Economic Crisis 101

Much has been made about the current recession, housing bubble, banking crisis and the credit crunch. Both parties have been blaming the other for the problem, the problem is with both parties and the policies they instituted. One of my favorite sayings is "Those that don't learn from history are doomed to repeat it." Even worse than that, when something works, the government abandons it and goes back to guessing and doing the same thing that didn't work in a previous attempt.

Let's start with the recession in 1920, never heard of it? They don't talk about it in textbooks or schools, it lasted only about 18 months but was marked by extreme deflation, as much as 18%. Wholesale prices dropped as much as 36% and unemployment rose as high as 11% and industrial production dropped by 30% (60% in the automobile industry) and of course the stock market dropped 47%.

Why did the recession end so quickly? What did the government do to end the recession? The reason it ended so quickly was because of what the government did...absolutely nothing. The government let the economy correct itself. President Harding's laissez-faire policy and an aggressive downsizing of government had a direct influence (through intentional non-influence) on the rapid private sector recovery. There were massive economic distortions caused by government influence in relation to World War I and equally massive corrections were needed to realign the economy to a peace time condition. The government allowed the private sector industries to fail and as economics teaches us, the economy corrected itself, with no government involvement, imagine that. Free market capitalism wins!

Let's fast forward to 1929 and what has been called "The Great Depression", some of the same reasons that caused previous recessions caused this recession. What turned a normal every few year recession into the "Great Depression" is the exact opposite reason the ended the 1920 recession, government involvement.

This brings us to one of the most overrated Presidents in the history of the United States, Franklin Roosevelt. Roosevelt's New Deal programs actually prolonged the recession and turned it into the Great Depression. The progressive Roosevelt used the recession as the crisis he needed to begin the transformation into a "nanny state". Instead of using the same "non-influence" that worked so well for the Harding administration, FDR and his administration took an about face. Instead of allowing the free market economy to correct itself, they turned to government intervention and, according to economists, prolonged the depression by about 7 years. Government programs designed to help the poor and the middle class actually hurt them. New Deal programs were funded by not only increasing taxes, but tripling them. FDR raised income taxes, excise taxes, inheritance taxes, corporate taxes, holding company taxes and even excess profit taxes. The majority of tax revenue until World War II was from excise taxes, taxes on everyday items like alcoholic beverages, cigarettes, matches, candy, chewing gum, margarine, fruit juice, soft drinks, cars, tires (including tires on wheelchairs), telephone calls, movie tickets, playing cards, electricity, radios. These were the things that everyone had to buy and now they have to spend more to buy them. Not only did everyday items cost more, but the tax increases also hit the business sector. With corporate taxes raised, business couldn't hire new employees or spend on growth. Most New Deal programs destroyed jobs, National Industrial Recovery Act cut production and increased wages, making it it more expensive to hire employees to produce less goods. The Agricultural Adjustment Act cut farmer production when farmers needed the work the most. The National Labor Relations Act gave Unions more bargaining power and forced higher wages, causing more layoffs. What about all the good the New Deal programs did? That's hard to find, all of the New Deal programs were paid for by the taxpayers, that means they have less money to spend, which would help the economy recover. New Deal money was funneled away from the poor South and spent in the much wealthier parts of the country. The Tennessee Valley Authority dams flooded over half a million acres of land and displaced thousands of people.

Let's recap for a minute, recession of 1920 with no government intervention lasted only about 18 months; in contrast, the "Great Depression" lasted most of the 1930's and was filled with government intervention that was supposed to "help". So if history teaches us anything it should be that government doesn't help a problem, the free market if left unfettered will correct itself. The law of supply and demand can not be questioned.

