Posted by Chad Crosier on 02/20/09 02:16 AM

The Free-Market Hasn’t Failed Us, Keynesian Economics Has
By Chad Crosier, 1/8/2009 8:19:09 AM

With all this talk about Capitalism and Free Markets systems failing us one has to wonder if the talking heads on the financial shows truly understand basic economics or are they projecting their interpretation to sway public opinion.

The fact is the U.S. is not under a Free-Market system. Free Markets by definition is markets not interfered by the government. We have just the opposite of Free-Markets in America. If we did, we would not have government backed Reverse Mortgages, trade agreements like NAFTA, CAFTA and the like. Nor Sarbanes-Oxley, Fanny and Freddy Mac, we wouldn’t have legislation that permitted HMO’s and PPO’s to be formed. And the biggest one of all, a Central Bank like the Federal Reserve Bank dictating the value of the dollar.

A Free-Market system would let the value float and be priced by buyers and sellers. That’s called the equilibrium price, remember Econ 101? Instead the value of the dollar is managed by a handful of men at the Fed. They are independent from our Government. Neither Congress nor the people have any say or any direct control over the actions of the Fed.

Whenever the chairman gets pulled in front of a Congressional committee he just sits there and gives often befuddling answers. In a Free-Market society there wouldn’t be the thousands of regulations and legislation in this country creating a market climate induced by the government favoring certain businesses. Making well connected business and government insiders wealthy at the taxpayers’ expense. This is exactly what we have today.

The housing crisis was brought about by many cascading factors but the root cause is due to the monetary policies of the Federal Reserve Bank. The Fed was following a policy (based on Keynesian School of Economics)of lowering interest rates to spur economic activity.

The Keynesian School of thought is by lowering interest rates you promote lending and consumption of products and services which in turn will lead to more employment and greater economic prosperity. While this does actually work in the short term and creates a “boom” this artificial lowering of the interest rates also creates a “bust”. Let me explain why. To lower interest rates the government increases the money supply. Meaning they print and circulate more “dollars”.

This makes loans cheap (easy to obtain) but because money is now more widely available this now bids up prices on assets (i.e. houses. stocks). This is exactly what happened in the latest housing crisis. Due to the Fed policy people were are getting cheap loans and purchasing houses therefore prices are going up (because of artificial demand). Investors see that prices are rising sharply eager to get in on the action investors start buying up houses which accelerates prices even further.

Then builders, seeing a demand start getting loans or investments to build to meet the demand. This is called misallocation of capitol. This misallocation of capitol by consumers, investors and builders will lead to money invested on this asset to be wasted. This scheme works as long as there is a never ending amount of consumers, loans and money to be spent on housing. But as soon as there is no one to keep buying up property, prices begin to level then eventually fall. Builders with excess inventory cannot sell and default on their loans.

Wages lag behind inflation which is caused by the money supply expansion policies of the Federal Reserve. Prices are so high on houses they are disproportionate to wages and most people cannot afford a house without prices falling. And the people that did buy houses at the end of the cycle are now stuck with a debt greater than the value of their declining asset (home).

This greatly lowered demand will have the opposite effect of the artificial demand created by the actions of the Fed. Businesses created in the “boom” phase will either go out of business completely or lay off workers due to the “new economic reality”. There will be an unwinding of economic activity creating a “bust”. This is history repeating itself. This is what happened in the Savings and Loans in the ‘80’s, .com bubble in the ‘90’s and the roaring 20’s just prior to the Great Depression.

So as you can see Inflation (more specifically monetary Inflation) is directly caused by the Federal Reserve Bank. Although most people do not understand how inflation comes about they do intuitively understand that inflation is bad. Where most people make the mistake is that they feel inflation is a fact of life but it doesn’t have to be. The Federal Reserve had failed miserably to meet one of its primary directives which is to have price stability. Instead, since the creation of the Fed in 1913 the purchasing power of the dollar has fallen to 4% of its original purchasing power.

The United States did very well without a Central Bank for hundreds of years. We will do well again without one. The Keynesian School has failed us we should now look towards the policies promoted by the Austrian School of Economics which have been a long time critic of the Keynesian School.

Posted 11/11/09 08:18 AM mcbowler Aiea, HI

Keynesian economics isn't even as bad as our central bank. I did a little studying to find out what Keynes was talking about. What I found was that he was referring to printing money to get us out of an economic emergency. Therefor when not in an economic emergency we should return to some kind of standard. The problem is that it is politically favorable to always be in an emergency, always be at war, always have a reason expand. Sorry Keynes, your policy directed by simple men creates the bubbles that lead to the problems that your economics tries to fix.