BOOK REVIEW: Thomas Woods' Meltdown
Well before the "Financial Crisis of 2008" there was a prominent, but largely ignored group of Austrian School economic thinkers who were warning of difficult times ahead. To some, including this writer, the economic problems of the past and present are and were the expected result of Austrian malinvestment whereby limited capital flowed into non-economic concepts that our federal masters championed.
Thomas Woods' essential book, Meltdown, is the best yet when it comes to describing how this occurred.
It should first be stressed that this is not a partisan book. The recessionary rush to property was most certainly authored by both political parties, and neither Party escapes Woods' brilliant critique.
At the same time, for those who've long suffered the often bipartisan suggestion that our problems resulted from too little government regulation, Woods happily eviscerates this absurd line of thinking. As Woods puts it, the "current crisis was caused not by the free market but by the government's intervention in the market."
And for those who remain skeptical, Woods reminds us that at best, the notion that more regulation would have saved us from much worse down the line misses the point. As Woods notes early on, "lenders were doing exactly what the federal government and its central bank wanted them to do."
One can only hope that Woods' book achieves a wider audience with the above in mind. If not, the U.S. economy will continue to be weighed down by solutions authored by the very government that created the crisis. As Woods puts it, "government failure is being used to justify further increases in government power."
Worse, government activity has "diverted attention to the patient's runny nose and away from his cancer." So true, and so scary considering commentary in and out of government which decries the symptoms, while turning a blind eye to the much greater problem that concerns a government and political class unwilling to let the economy heal itself.
The Federal Reserve is the logical victim of the greatest criticism in Woods' account, and most fun is his simple, but widely misunderstood point that the "Fed has no real resources to inject into the economy. Credit has to derive from real saved resources." Very true, but largely ignored by an economic commentariat eager to ascribe magical powers to a very fallible central-banking establishment.
To state what isn't but should be obvious, the Fed cannot create economic growth despite its naïve attempts since its founding to do just that. Woods specifically cites the Fed's decision to lower the cash rate to 1% in 2003 as a major driver of our ills. There's disagreement there, but disagreements will be covered later on.
Beyond the Fed, Woods masterfully simplifies the doings of Fannie Mae and Freddie Mac, while noting the contradictions inherent in both. By 2008 the politically protected GSEs had a hand in half of all U.S. mortgages, and even though they were created to make housing affordable, Fannie, Freddie and their enablers in Washington did everything they could to keep housing expensive, rather than allow market forces to adjust prices downward. Adam Smith has doubtless been spinning for years now, not to mention that the politically correct fealty to home ownership turns his essential logic about capital formation on its head.
Considering the alleged housing bust, Woods makes plain what the media have largely missed, that the mortgage defaults did not result from a collapse in home prices; rather they began when median prices declined slightly, 1.4% in 2006, 23% since. Hardly cause for worry, particularly when we consider the much bigger declines in the prices of stocks that no one can live in. But housing is protected in Washington, and once the defaults began, vain politicians found a purpose.
Not surprisingly, government intervention made things much worse. Most prominent here were government attempts to cushion the mistakes of borrowers. Though this was not limited to Fannie and Freddie (remember Henry Paulson's attempts to get lenders to "voluntarily" reduce the cost of mortgages, along with the Senate's talk of "mortgage cramdowns"?), both offered assistance to delinquent borrowers once the defaults picked up speed.
Not commented on enough amid this intervention was that Fannie and Freddie's actions created the incentive among the solvent and insolvent to be delinquent on their loans. Is it any surprise that markets for packaged loans suddenly froze?
Some of Woods' best commentary centers on the bailouts of the banks and car companies alike. Back then, those with the temerity to suggest that it was a bad idea to save failed institutions with taxpayer dollars were referred to as "ankle-biters", and generally dismissed as unserious cranks. As Woods put it, "respectable opinion" on the right and left largely favored the bailouts; free markets be damned.
Happily, Woods crushes the bailout illogic which has done the economy so much harm. Indeed, as he so articulately points out, bankruptcy does not mean that businesses disappear. Instead, it means that capitalism is working, and poorly run businesses will soon have better owners.
