A very good article, and your analysis is spot-on.

The root problem is that the election cycle is shorter than the economic cycle, so politicians have an incentive to set off booms by lowering interest rates.

When the unavoidable bust eventually comes, the guilty parties are retired on a pension paid for by all the people they defrauded, leaving the incumbent politicians to desperately try to repeat the trick, so the bust won't happen on their watch.

But the boom that comes from lowering interest rates is not from the creation of net wealth, it is from the consumption of capital, which makes us as a society poorer.

Sorry Troy, completely unconvincing. Neither graph says anything - let along demonstrate any connection - despite the fancy circles. One section of the bottom graph shows some sort of correlation but correlation is not causation, as the saying goes.
A few basics:

*The root cause of the global crisis was stupid lending and stupidier gearing up on that lending by poorly regulated American banks which resulted in mass failures. Those failures had a knock on effect through the now tightly interwoven global financial system, exposing weaknesses in other national systems.

* The general financial problems make banks everywhere cautious and their clients even more cautious. No one wanted to borrow, fewer banks were prepared to lend. The whole system paused. Now everyone is recovering from the shock. That basic model fits what seems to be happening.

* Keynesian economics had nothing to do with the original problem but both it and monetary policy are being used to boot economies along again.. maybe its working. We shall see.

* As unemployement rates would take far longer to react to changing circumstances than market prices then the fact that one is lagging the other is meaningless.

Leave it with you.

Troy,

Just how would you deal with the social dislocation which would inevitably occur if the market was allowed to rip?
Will you volunteer to forego your economic stability in order that the market undertake its "correction"?

I notice that you are a dealer/trader. Do you accept any collective responsibility for the current situation?

That's the problem when ideology triumphs over empathy.

Hi Posters. Thanks for reading my article. In response to Curmudgeon: I don’t think it is a leap of faith to make a connection between unemployment and poor market conditions.

“The root cause of the global crisis was stupid lending and stupidier gearing up on that lending by poorly regulated American banks which resulted in mass failures.”

Alan Greenspan had everything to do with this by dropping US interest rates to 1% back in 2001. This created a credit orgy not just in the US but all over the world. Other central banker’s followed suit. Over time we are going to increasingly learn that it is not just US banks that lent irresponsibly. Interest rates set at historically low levels for extended periods of time created a climate where the temptation for banks to soften lending standards became irresistible.

“Keynesian economics had nothing to do with the original problem but both it and monetary policy are being used to boot economies along again.”

How sustainable are present fiscal and monetary policies? The US and UK have essentially run out of interest rates to cut. Can you name me a country in history that has experienced a positive outcome from quantitative easing (printing money)?

To Shal. “Just how would you deal with the social dislocation which would inevitably occur if the market was allowed to rip?”

Let me just say we don’t operate in a “free market”. You can no more set the price of money (which central bankers do) than the government could come out tomorrow and effectively set the price of milk or bread. Free market activity has not got us into this mess but a lack of free markets. Human greed whilst a nasty symptom of what occurred is nothing new and would never have happened to the degree it did under a genuine free market system. There is no silver bullet for the economic mess we are in. More of the same however is certainly not the solution.

Well said, Troy, I agree that Greenspan’s lack of caution was a major factor in the crisis, and that government action here and elsewhere will exacerbate the recession, prolong the recovery and have great net medium/longer term costs through higher tax and interest rates and slower economic growth than would occur if the imbalances were allowed to work themselves out through market forces.

“Government needs to ensure they run their affairs more efficiently and cost effectively. … To argue that government is more effective at investing money than the private and business sectors [makes no sense].” Again, true, the incentives for governments and bureaucracies do not encourage efficiency or effectiveness; while businesses which are inefficient and ineffective go out of business, governments can cover bad policy and management by raising taxes and running deficits. And get 66% popular support while they do so! Good grief!

“The present unfunded fiscal policy employed by the Australian government will only serve to prolong this recession as the private sector now competes with government for scarce capital resources. The share of the economy run by the government will also increase. Antiquated, ineffectual Keynesian economics lies at the heart of our financial problems.” Yes, yes and yes. Ruddonomics is a recipe for an impoverished nation - and for increasing dependence on government, the opposite of what is required.

Troy,

If the market was not the cause of this what was?

What has the last 40 years of free market management of the economy been about?

And i repeat are you going to forego your comfortable lifestyle in defence of the market or should we only expect the marginalised and unskilled and the underclass to do so?

These are real people and this is real pain not some economic theory.

Shal

“If the market was not the cause of this what was?”

Good question. A succinct answer is here: http://www.lewrockwell.com/woods/woods111.html

“What has the last 40 years of free market management of the economy been about?”

‘Free market management of the economy’ is a contradiction in terms. ‘Free market’ means one in which the price level is governed by the voluntary contracts of the parties. Government “management” of the economy means using law and policy – ultimately courts, police and prisons, i.e. violence or threats - to force prices e.g. interest rates to something other than they would be in the absence of such interventions.

What the last 40 years of *government* so-called “management” of the economy has been about, is manipulation of interest rates for political reasons, based on two main economic theories: Keynesianism and monetarism (Friedman). The current crisis has proved both of these theories wrong, both because a) it happened in the first place, and b) their ‘cures’ haven’t worked.

