CHAPTER 1
Why the Debt Crisis Was Predictable
How was it that we, of all people, were able to successfully predict the major financial and economic crisis that continues even as we write these words today? What differentiates us from the army of economists, professors, analysts, bankers, fund managers, central bankers, politicians, and journalists who only recognized the impending calamity after it was well under way?
We are not whiz kids or members of Mensa. Nor do we have any secret access to knowledge.
Rather, our only strategic advantage is the willingness to swim against the tide, and to remain immune to the siren songs. Most human beings are gregarious animals who can believeâand sometimes, must believeâalmost anything, as long as they are part of a group that subscribes to the same viewpoint. It seems no theory or thought is too absurd to be accepted by vast numbers of otherwise thoughtful people. Fictions that few could ever believe individually are trusted implicitly within the shelter of the group. Individuals who otherwise might be totally rational are swept up into irrational groups that suppress and inhibit even the most basic of common sense.
The second factor that has helped us distance ourselves from the crowd is the absence of any conflicts of interest. We view market analysisâwhich necessarily includes political analysis, social analysis, and even mass psychologyâas one of the most worthy pure intellectual challenges that the world has to offer. We have no professional ties, contracts, or commitments that interfere with or bias that endeavor.
From a technical point of view, the key is our intensive focus on the phenomenon of the speculative bubble. A comprehension of its causes, its dynamics, its burstingâand the consequences thereofâhas enabled us to see the period since the mid-1990s, when the largest stock market bubble of all time began, through different eyes from the majority of our colleagues. Furthermore, the internal logic of the speculative bubble forced us to ask further critical questions and to connect the dots to what others may have seen as unthinkable conclusions.
Finally, and most important, our understanding would be woefully incomplete if we were not familiar with the Austrian School of economics. The brilliance and consistency of its approach, dedicated to the cause of freedom, is both inspiring and persuasive. Its logic will propel you toward insights that cannot be reconciled with ready-made views of the world. But therein lies one of its great strengths. Moreover, it does not stop at the gates of institutions that continue to be regarded as sacrosanct. Quite the contrary, the Austrian School debunks the wisdom of the stateâs monetary monopoly, reveals the danger of its resulting system of central banks and fractional reserve banking, and exposes this monetary complex for precisely what it is. As we will document here, this monetary complex is the underlying root of the crisis now unfolding. Worse, the global official response to the crisisâunprecedented interventionismâthreatens the continued existence of our free market system and, with it, individual freedom itself.
Keynes versus Mises and Hayek
Let us start this chapter about the huge differences between classical liberal thinking and Keynesianism with a central quote about money from F.A. von Hayek.
We refer again and again in our analyses to the insights of the Austrian School of economics, whose preeminent thinkers were Carl Menger, Eugen von Böhm-Bawerk, Ludwig von Mises, Friedrich August von Hayek, Walter Eucken, and Murray N. Rothbard.
At the heart of this school of thought, which extends far beyond the realm of economics, is freedom of the individual. And inextricably tied to freedom is, of course, propertyâspecifically including ownership of the means of production. Freedom of contract and self-responsibility are the most important additions to these key concepts, which underpin classical liberalism and from which the political program of a free society emerges.
It goes without saying that the boundaries of the freedom of one individual lie where the freedom of another begins. It is easy to derive the rules governing cooperation from this basic principle.
At the same time, there are also thieves, liars, and fraudsters, seeking to acquire other peopleâs property for themselves. It follows that certain measures must exist to protect property rights. Furthermore, freedom of contract would have little meaning were there no mechanism in place for the enforcement of contractual agreements.
At discussion of the precise form of such mechanismsâand what concrete proposals classical liberalism offers for their regulationâis beyond the scope of this book. Suffice it to point out that individual freedom continually faces a series of specific threats and that the greater threat to individual freedom comes not from other individuals but rather from powerful organizations.
Organized crime, like the Mafia, is a common example that springs to mind, but it is not the one that affects the most people most of the time. Rather, the single greatest threat to individual freedom comes not from common criminals, but from the mightiest organization of allâthe state.
The Road to Serfdom
History is littered with examples of horrendous crimes. But the biggest, the worst, and the most devastating have, almost without exception, been perpetrated in the name of the state. This unmistakable conclusion has led the philosophers of freedom to adopt a healthy mistrust of government and its representatives.
Based on the most thorough analytical and empirical arguments, they see the government as the greatest threat to freedom, against which a society must protect itself at all costs, lest it degenerate into dictatorship. The separation of powers is one such protective mechanism. But equally important is strict adherence to a currency that cannot be multiplied at will, thus forcing the government to treat the nationâs finances in a responsible manner, while protecting the people from the greed of the politicians.
In principle, there are two ways freedom can be abolished and slavery introduced: through revolution or evolution. The reader will certainly be familiar with revolutions that have led to the rise of dictatorships. The communist revolutions, causing untold suffering and poverty across great swaths of the globe have, after all, only recently been consigned to history. A repeat of this ghastly period in history hardly appears to be an imminent threat today, while the threat of Islamist revolutions seem more current, threatening the introduction of new tyrannies in several parts of the world.
In Europe, most of the Americas, and other regions, freedom is not currently threatened by domestic groups demanding revolution. Instead, the greater threat stems from an evolutionary process initiated long agoâa not-so-subtle, insidious progression in which the government spreads gradually like a cancerous tumor, increasingly limiting or abolishing individual freedoms.
To describe this process, Hayek coined the phrase âthe road to serfdom.â2
In this book we refer primarily to Keynesianismâto embody not only John Maynard Keynesâs economic program, but also, to some degree, all schools of economic thought that seek to accord the government a sphere of influence extending far beyond the essential sovereign tasks of ensuring security at home and abroad.
