Investors Bow Their Heads and Say a Prayer

This week opened with the wail of fire engines. The Europeans announced a bank rescue, variously reported to cost 1.3 trillion euros (Le Monde)...1.7 trillion (Liberation) or 1.873 trillion (Financial Times). They ought to get their story straight. But who cared...investors had a bid!

As the Great Fire burned through their capital, investors bowed their heads and said their prayers: 'Please God, spare me...and I will be happy with what I've got." And lo! A host of smoke jumpers came down from the heavens. Investors turned their faces to the sky and thought they saw angels. And there was the archangels Gordon Brown and Henry Paulson leading the flock. Suddenly, the wind died down...and the fiery furnace calmed. 'Hallelujah,' they said...and bought some more stocks!

In the last 100 years there have only been two fires similar to that of today. The first inferno was in 1929, centered in New York. The second was in 1989, when Tokyo went up in flames. In both instances, rescuers took extraordinary measures. And in both cases, they not only failed to save the economy, they scorched it even more. Obviously, few economists share this analysis with us. The few who do are probably either insolvent or insane, or perhaps both. So, the burden of proof is on us.

We begin by calling an expert witness; Murray Rothbard, once professor at the University of Las Vegas, now among the forgotten dead. A properly-functioning economy is balanced, he explains in his classic, America's Great Depression. One industry enjoys an expansion, another suffers a contraction. But sometimes there is a "cluster of errors" which causes a major boom. Whence cometh these errors? Who is responsible for them? Rothbard identifies the culprit: "monetary intervention in the market, specifically bank credit expansion to business." If Rothbard were still among the quick, he'd probably be pointing his finger at Alan Greenspan - the arsonist who lowered the key U.S. lending rate to an "emergency" level of 1% and held it there long after the emergency was over. With the Fed's false signal before them, business, investors and consumers racked up the biggest pile of tinder in history. Then, he'd probably point at Ben Bernanke, who continues to add kindling...and to Hank Paulson, who led Goldman Sachs while it created trillions of dollars worth of asset-backed explosives and sold it to financial institutions all over the world.

"The boom...is the time when errors are made..." Rothbard continues. "The 'depression' is actually the process by which the economy adjusts to the wastes and errors of the boom... Far from being an evil scourge, [the depression] is the necessary and beneficial return of the economy to normal... Evidently, the longer the boom goes on the more wasteful the errors committed, and the longer and more severe will be the necessary depression readjustment."

But here come the rescuers with yet more dry wood! After stoking the flames with easy credit...they bring more. Professor Rothbard, reviewing the record of the post-'29 rescue team came to this conclusion: The authorities "met the challenge of the Great Depression by acting quickly and decisively...[using] every tool, every device of progressive and 'enlightened' economics, every facet of government planning to combat the depression."

Yet, the fire didn't go out. It intensified. An expected recovery in 1931 went up in smoke, says Rothbard, thanks to government meddling:

"The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy and placed where it properly belongs: at the doors of politicians, bureaucrats and the mass of 'enlightened' economists. And in any other depression, past or future, the story will be the same."

Six decades and half a world away, the Japanese proved him right. In January, 1990, a spark touched off the Nikkei Dow. Soon, Japan's miracle economy was in trouble. Bankruptcies rose. Profits fell. Banks teetered. But the Japanese had their economists too. And soon, they were doing what Hoover and Roosevelt had done before them. As to monetary stimulus, the Bank of Japan's key lending rate was cut from 5% down to "effectively zero." And there were plenty of fiscal stimuli too. Japan's government did just what Keynes recommended - it spent money. It went on a spree of what Alan Booth calls "state sponsored vandalism" in the 1990s, taking the budget deficit to a remarkable 5% of GDP in 2002. Roads to nowhere, concrete shorelines, bridges and dams...Japan, per square mile of available territory, covered 30 times as much surface in concrete as in America. In 1996, the Shumizu Corporation even announced plans to build a hotel on the moon using specially developed techniques fo r making cement on the lunar surface.

Once again, these heroic efforts produced nothing more than farcical consequences. The Japanese economy is still barely on speaking terms with prosperity. And the Nikkei Dow closed at 8,276 last week... a level last seen (except briefly in 2003) a quarter of a century ago.

America's pyromaniacs still have a ways to go. There are 150 basis points between the Fed's current key rate and zero...and the US budget deficit is expected to quadruple - reaching $2 trillion in 2009. In the resulting roast, we predict, even the devil will sweat.

Bill Bonner
for The Daily Reckoning Australia

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