars needed to purchase a loaf of bread as they do in Zimbabwe and as they did in Germany in 1923. The market promptly reacted to all this government intervention, nationalization and socialism with gold jumping nearly $100 an ounce, the largest single day jump in history. As one trader said "What is left for people to put their money in?" They can’t trust the banks, they can’t trust insurance companies, they can't trust the stock markets.”
And what of the "moral hazard" from all of this? Bailouts remove the discipline of the marketplace and create a devil-may-care attitude in the running of large firms. Already they are lining up in Washington for more handouts. During the week US automotive executives were in Washington knocking on the doors of Members of Congress seeking a $25 billion government bailout as well. These are the same Members of Congress from whom Felix Rohatyn has been seeking billions of dollars for infrastructure projects in the USA. Who else will join the corporate soup line seeking a bailout or a "life line" from the American taxpayer?
One of the candidates for the Presidency blames all this on inadequate government regulation and the Republican candidate blames it on Wall Street greed. They do not have any understanding of the root cause of the crisis. But the politicians and bureaucrats love this — crisis and conflicts and government intervention is the game in which they thrive as they take on "responsibility to solve the problem" (the problem government caused in the first instance). More power is given to the central bank and government. Except for the Austrian economists, libertarians and Ron Paul few if any place the blame where it belongs — government intervention in the marketplace. So what should governments and central banks do to aid in the correction and recovery? Absolutely Nothing!
Jacob Steelman [send him mail], an American ex-pat, is President of International Ventures Group a global investment, finance and development company located in Sydney, Australia.