By Peter Brimelow, MarketWatch Last update: 1:03 a.m. EST Feb. 23, 2009
NEW YORK (MarketWatch) -- Everyone knows the crash of 2008 was caused by financial deregulation except Thomas E. Woods, who blames financial regulation, in the shape of the Federal Reserve.
Wood's new book, "Meltdown: A Free Market Look At Why the Stock Market Collapsed, the Economy Tanked and Government Bailouts Will Make Things Worse" (Regnery), has just made it to the New York Times best-seller list without the benefit of any major reviews.
That's par for the course for Woods, a fellow of the Auburn, Ala.-based Ludwig von Mises Institute, advocates of "Austrian economics," a particularly embattled faction of free market economists -- all of whom are pretty embattled, or out of fashion, right now.
The Austrian school argues that business cycles are driven by central banks keeping interest rates too low, expanding credit and encouraging uneconomic investments, creating an unsustainable boom, inevitably followed by a bust.
That's what happened here, says Woods, most recently with the Fed's multiple interest rate cuts to stave off the 2000-2002 slowdown. Certainly debt levels had reached historic highs before the crash. (See June 1, 2008 column).
Woods argues the crash of 2008 was a perfect storm. Other elements included immense government pressure on mortgage lenders to loosen standards and make loans to questionably credit-worthy but politically favored demographic groups; and securitization, which spread the effects of bad mortgage lending around the world.
Recovery from even serious business cycle downturns can be swift, says Woods, citing the almost-forgotten 1920-1921 slump. But that's because the federal government did not step in. It allowed excesses to correct themselves. In contrast, the federal government did step in after 1929, as Japan's government did in a similar downturn after 1990. Result, according to Woods: the Great Depression in the U.S.; 18 years of stagnation in Japan.
If Woods is right, public policy is on exactly the wrong course right now in trying to sustain demand and asset prices, just as it was in the early years of the Depression. Ironically, this wrong course is bipartisan. Both Hebert Hoover and George W. Bush, Woods notes, were highly interventionist presidents just like their successors, contrary to myth.
Woods' cheerful prediction: prolonged stagnation, eventual inflation and an even bigger collapse.
Nobody wants to hear this argument, least of all Wall Street, which has benefitted enormously from the boom and now appears to be benefiting (some of it) from the bust. I've argued before that a second Pujo Committee is needed to look into some of the suspect stuff that's gone on. (See Sept. 29, 2008 column)
Of course, you have to be careful. The Pujo Committee led to the creation of the Federal Reserve.
I do have a couple of questions about Woods' work:
Why didn't this decade's credit expansion show up in consumer price inflation?
(Wood's suggestion: something similar happened in the 1920s. Expansionary monetary policy met a supply surge -- just like the recent falling price of computer power -- resulting in apparently stable prices.)
What about the U.S. dollar-Chinese yuan peg? Arguably, China's determination to keep its currency underpriced relative to the dollar has been a statist intervention in the global economy to match that of the Fed in the U.S. domestic economy. (See Oct. 19, 2006 column)
China's motive may be "exchange-rate mercantilism" -- maximizing its manufacturing capacity rather than living standards. Washington's complaisance may be because China buys U.S. Treasury bonds, thus bankrolling federal government spending (while bankrupting U.S. manufacturers).
Yet it could strengthen his case -- an undervalued yuan would have meant lower import prices, which would have masked inflation by keeping U.S. consumer prices low. End of Story