Skipping forward to the mess we are in today. To fully understand this mess, we first must understand what caused it. There is speculation abound about the causes, the only bad thing is liberals blame it on the "greedy" bank execs while ignoring the problems. There were many reasons from the Community Reinvestment Act in 1977, to lawsuits, to Fannie Mae and Freddie Mac but to find the beginning of the problem we need to look no further than the Federal Reserve, the central bank of the United States (one of the 10 planks of Communism). The Federal Reserve was created in 1913 by another wildly overrated President, Woodrow Wilson. The Federal Reserve is a PRIVATE company that is in charge of watching over the economy and in fact manipulates it. The Federal Reserve answers to no one and is not regulated by Congress or even audited by the government, so it has free reign to do whatever it wants, any profits generated by the Fed are supposed to go into the Federal Treasury but after a $54 billion profit (bigger than Exxon and those evil oil companies) but there is no mention of where it went. The Federal Reserve gets to print money, adjust interest rates and set monetary policy. Printing money and manipulating interest rates is one piece in the puzzle. How did the Fed's activities assist in creating the mess we are in now? The problem with the Fed's actions is they create what Sen. Ron Paul calls an inflation tax and let me take a minute to explain what is meant by an inflation tax. When the Fed cuts interest rates, what they are doing is reducing the interest rate that banks charge each other. Banks are required to keep a certain level of cash reserves on hand, when those reserves fall below federal levels they must borrow money. The reason banks could be below the minimum level because of lots of lending or lots of withdraws. When more banks need money than have money to loan, the rate rises and the reverse also happens. The Fed doesn't actually say the rate is X%, but they influence the rate by buying bonds from the banks. Where does the Fed get the money to buy these bonds? It just writes a check against itself and passes it on to the banks. Nothing wrong with that practice, creating money out of thin air. The Federal Reserve intervenes like this and hurts the economy. The introduction on new money devalues the dollar. Ron Paul uses the best analogy, Mickey Mantle baseball cards are very rare and expensive, if all of sudden someone finds one million Mickey Mantle baseball cards in a foot locker, the rarity and expense of those cards have all been devalued because of the influx of the new cards into the market. The existing cards actually lost value just because there are more of them. The decrease in the value of the dollar makes people poorer and in the long run all the additional borrowing and spending tends to be harmful because it's manipulated, it's not true stimulus. This creates inflation and prices rise, the big misconception is that wages raise as well but the immoral effects of redistributing wealth from the poor and middle class to the politically connected. Inflation does not effect everyone the same, those who first receive the money get their hands on it before the inflationary increases set in, before the new money trickles down to the poor and middle class they have to pay the price increases. This is called the Cantillion Effect. The Consumer Price Index, which measures inflation rate is misleading, it fails to take into account the inflation on food and energy which happen to inflate at much higher rates. Government will try to get people to think about the rising prices when thinking about inflation when inflation is the cause of higher prices. Inflation is an increase in the money supply, you can't influence inflation by installing price and wage control. The artificial rate induces malinvestment (investments not sound under normal economic conditions). Prosperity comes in the short run but must be re-corrected, prices rise, interest rates rise and their is not enough economic resources currently available. The Fed tries to delay the inevitable, by cutting rates again but the malinvestment continues. This tactic could cause hyperinflation and the destruction of the dollar. Additionally, inflation causes financial bubbles and instability. Between 1996 and 2000, NASDAQ companies made $145 billion in profits and it was all lost in a single year and add to that the trillions lost in stock value and politicians still can't make the connection. Instead they blame analysts, executives and other greedy companies, anyone but the Federal Reserve. Failing to let the market correct itself inflates the bubble and makes the crash much worse when it finally hits. It's this policy that helped cause the housing bubble, with all the extra money around for lending, credit was freely extended and people bought bigger and more expensive houses than they would under normal circumstances. People felt wealthier under the artificial economy, taking equity out of the artificially inflated housing prices. The bubble breaks, home values plummet, variable rate loans and subprime loans hurt those and foreclosures skyrocket as people walk away from their financial disasters.

