The past 20-30 years of economic history will one day provide a great lesson to those who legitimately choose to study the economic truth. Austrian Economics teaches that booms and busts are very often produced by unnatural adjustments in the rate of interest. These unnatural interest rates are primarily caused by government intervention in the financial portion of the economy.

With a good number of individuals essentially being short sighted, often driven by greed, and very welcoming to the idea of instant gratification, the story of the past 30 years has been one of increasingly growing unnaturally cheap and easy credit (this means interest rates are lower than they would be in a completely free and unfettered market with sound money).

With the functioning Federal Reserve (a strange quasi-government institution) and other central banks worldwide acting based on a fiat monetary system, an unanchored currency, interest rates have become much more easy to engineer on the part of government authorities. With the structure lending itself to government engineering, the people gradually accepted the premise that the government controlled the rates and generally followed suit. This is a key point because, without public belief in the key tenets of central banking, fiat currency, and the powers of the Federal Reserve, they would not have the power they have accumulated.

So as the economy faced a number of shocks - as economies always will, regardless of their economic structure, this is the way life is, inherently - the Federal Reserve and other government authorities and semi-governmental agencies constantly stepped in and forced the market rate of interest below where it would be absent the central authority.

Once the rate of interest was jimmied below what it would have been in a truly operational free market with anchored money - and the public gained belief in the ability of the central authorities to jimmy the rate - the economy generally acted in ways that were no longer compatible with completely free market forces. With the subconscious belief that the Fed would always step in if there was any shock to the system and engineer below-market interest rates, economic actors let the party run completely wild. Acting with the “Greenspan Put” as a floor “eliminating” (a better word would be hiding) economic risk, Wall Street, main street, global investors, the average Joe, corporations, government legislators - in a word, everybody - acted in ways that would not have been so without a belief in the Federal Reserve central banking authority.

People went nuts, the economy boomed unnaturally, risks were hidden or inflated away, generally the economy acted in a non-free-market-way. And in an unsustainable manner as risks were mounted on top of each other. Big brother was always there to clean things up if it got too reckless. Few really knew about it, beacuse it happened gradually, generally discreetly, the education system and mainstream media communicated without a critical eye, people in general abdicated responsibility and failed to perform due diligence, and society generally ignored the teachings of Ludwig von Mises and other Austrian Economists, who had the insight to describe the situation.

The Savings and Loan debacle, the 80s LBO issues, the Crash of 1987, the housing adjustment in the early-90s, the Asian Currency Crises, Long Term Capital Management in 1998, the Tech/Telecom/Internet bubble of the late 90s, the ridiculous housing, mortgage, fixed income, LBO, M&A and all-around bubble to end all bubbles of 2003 through 2007 - each of these events arose partly due to below-free-market rates of interest and, more importantly, due to the implied put option associated with the fiat system and the Federal Reserve. Bail outs were common - hiding risk. Interest rate jimmying was common - hiding and postponing risk. Soothing of the markets by central authorities was common - easing fear and postponing reckoning while further hiding risk. All of these events were fostered by our allowance of a central banking authority, fiat currency and unnatural engineering of interest rates. This was no free market economy. It was quasi-free. Any economy with government controlled central banking and currency backed by writ is not a truly free market economy and needs to be described as such.

Given the growth of imbalances through artificial interest rates, government intervention, and the adjustment of popular and financial psychology to a belief in the powers of the central authority, both booms and busts have become potentially significantly magnified. As risks have been piled up and hidden from consciousness, it is only a matter of time before the system faces a significant readjustment.

Only when individuals fully demand a return to free market credit and currency will it be possible to eliminate the major issues associated with central bank engineered credit dislocations.

While the economy has appeared strong over the past several years, there remains a very high likelihood that major dislocations (a la what we are witnessing in the mortgage and subprime areas) will continue to batter the economy as society begins to pay for the “hidden risk” that has been tucked away over the past 30 years and, increasingly, over the past five.

Meanwhile, check out this article from the Wall St. Journal highlighting the reality of the credit situation.

Also, check out this quality commentary on the Federal Reserve by M.A. Nystrom.

By Kemp Moyer 2007

Filed under: Social Mood, Economics