More broadly, Woods makes the important point that if a corporation has four profitable lines of business, and two that are unprofitable, it's a good idea to let the failed ones go under. Economies grow when bad ideas are allowed to die, and they stagnate when they're propped up. Government intervention has disallowed the re-orientation of capital to what is economic, and the resulting pain has been very real. Notably, the Dow Jones Industrial Average stood at 10,482 the day TARP was passed, but fell all the way to 9,000 a week later.
The logical response to all of this is that had banks been allowed to fail, their decline would have taken the rest of the economy with it. Woods quickly destroys this thinking, however, in pointing out that by 2008 80% of all corporate lending occurred outside the traditional banking system, not to mention that amid the panic in October of 2008, there was no decline in business/consumer loans.
To put it very simply, bank failures in the 1930s could not have caused the Great Depression, and much the same, failures in modern times wouldn't have given us a major recession. As Woods so helpfully points out, economic hardship in the ‘30s was caused by government intervention, and if we're not careful, we'll repeat history.
Throughout, Meltdown mocks the thinking of Presidents Bush and Obama who looked for advice on how to "fix" the economy from the very "dopes who didn't see the crisis coming." So true, and within the book there are some excellent quotes from Bernanke and Paulson showing how very optimistic they were right up to the point that the crack-up began. This should be required reading for the dopes we suffer in and out of Washington today who think that if we just apply their regulatory solutions to finance, all will be well. Financial commentators and the politicians they enable are the picture definition of hubris, along with naivete.
Best of all for me was Woods' essential point that far from recessions causing damage, they are in truth an economic good for fixing past mistakes. Indeed, the actual "damage is done during the boom phase, the period of false prosperity that precedes the bust." This argument is rarely made, but it's essential.
The rush to property in the decade just passed was the recession, and the correction of the rush was our economic salvation if only Washington had gotten out of the way. More simply, the bank failures were a sign the economy was on the mend, while the government's interventionist efforts were the crisis for non-economic concepts not being allowed to die. Commentators on the left and right clamored for government measures that would force banks to free up lending during the "crisis", but as Woods so rightly puts it, "we should want credit to freeze up during a recession" as a way of minimizing capital destruction.
As with all books, there were disagreements. Early on Woods argued that Austrian School thinkers saw the "crisis" coming, but this seemed contradictory. Prime and subprime loans began to falter in 2006, yet the stock markets continued to rise. In that sense it should be said that the Austrians saw the recessionary mistakes, but only government intervention to fix the mistakes could have caused what we now deem the crisis.
Like many commentators, Woods attributes the property boom to low rates set by the Fed, most notably the year (2003) in which it kept the Fed funds rate at 1%. This is a popular thought, one widely held by the commentariat, but it ignores basic history. There are many examples to point to, but property skyrocketed in 1970s England and the U.S. despite nosebleed interest rates. A gold-defined dollar achieves prominent mention in Meltdown, but its rise amid the dollar's decline is not properly fingered as the cause of the frothy property markets. They occur wherever currencies decline versus gold, and a major reason housing still hasn't corrected has to do with a dollar which continues to test all-time lows in gold terms.
One reason gold's rise this century goes unmentioned has to do with how Woods defines inflation. He sees it as a rise in the supply of money specifically, not a decline in the dollar versus gold. To him, the late ‘90s were inflationary times given a 52% increase in the money supply, yet the dollar crushed gold along with all paper currencies during that period. To Woods, the 1920s were inflationary also, despite commodity declines then too; commodity movements the best market-based signals of monetary error. The Roaring ‘20s, if he's to be believed, did not result from tax cuts (not mentioned, nor was Smoot-Hawley which caused the 1929 crash), but instead resulted from allegedly easy money.
The problem here is that money supply is not a very good predictor of much at all. Sure enough, when individuals are productive, their "demand" for money increases. Money supply grew in the ‘20s and ‘90s precisely because Americans were enormously productive. Productivity is money demand, and aggregates increase when production does. Looking at the ‘70s and ‘80s alone, the Fed's monetary base grew the same in both decades, but only in the ‘70s did the dollar collapse.