The Federal Reserve is partially to blame for the mess we are in, but another reason is the Community Reinvestment Act (CRA)of 1977. This act was created to force banks into loaning money within the community they are chartered, including low and moderate income families. It was to reduce the racial inequality of loans, called redlining. Many of these families could not qualify for normal home loans under normal circumstances so the government forced banks into lending to the unqualified. The government claimed that many of the sound lending practices that banks use were discriminatory and eliminated them from the process. Now lets jump ahead to the mid 1990's under the Clinton administration, which actively sought to enforce the CRA and help house those unqualified for home ownership (not because of race but because of sound lending practices). Then lawyer, Barrack Obama comes along and represents ACORN against banks for redline practices because not enough poor minorities were getting home loans. The perceived threat of being exposed as racist (whether true or not) was enough to make the banks cave and lower their lending standards. We have all these lending institutions making risking loans to unqualified people, most of these people were pushed into sub prime loans and variable rate loans or even zero down, whatever they could to be in compliance with the CRA. The banks had to find a way to decrease the risk in the questionable loans so they got bundled together and sold them to other banks. We can't leave Fannie Mae and Freddie Mac out of the equation, Fannie and Freddie bought a lot of these bundled home loans, rebundled them sold them to banks, wall street firms and anyone else they could. Fannie and Freddie kept several of the risky loans, after all they don't have to worry about profits, risk or debt, they are government guaranteed (tax payer backed) loans. One way to look at the bundling is along these lines: I want to borrow $10,000 from you, I'll give you 20% interest but you only have a 15% chance that I won't default; before you answer, you can't say no. Not only to me but to hundreds of others. Now to reduce your risk, you find someone who will buy them from you, relieving you of your risk, wouldn't you sell them?

We all know what happened next, people living outside their means couldn't live up to their obligations and CRASH!

The main problem is the government still doesn't want to admit that it was at fault, or caused any of the problems. If our elected officials can't learn from history we must replace them and elect new ones. Let's take a look at what some elected officials have said about the crisis. "These two entities-Fannie Mae and Freddie Mac-are not facing any financial crisis." Barney Frank, Sept. 11, 2003. "Fannie and Freddie are fundamentally sound, they are in no danger of going under...I do think their prospects going forward are very sound." Barney Frank, July 14, 2008. "The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see." Barney Frank, Sept. 10, 2003. "I want to roll the dice a little bit towards subsidized housing." Barney Frank, Sept. 25, 2003. "I believe there has been more alarm raised about potential unsafety and unsoundness (of Fannie and Freddie) than, in fact, exists." Barney Frank, Sept 25, 2003. "This nation must come to grips with the repercussions of recent financial irresponsibility." Charles Rangel, 2007. "When it comes to deficits, this president owns all the records. The three largest deficits in our nation's history have all occurred under this administration's watch." Harry Reid, 2006. "After years of historic deficits, this 110th Congress will commit itself to a higher standard: pay as you go, no new deficit spending. Our new America will provide unlimited opportunity for future generations, not burden them with mountains of debt." Nancy Pelosi, 2007.

I know this is a long read, but I feel it is very important for everyone to know that the government doesn't solve problems, it creates them and blames everyone but the actual source. The recession we are in was created by government regulation and intervention. Not only has history shown us that less government intervention can speed up recovery but the laws of economics tell us the same thing.

The last point I want to make for free market capitalism is some research done by Eugen Varga, a economist under Stalin in Soviet Russia. He ran an economics institute in Moscow and studied actual data from all over the world and came to the conclusion that capitalism was far superior to other types of economies because a capitalist economy will allow business to fail, where communism will support the failing enterprise at great cost to the health of the economy. After his report, Stalin closed his institute, some reports say he was executed by Stalin but I found no evidence of that.

Recycle Congress, do your homework and make an informed decision.

Thanks to: The Revolution by Ron Paul, Arguing with Idiots by Glen Beck, History.com, Forbes.com, Federal Financial Institute Examination Council, the Federal Reserve website, wordpress.com, fdic.gov and business insider for doing most of the research for me.