Economic truths are not altered by partisan politics; good ideas are good, and bad ideas are bad, regardless of who implements them. Despite this, many on every side of the aisle engage in the politicization of economics.
Economist and New York Times columnist Paul Krugman may be the most well known economist in the eyes of the general public. He has a remarkable level of notoriety and access to readers and publishes books, blogs, and opinion pieces in concert with his weekly column. The man’s ideas are widely spread, to be sure.
This is terribly unfortunate. Krugman is a Keynesian economist, believing that unregulated markets result in instability, and that it is necessary for the government to step in and supplement the shortcomings of the market. He is patently wrong.
In a 2008 article, Krugman attacked the Austrian theory of business cycles in his weekly column. With eye-roll-inducing self-satisfaction, Krugman made the point that health-care premiums were lowered between 1993 and 2000, at which point they again rose. He failed, however, to mention any sort of cause for the aforementioned effects. Krugman can most often be found attacking free markets, blaming conservatives, or extolling the virtues of federal intervention. More often than not, it is some combination of the three.
The Austrian model of economics does offer an explanation to the machinations of the economy, and why things happen the way they do. It is worth mentioning that labels to things do not change how they behave, nor do they change any inherent truths.
The Austrian cycle has five major steps:
- Government encourages borrowing through artificially lowered interest rates
- Expansion leads to more borrowing, higher employment, and greater rates of investment
- Markets reach their peak, and overproduction due to inaccurate trends floods the market
- Consumers spend less, resulting in contractions in the market, and the government raises interest rates to counteract the slowdown in spending
- Asset value declines, borrowers default on the increased interest rates, companies go under, and unemployment sets in.
If that cycle seems familiar, it is because it happens regularly on the small scale, and on a much grander scale at three major points in American history. Each instance was preceded by assurances that the booms would last, and that there would be no more busts. Such promises were made in the 1920s, the 1960s, and in the 2000s. These three points in time came directly before the Great Depression, the recession of the 1970s, and the housing crisis of 2007.
The key point of the Austrian business cycle theory is that interventions in the monetary system create a mismatch between consumer time preferences and entrepreneurial judgments regarding those time preferences. Essentially, it is impossible to predict the preferences of consumers in the future, which is what the government requires investors to do when it lowers interest rates.
1924 saw Reserve banks create $500 million in new credit, with no actual backing, leading to credit expansion of over $4 billion in less than one year. As predicted by the Austrian theory, the sudden influx of cash and credit increased spending power and investments. Eventually, overproduction and investments made on false information led to extreme contraction of the market, followed by levels of unemployment never before seen in the United States. One in four people within the work force was out of a job. Similar, albeit significantly less impactful, boom-bust cycles occurred in the years prior to the Great Depression. Specifically, 1819–1820, 1839–1843, 1857–1860, 1873–1878, 1893–1897, and 1920–1921, each of which was spurred by synthetic numbers created by the federal government.
The housing bubble crisis of 2007 followed generally the same pattern. Prior to the crash, Alan Greenspan, then chairman of the Federal Reserve, created monetary growth rates comparable to those of the 1970 recession, and to the Great Depression. In an attempt to grow the number of homeowners, the Clinton and Bush administrations sought policies which lowered interest rates on homeowner loans to eventually 0%. In such a climate, people who would otherwise be turned down for such high-risk loans were able to borrow large sums of money. These are regularly referred to as “sub-prime” loans. Knowing they would be bailed out in the event of failure, banks had no reason to refuse such loans, virtually guaranteeing the following economic meltdown.
In a free-market economy, businesses and consumers are rewarded for implementing positive fiscal policies. Such examples include providing better services, charging less, buying what one can afford, and investing wisely. These are nearly impossible when the market is plagued by made-up numbers created from nothing by the federal government. This will always lead to collapses in the economy. Rather, a market economy stems any recession by adapting appropriately. As consumer needs and wants change, so too must business practices. Businesses that do not adapt are relegated to failure, making way for new entrepreneurs who do adequately meet the needs of consumers.
Paul Krugman and other Keynesian economists adopt the notion that deficit spending, government intervention, and top-down planning are the only ways to avoid the tumultuous uncertainty of free markets. Their very practices, though, are what ironically create real uncertainty in the market. Boom and bust cycles exist in purely market economies. However, they do not last long, they are not devastating to the entire economy, and they ensure that companies have to make good decisions to make a profit and avoid bankruptcy. When the federal government steps in, it both creates the conditions for economic failure, and also rewards failing companies for their failures, which leads to a lack of competition from new businesses, ensuring continued failures and pseudo-monopolies. The market is made of people exercising their freedom to choose for themselves, which allows it to correct itself. When the government steps in, its actions are short-sighted, and always negative. Sometimes, the results are even catastrophic. To ensure economic freedom for all people, markets must be freed from the shackles of government meddling.
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