Sunday, October 12, 2008


From Paolo's blog
I saw an interview on CNN the other day, in which the reporter asked <he who must not be named> what he would do, RIGHT NOW, this split second, to get us out of "the Crisis." <he who must not be named> began to respond that before you proposed solutions to a problem, you have to understand what caused the problem. He began to patiently explain how government creation of money and cheap credit caused the problem, but the reporter cut him off. Again, the reporter insisted he offer solutions for the problem RIGHT NOW, without explaining the cause of the problem.

This, I submit, is the problem. Until people are willing to invest a little time in understanding economics, they will always be vulnerable to this charade of lurching from false prosperity to crisis. Economics is really not difficult to understand, at the fundamental level; <he who must not be named>'s favorite school of economics, called the Austrian School, is loaded with Nobel Prize winners and features plenty of thick books filled with difficult prose. But at root, the basic principles are not difficult to understand.

A few sentences are all that is required to explain the roots of the current crisis. The government, trying to give the illusion of prosperity, has inflated the money supply. The excess money goes to buying all sorts of products. Producers, seeing their inventories go down, order an increase in production. Financial markets, seeing the increased production and increased sales (in terms of cheap dollars), decide to invest in these companies. New companies, in this environment, spring into being in the form of Initial Public Offerings (IPO's).

No matter where investors put their money, they seem to win. Companies with no track record rise in value, on paper. Large investment firms begin to direct ever-larger amounts of (cheap) cash into whatever makes money, which is just about everything. Housing and stocks, which seem always to go up in price, get the most investment.

This, ladies and gentlemen, is known as a "bubble."

But a bubble can only go on for so long. Because so much phony money and credit has been pumped into the system, prices begin to rise as more and more money chases the same goods. Those who don't earn enough to invest huge amounts in the bubble are particularly hurt as prices of everything start to rise. Eventually, the economy reaches a point where either you let the bubble burst, liquidating bad investments, and allowing prices to plummet, or you keep pumping in more money in a frantic attempt to keep prices high.

The latter is the approach of both major parties. If enough money is pumped into the markets, you can keep the drunken orgy going a little bit longer. During this time, prices will begin to rise even more precipitously. Food prices will double. Gas prices will triple. Soon, the entire lower and middle classes will find it difficult just to buy groceries and fill their gas tanks. They will begin to scream for Washington to DO SOMETHING!


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