As a senior fellow at the Ludwig von Mises Institute, Woods doubtless knows his thinking better than most, but when it came to money supply, in The Theory of Money and Credit, von Mises was pretty clear that government meddling with the supply of money was "as unnecessary and inappropriate as, say, intervention to ensure a sufficiency of corn or iron or the like." The Austrian School teaches us so much about the free markets, as have monetarists similarly in thrall to the Ms, but the mystery to this writer is how both schools can so properly elevate free markets only to presume with confidence what is too much or too little money.
This could be a misread, but von Mises wasn't so much concerned with money supply as Woods is, but instead felt the quality of money was most important, and specifically that ideal money would have "an invariable exchange value." The purpose of money to von Mises was solely as a medium of exchange, at which point supply wouldn't matter, while stable money prices would. Woods seemingly disagrees, noting that the supply of money should be fixed to the gold stock (not defined in terms of gold's market price as this writer would like), and as "output increases, the monetary unit simply gains in purchasing power."
To me, this retards money's essential function as measuring rod of exchange, plus it would quickly wreck the debtor/creditor relationship as debtors would owe dollars substantially more valuable than those borrowed. As von Mises observed about inflation, "one cannot repair" its evil "by bringing about a deflation."
Considering rates once again, von Mises was clear, as was Henry Hazlitt, and Woods to a high degree, that just because the Fed sets rates low does not mean credit is plentiful. Usually the opposite occurs whereby savers disappear thanks to rate controls reducing their compensation for saving.
In that case, it's hard to once again countenance his view that low rates drove the housing boom. Instead, low rates made capital scarce, but with the weak dollar driving up commoditized assets (von Mises referred to this as a "flight to the real"), housing thrived in nominal terms thanks to the weak dollar enhancing the money price of commodity-like assets. In that sense there was no boom to speak of this decade, and Woods does allude to this. Instead, a reduced capital base thanks to low rates found its way to assets least vulnerable to the dollar's debasement. Importantly, and as 1970s England and the U.S. again make plain, currencies are historically more likely to lose value against gold when central bank rates are high, as opposed to low.
Considering the bank failures, Woods correctly notes once again that they should have been allowed to fail. At the same time, he attributes to some degree their reckless nature to their being "too big to fail." To me, this is backwards. The bailouts most definitely should not have occurred, but at the same time, the executives and shareholders of banks thought too big to fail most definitely saw a lot of their equity wiped out, thus raising the question of whether their recklessness was rewarded.
Not really. More realistically, we should say that depositors (Woods surely makes this point), creditors and those with exposure to the banks too big to fail represented and still represent true moral hazard. It should be noted here that Woods' solution here is very easy and elegant, and requires no federal involvement: his answer is to "Let them go bankrupt." Amen.
Other solutions include abolishing Fannie and Freddie, an act that would be dreamy for our economy given how much capital is re-oriented into the ground thanks to the government's politically correct worship of home ownership. Woods would like the Fed's role to be debated, and that can't occur soon enough. The ending of the government's monopoly on money would be another positive step that he supports. Indeed, anything the government can do, the private sector can surely do better. Why do we leave the most important economic function of all - money - to the federal government?
Ultimately, it can't be stressed enough that Thomas Woods has written a highly readable, easy to understand, and all too essential book. Still, there remains to be written a book that makes plain as Woods does that the Fed is destructive at worst, superfluous at best, but that also acknowledges that there's a reason Fed officials rarely comment on the dollar's value, and the reason has to do with the dollar being the preserve of the U.S. Treasury.
Treasury's policy of dollar weakness this decade was the major factor in the recessionary rush to housing, but its role continues to go unmentioned. Woods' book is a must read for sure, and the best I've read, but the ultimate "crisis" book will properly finger the U.S. Treasury's dollar policies as the unsung, but largest factor. That book has yet to be written.