“And i repeat are you going to forego your comfortable lifestyle in defence of the market or should we only expect the marginalised and unskilled and the underclass to do so?”

Good question. Everyone decries the bust, but *the damage is done during the boom*.

Lowering interest rates deceives the population into thinking that there is more capital available than there really is, and that certain investments are profitable when, absent the inflation, it would be seen that they are not.

The bust is the process by which these unsustainable malinvestments are liquidated, and the market – the population at large by their voluntary valuations – washes them out of the system. The people through their sovereignty as consumers send broke the businesses based on the fake demand and fake money. The mass of people thus reject government’s monetary policy and impose on politicians the monetary values they will accept.

It is important to understand that there is not an option for government to fix this problem caused by the political manipulation of interest rates.

The issue is not whether to fix it or not. The issue is whether to suffer the consequences of their ignorant greedy incompetent violent elitist meddling now, or suffer much worse consequences later - that is all.

This is because all politicians can do by monetary policy is create more malinvestment and hence worse problems later on for everyone, the burden of which will fall unequally on the marginalized. Politicians’ only concern is to postpone the disaster until they are out of office.

“These are real people and this is real pain not some economic theory.”

True - and that’s the entire argument against political manipulation of the money supply, and is why it should be illegal in the first place!

It is fake, it is fraudulent, it makes us as a society poorer, it privileges bankers and politicians and the financially sophisticated, and it suckers the poor, the workers and the financially unsophisticated.

But the solution is not more and more government ‘economic management’ for gossake!

The solution is to stop what is causing the problem in the first place: letting politicians engage in a Santa Claus act, stimulating booms that lead to inavoidable busts, caused by counterfeiting mountains of fake money via the central banks.

The argument that the problem is caused by free markets is based either on simple ignorance or on deliberate dishonesty. Anyone running that argument first needs to disprove these facts: http://mises.org/story/1315 and to understand the unavoidable social injustice caused by these interventions.

It is an utter delusion to think that the solution lies further down the path to more fascism, which is the way the governments of the western world are headed now – to the point where *Pravda* of all people recently warned the USA and Britain against the ‘descent into Marxism’! See for yourself:
http://english.pravda.ru/opinion/columnists/107459-0/

The ethical and practical solution is also the simplest: freedom – or have we forgotten what that means?

give me a break, blaming keynesianism for the Global Financial Crisis you have to be kidding.

The US and UK abandoned Keynes' teachings to embrace the wonderful world of Milton Friedman and the Chicago School. Reagan, Thatcher and Thatcher light(Blair) changed the economic paradigm to that of the Chicago school. Quite simply over reliance on Monetary policy, abandonment of the Bretton Woods system has led us to where we are.

Let us not live in the world of make believe please!

Thanks again for all your comments. Slasher:

"Quite simply over reliance on monetary policy, abandonment of the Bretton Woods system has led us to where we are."

I agree with you. When I look at the fiscal policy however being employed by western governments around the world it points to larger government (not smaller) and heavy deficit spending which is very much consistent with Keynesianism.

A recent interview well worth a look:

http://watch.bnn.ca/squeezeplay/april-2009/squeezeplay-april-21-2009/#clip163848

Slasher
40 years ago was 1969, before both Reagan and Thatcher.

Any time governments ‘prime the pump’ by ‘injecting’ money into the economy, and any ‘stimulus’ policies such as the latest round of idiocy – these are based on Keynesian, not monetarist theory

i love the austrian delusionists. The current crisis was caused by the private sector creating a secondary monetary system based on property derivatives. Totally unregulated and totally privately owned. Just as the Austrians advocate. It collapsed and we are all paying the price sovereign nations are having to absorb the debts created by the private sector. Stop daydreaming the Austrian experiment has failed.

Shal
I don’t know why you are so hostile to Austrian theory when you obviously don’t understand it.

No-one is suggesting, given the prior fact of governmental manipulation of the supply and the price of money, that the resulting economic phenomena will be restricted to public offices and will not manifest in private firms.

The Austrian argument is against the original monetary manipulation, of which all the facts you mention are subsidiary consequences which are entirely predictable, and which were in fact predicted by the Austrian school years in advance, unlike the Marxian, neo-classical, Keynesian and monetarist schools who didn’t see it coming and remain clueless about how to fix it.

The name ‘derivative’ itself should tell that you are looking in the wrong place for the *origin* of something. A derivative is a derivative *of * the underlying contract. The function of derivatives is to hedge risk, so the greater the risk in the underlying monetary bubble, the greater will be the derivative bubble - a mystery to you obviously, but not to sound economic theory.

Your hypothesis would only make sense if the economic phenomena in issue - the supply of and demand for money; the underlying contracts and the derivatives - were unrelated to each other. Yours is a kind of uneconomic, or anti-economic theory.

Your facile misrepresentation that the status quo leading into the crisis satisfied the precepts of Austrian theory is laughable. The links I posted above show a small summary of the vast panoply of extensive and intensive governmental controls of money and banking which explode the fallacy that the crisis was a result of laisser-faire.

You should have the minimum intellectual honesty either to refute or accept Austrian theory, but so far you have only demonstrated that your intellectual standards are satisfied by snivelling ignorance or deliberate dishonesty. Which is it?

But thanks for the love, by the way.

Wing Ah Ling,
Huh?