Artificially Created Credit by the Federal Reserve System Got Us into This Crisis

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The financial meltdown the economists of the Austrian School predicted has arrived.

We are in this crisis because of an excess of artificially created credit at the hands of the Federal Reserve System. The solution being proposed? More artificial credit by the Federal Reserve. No liquidation of bad debt and malinvestment is to be allowed. By doing more of the same, we will only continue and intensify the distortions in our economy – all the capital misallocation, all the malinvestment – and prevent the market’s attempt to re-establish rational pricing of houses and other assets.

[On September 25] the president addressed the nation about the financial crisis. There is no point in going through his remarks line by line, since I’d only be repeating what I’ve been saying over and over – not just for the past several days, but for years and even decades.

Still, at least a few observations are necessary.

The president assures us that his administration “is working with Congress to address the root cause behind much of the instability in our markets.” Care to take a guess at whether the Federal Reserve and its money creation spree were even mentioned?

We are told that “low interest rates” led to excessive borrowing, but we are not told how these low interest rates came about. They were a deliberate policy of the Federal Reserve. As always, artificially low interest rates distort the market. Entrepreneurs engage in malinvestments – investments that do not make sense in light of current resource availability, that occur in more temporally remote stages of the capital structure than the pattern of consumer demand can support, and that would not have been made at all if the interest rate had been permitted to tell the truth instead of being toyed with by the Fed.

Not a word about any of that, of course, because Americans might then discover how the great wise men in Washington caused this great debacle. Better to keep scapegoating the mortgage industry or “wildcat capitalism” (as if we actually have a pure free market!).

Speaking about Fannie Mae and Freddie Mac, the president said: “Because these companies were chartered by Congress, many believed they were guaranteed by the federal government. This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk.”

Doesn’t that prove the foolishness of chartering Fannie and Freddie in the first place? Doesn’t that suggest that maybe, just maybe, government may have contributed to this mess? And of course, by bailing out Fannie and Freddie, hasn’t the federal government shown that the “many” who “believed they were guaranteed by the federal government” were in fact correct?

Then come the scare tactics. If we don’t give dictatorial powers to the Treasury Secretary “the stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet.” Left unsaid, naturally, is that with the bailout and all the money and credit that must be produced out of thin air to fund it, the value of your retirement account will drop anyway, because the value of the dollar will suffer a precipitous decline. As for home prices, they are obviously much too high, and supply and demand cannot equilibrate if government insists on propping them up.

It’s the same destructive strategy that government tried during the Great Depression: prop up prices at all costs. The Depression went on for over a decade. On the other hand, when liquidation was allowed to occur in the equally devastating downturn of 1921, the economy recovered within less than a year.

The president also tells us that Senators McCain and Obama will join him at the White House today in order to figure out how to get the bipartisan bailout passed. The two senators would do their country much more good if they stayed on the campaign trail debating who the bigger celebrity is, or whatever it is that occupies their attention these days.

F.A. Hayek won the Nobel Prize for showing how central banks’ manipulation of interest rates creates the boom-bust cycle with which we are sadly familiar. In 1932, in the depths of the Great Depression, he described the foolish policies being pursued in his day – and which are being proposed, just as destructively, in our own:

Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion.

To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection – a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end… It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression.

The only thing we learn from history, I am afraid, is that we do not learn from history.

The very people who have spent the past several years assuring us that the economy is fundamentally sound, and who themselves foolishly cheered the extension of all these novel kinds of mortgages, are the ones who now claim to be the experts who will restore prosperity! Just how spectacularly wrong, how utterly without a clue, does someone have to be before his expert status is called into question?

Oh, and did you notice that the bailout is now being called a “rescue plan”? I guess “bailout” wasn’t sitting too well with the American people.

The very people who with somber faces tell us of their deep concern for the spread of democracy around the world are the ones most insistent on forcing a bill through Congress that the American people overwhelmingly oppose. The very fact that some of you seem to think you’re supposed to have a voice in all this actually seems to annoy them.

I continue to urge you to contact your representatives and give them a piece of your mind. I myself am doing everything I can to promote the correct point of view on the crisis. Be sure also to educate yourselves on these subjects – the Campaign for Liberty blog is an excellent place to start. Read the posts, ask questions in the comment section, and learn.