For the sake of simplicity, we draw no distinction among multiple schools of economic thought, all of which have one major commonality: namely that they all demand an overly robust role for the government in the economy and society.
In this broader sense, we also characterize monetarists as Keynesians inasmuch as they advocate the government monopoly over money and the system of central banks, which that monopoly necessarily entails. Granted, in other realms, monetarists espouse thoroughly non-Keynesian positions that may seem to favor freedom. But for the purposes of this book, they continue to fall under the broader rubric of Keynesians.
The administration of former president George W. Bush and the neoconservatives, despite all their rhetoric to the contrary, were, in fact, out-and-out Keynesians. This is so obvious it should not even be worth mentioning. However, in the wake of the debt crisis, since the blame game and search for scapegoats is so ubiquitous, and since neoliberalism is first in the firing line, this observation is nonetheless necessary. Itâs ironic that liberalism and free market philosophies are getting lynched, when the real culprit that deserves to stand trial is Keynesianism.
The key point here is not whether government intervention in the economyâincluding massive economic stimulus programsâare financed by deficits or not. We know that Keynes proposed that the government should accumulate reserves in good times so that it could afford to finance stimulus programs in bad times. But because Keynes himself was, in large measure, a politician, it is inconceivable that even he considered the implementation of this proposal to be possibleâlet alone probable. The interests of politicians who depend on votes are diametrically opposed to Keynesâs proposition of accumulating reserves in times of plenty. Voters almost invariably demand that surpluses be spent todayânot in some elusive future.
To reveal a governmentâs hidden agendaâeven behind its smokescreen of public relations and propagandaâall that is typically required is to consider a few key variables: you can look at the trend in the governmentâs share of total economic activity, the amount of legislation passed or, more commonly, the level of national debt. If each of these is expanding, you can be almost certain that the government is not pursuing a liberal agenda. It is immaterial what kind of rhetoric or propaganda the government is deploying. Do not let them fool you. And donât be hoodwinked by false critics, either. Judge both sides not by their words, but by their deeds.
Classical liberalism and the Austrian School of economics stand, as we do, for freedom of the individualâwith no ifs or buts. Classical liberalism and the Austrian School are the offspring of unwavering philosophers of freedom. And these are philosophers who think ideas through to their logical conclusion with inexorable consistency, even in circumstances in which others would prefer to take a more relaxed viewâto further their career or to avoid established taboos. It should therefore come as no surprise that thinkers of this provenance have no powerful friends. They are a thorn in the side of the powerful.
In The Denationalisation of Money, F.A. von Hayek sums it up as follows: âI fear that since âKeynesianâ propaganda has filtered through to the masses, has made inflation respectable and provided agitators with arguments which professional politicians are unable to refute, the only way to avoid being driven by continuing inflation into a controlled and directed economy, and [the only way to] ultimately save civilization, will be to deprive governments of their power over the supply of money.â3
We agree. But some of the most powerful menâcontrolling trillions of a nationâs money supplyâdo not.
Dr. Greenspanâs Great Experiment
âDr Greenspanâs great experimentâ was the title of an important chapter in our book Das Greenspan Dossier. We coined this term, with good reason, to refer to the policy of unrestricted use of the printing press to create moneyâa policy pursued aggressively at that time to counteract the consequences of the technology stock bust (the Tech Wreck) between 2000 and 2002.
The United States had witnessed the bursting of a giant stock market bubble once before, in 1929. And the Crash of 1929 proved to be the prelude to a serious banking crisis and a global recession that would later go down in history as the Great Depression. The causes of this historic crisis are the subject of extremely heated debate even today. Nonetheless, in recent years, the Keynesian view has increasingly prevailedâa view we regard as mistaken.
Believers in Government Omnipotence
On one side of this dispute are John Maynard Keynes and the school of thought that is now followed by the vast majority of economists. Above all, this school places its faith in the government. It maintains that the massive monetary and fiscal measures taken in the 1930s were fundamentally correct; it was simply the extent of government intervention that was believed to be insufficient to prevent the catastrophe. âToo little, too lateâ is the shorthand version of the analysis that predominates today.
Strangely, in their theory and worldview, the preceding boom, made possible by the lax monetary policy of the 1920s, plays no role. To be precise, it does not even appear in this theory at all.
Nevertheless, virtually every central banker and policy advisor, together with almost every economist in government, subscribes to this school. Naturally, he who pays the piper calls the tune. Unfortunately, itâs ultimately the average citizen that gets stuck with the bill.
Free Market Economists and Skeptics of the State
On the other side of the debate are Friedrich August von Hayek and a beleaguered minority thatâs been consistently skeptical of government. They see the true cause of the 1930s bust not in the inadequacy of the governmentâs response, but rather, in the monetary excesses that created the speculative boom that preceded it.
It was lax monetary policy that drove the credit-financed boom and stock market bubble of the 1920s. And it was the unprecedented monetary and fiscal government responses in the 1930s that prevented or postponed a long-overdue correction process, serving merely to prolong and deepen the depression.
As we said at the outset, we subscribe, without reservation, to the second point of view, based largely on the insights of the Austrian School of economics.
This school is the primary foundation of our analyses and forecasts. And itâs the Austrian Schoolâs far-reaching perspective that enabled us to give our readers advance warning of the dangers of the 1990s stock market bubble and, later, of the real estate bubble. It is also this approach that enabled us to recognize the extent of bad investments and economic imbalances associated with the real estate bubble early on, together with the enormous attendant risks.
To drive home the importance of this approach, donât be surprised if we sometimes repeat ourselves. The repetition is deliberate, as many of our observations and conclusions will be new to most readers, and perhaps a little disconcerting.
Dr. Greenspanâs Gre...