Zombies R U.S.

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You think it's
bad now? It's going to get much worse. This is the big one, call
it Great Depression II. Why am I so sure? Because the depth and
duration of a downturn depend positively on 1) how long the preceding
boom lasted, 2) how distorted its capital structure became, and
most importantly, 3) how much government interferes with the classical
medicine administered by the marketplace.

By these metrics,
our current economy is one sick puppy and getting sicker. But what
caused this? Ironically, economic problems usually result from a
prior intervention too hard for most to trace and so lead to demands
for new interventions to "fix" the problems. Nowhere is
this confusion truer than for the mystery of the business cycle.

The cause of
our sick economy was world-class injections of artificial credit
by Maestro Greenspan and his Merry Band for double-digit years.
Now the inevitable bust is being aggravated by "stimulus"
programs mercilessly foisted on us by Ben Bernanke, in turn aided
and abetted by big business pleaders, business media, Paulson, Congress,
state governments, Ohio school districts, and assorted panhandlers
in business suits.

economists bear a heavy burden for this madness because, preoccupied
by their mathematical models, they have failed to heed the Austrian
Business Cycle Theory (ABCT). Only ABCT explains the wave-like,
boom-bust pattern of the business economy.

The determined
ignorance of most economists reminds me of a cartoon which showed
two men watching a Soviet May Day parade bristling with missiles,
tanks and soldiers, and one asked, "Who are those guys marching
in their business suits?" "Oh, those are economists,"
his friend replied. "You'd be surprised at how much damage
they can do."

ABCT is scientifically
successful because in a field of macroeconomic-model failures, it
is the only theory of business fluctuations based on individual
behavior. Even the greatest economists of all time like Irving Fisher
and Milton Friedman never "got it" because although they
focused on individuals and prices in their microeconomic or price
theory, they largely dispensed with these in their macroeconomic
or money theory. This "separation theorem" has produced
immense, avoidable suffering.

all economists acknowledge that prices have heavy lifting to do,
at least when it comes to micro matters. Prices transmit information,
provide incentives to consumers and producers to follow this information,
and coordinate or harmonize the actions of buyers and sellers in
the marketplace. And what if crucial prices are false? Put aside
temporarily deranged market prices – they will be corrected
– but consider prices deliberately distorted for extended periods
of time. That causes big trouble. Where would such lies come from?
One guess: government intervention.

What prices
do I have in mind? Interest rates of course. Interest rates in a
free market are determined by time preferences: if, say, households
voluntarily increase their savings, they give up some present consumption
spending in favor of the opportunity for increased future consumption.
These actions increase the supply of loanable funds which, in turn,
lowers the interest rate. Since the interest rate regulates the
temporal order of choice of investments in accordance with urgency,
a lower rate signals that more projects, especially projects with
more distant payoffs, can be profitably undertaken. This constitutes
healthy coordination among savers, investors, and entrepreneurs
and induces a production structure in accord with consumer demand.

Now "wise"
central planners (the Fed) get into the act. Its cheap credit policies
induce entrepreneurs to undertake previously unprofitable projects,
especially capital intensive, lengthier projects, say, lots of new
houses. The new credit is not backed by voluntary savings and there
is no downward shift in time preference. Credit expansion does not
bump up total investment because it still must come from unchanged
or even smaller savings, which equal investment after the fact;
meanwhile, the cheap rate misdirects investment into wrong projects
that cannot pay off. Businesses overinvest in the higher stages
of production, as Austrian-style economists say, and underinvest
in the lower stages.

The market
ultimately reacts to the Fed's distortion of the free-market interest
rate by reverting to a higher market rate: "This process –
by which the market reverts to its preferred interest rate and eliminates
the distortion caused by credit expansion – is, moreover, the
business cycle!," Murray Rothbard wrote. He called it a "distortion-reversion"

Wall Street
gradually caught on that all is not well on Main Street. Main Street
failures preceded Wall Street's, not vice versa. Depression is our
next stage as malinvested businesses go bankrupt and land, labor
and capital shift back to lower stages of production. Liquidation
of unsound businesses, "idle capacity" of malinvested
plants, and unemployed resources must shift to lower stages of production.

The deception
orchestrated by the Fed suckered businesses into overinvesting in
capital goods industries, contrary to consumers' wishes. Sad, isn't
it? The massive wasted saving and investment squandered in bankrupt
businesses is appalling, akin to the wastes of war.

business cycle theory cannot get much "wronger." Maybe
the worst part is that "depression expert" Bernanke is
clueless, virtually guaranteeing a depression. As I wrote in March

paper trail tells us…he fears falling money prices as the biggest
risk of all, so he stands ready with u2018an invention called the printing
press' to combat this evil. He promises faster inflation [er, u2018quantitative
easing'] in response to the next financial crisis, supplying the
u2018liquidity' the system needs…Mr. Ph.D. does not understand why a
bust happens. That makes him extra dangerous. Every bust is caused
by the preceding boom and its excesses. The bust is curative…When
Bernanke fights the market by injecting new credit in the next crisis
he will sustain unsound debt, weak debtors and lousy companies,
prolonging depression. That’s the opposite of u2018putting it behind
us.'" Bernanke can fight the market but he cannot win. However,
he might destroy the rest of us in the meantime.

8, 2008

Reynolds, Ph.D. [send him
], is professor emeritus at Texas A&M University and former
director of the Criminal Justice Center at the National Center for
Policy Analysis headquartered in Dallas, TX. He served as chief
economist for the US Department of Labor during 2001–2, George
W. Bush’s first term. Visit his
new website

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