The Necessary Correction Finally Arrives

Stock markets tumble around the world. Austrians school economists saw it coming several years ago.

Stock markets around the world suffered major losses in recent days after one rating agency downgraded the creditworthiness of the United States of America, casting doubt not so much on the nation’s ability to pay back its loans but on its ability to regain competitiveness and economic growth.

Tens of millions of Americans remain out of work and many millions more are part-time employed against their will. Meanwhile, companies are sitting on hundreds of billions of dollars in capital, reluctant to invest as they are uncertain about the future.

Personal consumption expenditures have recovered since the crisis three years ago in part because of government stimulus while two consecutive rounds of “quantitative easing” by the Federal Reserve managed to prevent the stock market from adequately reflecting the absolutely lackluster performance of the American economy — until now.

Technically, the recession is supposed to be over yet economic output, employment and housing prices haven’t recovered. The slow pace of growth is exacerbated by a mounting public debt burden on both sides of the Atlantic after governments intervened to prevent a potential collapse of the financial system in 2008. That potential collapse was brought on by too much debt in the first place. Indeed, markets have been overleveraged for more than a decade.

Since the Federal Reserve intervened to soften the bursting of the dot-com bubble around the turn of the century, authorities have tried to avert the economic correction that was necessary after the hype of the late 1990s and instead, set the stage for the next bubble — in housing. Semi-private mortgage giants with implicit government guarantees facilitated the investment of hundreds of billions of dollars in real estate, including millions of subprime loans that were engaged in by people without sufficient income or collateral, indeed, sometimes by people who didn’t even have a job!

When the financial industry caught up with reality in 2007, the adjustment that should have included the collapse of several banks was not allowed to happen. The United States government set out to “save” Wall Street lest a panic there affect the entire economy. Even failing automakers were bailed out at the expense of the taxpayer while bankers and their greed were blamed. The market was more heavily regulated and remained deeply distorted, perpetuating an anxiety among investors who not only fear higher taxes and inflation as a tool to alleviate the United States’ ballooning national debt but who just don’t know what is really a safe investment anymore and what is little more than hot air.

More than two years ago, Mark Thornton, a senior resident fellow with the Ludwig von Mises Institute, warned that entrepreneurs and investors — the very people who can generate economic growth — were “unhinged” from the normal parameters with which they operate. “The result is inaction and fear, conditions that make the stock market ripe for a crash,” he predicted.

If Thornton was right, so was Austrian School economics altogether, according to Judge Andrew Napolitano on the Fox Business Network last week. He blamed the stock market crash on “the futility of doing the same thing over and over and over again and expecting a different result.” What’s holding the economy back, he believes, is “the government’s idea of theft by taxation and confiscation by printing money and taxing by inflation.”

Statism has failed yet it continues to appeal to policymakers who want to “do something” to stem the tide of economic contraction and prevent a correction from inflicting too much pain on ordinary citizens. Now, they’ve run out of money and the pain is coming anyway.

“Cutting back on government spending will cause some contraction in economic activity,” former Federal Reserve chairman Alan Greenspan admitted this weekend but over the long term, it is the only way to minimize the detrimental impact on economic activity of permanent interventions in the form of entitlement programs, wage controls and unemployment compensation.

Rather than diminishing the government’s distorting influence on finance and housing however, new regulations and regulatory agencies have been enacted and created, representing perhaps “the largest regulatory induced market distortion since America’s ill-fated imposition of wage and price controls in 1971,” according to Greenspan.

The Austrians always warned that “oversight” and attempts to control markets were bound to fail because regulators, “and for that matter everyone else,” in Greenspan’s words, “can never get more than a glimpse at the internal workings of the simplest of modern financial systems.”

Today’s competitive markets […] are driven by an international version of Adam Smith’s “invisible hand” that is unredeemably opaque. With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices and wage rates.

Allowing the market — which means, free people — to set interest rates and determine prices and wages is “too much freedom” for progressives and statists though who do not believe that people are naturally prone to be moral; that it requires government action to compel or “nudge” them to do good instead and that without it, evil capitalists would exploit their workers and the old and jobless could be left to die in the streets.

For all government’s efforts to “help” and protect people, the world is in crisis because of it whereas the United States experienced their period of greatest prosperity during the largely unregulated late nineteenth century.

The lessons from that time should guide the path to recovery which, according to Thornton, requires that Washington “cut taxes permanently, eliminate government programs, balance the budget, eliminate regulation, free the entrepreneur, establish free trade, eliminate the Federal Reserve and return to the gold standard.”

Events have vindicated the Austrian vision. Will lawmakers too?