H.G. Wells once said that civilization was in a race between education and catastrophe. Let us learn the truth and spread it as far and wide as our circumstances allow. For the truth is the greatest weapon we have.

In liberty,

Dr. Ron Paul
for The Daily Reckoning Australia

United States Congressman Ron Paul
Dr. Ron Paul is a Republican member of Congress from Texas and perhaps the only voice in Washington still advocating "limited" government in the Jeffersonian tradition. He delivered several stunning addresses before Congress in the year 2003, including: "Sorry, Mr. Franklin, We Are All Democrats Now" and "We've Been 'Neo-Conned'!".
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Comments

  1. Excellent article. I’m still in amazement that congress and the administration doesn’t understand this and realize what a grave mistake they are making.

    Reply
  2. Including a measure of house price inflation into CPI will allow (for independent rate setters) the opportunity to quell a boom in housing into a dangerous credit boom. For any leader (business or political) that thinks for a minute that more availability of credit will resolve a credit boom then crash, you are an idiot.
    For any foreign investor who can not see that the U.S has no plan, and therebye no intention, of repaying its’ massive debt pile, believe me, they don’t.
    They are hoping that their pile of excess fiscal defication once pushed into the naughty corner, will be inflated away. Expect a crash in the U.S dollar. Expect the association of Oil to the dollar to be dropped, and from there it will devalue into oblivion.

    Reply
  3. Obama has jumped in, both feet, hook, line. and sinker. He wants to borrow a fortune from the Chinese, and they are hesitant – “The Chinese have you by the balls Yankee Doodle, and they eat meat”

    Reply
  4. […] UPDATE 2 [3 Oct]: A great editorial from Ron Paul in The Daily Reckoning. […]

    Reply
  5. Hi,

    Hope this email finds you in good spirits.
    The email below is pretty explanatory. If not, understand NY FED Reserve admitted electronic negotiable instruments are worthless.
    Know what that means?

    Alvie

    Federal Reserve Bank
    New York
    “From: ucclaw-l-bounces@lists.washlaw.edu
    On Behalf Of Joseph.Sommer@ny.frb.org
    Sent: Friday, March 26, 2010 11:15 AM
    To:xxx-xxx-xxx
    Subject: Re: [Ucclaw-l] Electronic PromissoryNotes

    If I were confronted with an “electronic promissory note”, I would walk very slowly
    away and break into a run as soon as I can.
    They are a logical impossibility, along with electronic chattel paper and UCC 7 electronic
    warehouse receipts.
    The word “electronic” is miserably defined in all the statutes. But we all kinda sorta know
    what it means: something in a computer, rather than in some more fixed medium. Of course, a
    computer is made of matter and energy, just like a slip of paper or the side of a cow. So it
    must mean something special to be “in a computer.”
    And it does! Most records are stably associated with a particular agglomeration of matter which–if it is not realty–can be
    physically transferred from one person to another. This includes paper, cows, and DVDs. If the piece of paper or Old Bossy or
    the DVD is uniquely distinguishable from any other piece of paper or cow or DVD that bears the same data structure, we have the basis for a system of negotiability.
    However, computer records are not stably associated with any particular piece of matter.
    Instead, they are stably associated with a system, which contains many pieces of matter amongst which the record may be sitting, at any
    given moment. Or the record could be sitting in 12 places in the system; it makes no difference. You don’t need a unique piece of
    matter to uniquely identify an obligation—there is no unique matter (or energy) associated with the record. You just need an authoritative registry.
    Hence the logical impossibility of an electronic promissory note. “Promissory note” means unique piece of matter. “Electronic” means
    that there is no unique piece of matter, and we’re dealing with authoritative registries.
    UCC 8 gets this right. It has two property systems that rely on unique pieces of matter (registered and unregistered certificates), and
    two systems that rely on authoritative registries (transfer agents and securities intermediaries.)
    The cotton warehouse system gets this right, and talks in great detail about authoritative registries. UCC 7, 9 and UETA screwed up.
    They are bad law—literally incomprehensibly bad law.
    The courts will probably eventually define 7, 9, and UETA into registry systems of some kind.
    But until then, I would treat electronic negotiability systems as if they were rabid cows.”

    Reply

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