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The Continuing Economic Depression, Part 2

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Contrary to popular belief, economic downturns in a free-market economy do not linger or continue for many years. The Great Depression was “great” because government policies made sure that the calamity became ingrained in American life for a decade. One can only hope that the present economic difficulties in the United States will not turn into a decade of high unemployment and lost opportunities.

A continuing depression is not necessary, and had Washington’s policymakers actually done the right thing when housing markets began to tank in 2007, the economy would already be in a recovery. Instead, we are likely to be looking at years of a moribund economy.

When the nation’s financial houses went into a tailspin, President Bush remarked, “Wall Street got drunk.” While he was correct, he made a couple of important mistakes. First, he failed to point out that the Federal Reserve System was the main supplier of the financial “booze,” and, second, he decided that the best way to get Wall Street sober again was to reopen the liquor cabinet.

It is hard to know what Bush was thinking but the long-term results of the Wall Street bailout were disastrous. No, that is not what the pundits will say. Instead, they point to the quick payback of the government loans as “proof” that Washington did the wise and prudent thing.

Unfortunately, we are dealing with paper figures, hidden under a blizzard of more Washington-created paper. The notion was that Washington would bail out the banks this one time and then ramp up the regulations in order to keep Wall Street from misbehaving. As usual, there is another account.

First, and most important, not everyone on Wall Street and in financial houses elsewhere “drank the Kool-Aid.” By propping up the bad investments, the government also managed to overshadow those firms that had made sound decisions. In effect, the government put foolishness on a par with wisdom. (Anyone familiar with the ways of Washington cannot be shocked at such a state of affairs.)

The free-market system is one of both profits and losses, and losses send signals to producers that they need to pursue other lines of production or change the way they are doing things. However, when government forces taxpayers to paper over the losses with what is essentially printed money, those signals become meaningless, as the political system overwhelms them and turns economic logic upside down.

The problems are more than symbolic. Capital in a free market moves to its highest-valued uses, and when government intervenes to direct capital to places where it is less-valued, the economy suffers. Furthermore, economic recoveries following financial crises occur only when the malinvested capital has been liquidated or directed to more profitable uses — that is, where consumers trading freely want them to go.

Repeating errors

Unfortunately, the Bush administration, and then later the Obama administration, had other ideas. Instead of permitting resources to go where they were most highly valued, Washington decided to flood the world with dollars, courtesy of the Federal Reserve System. According to Fed Chairman Ben Bernanke, who claims to be a student of the Great Depression, the cause of the downturn 80 years ago was the lack of a response from the central bank to the aftermath of the 1929 stock-market crash.

Bernanke has said many times that he does not wish to “repeat the mistakes” of the 1930s. Because he is not a good student of economic history, however, he has managed not only to repeat those policy errors, but also to claim that if it were not for the Fed’s interventions the U.S. economy really would be in the tank.

In truth, the economy is tanking precisely because of Bernanke’s strategy — the very strategy that he and his legion of supporters claim has “pulled the economy from the brink of depression.” Because Bernanke’s Fed has intervened in numerous ways, from providing the “backstop” for the bailouts to buying stocks in private firms (such as AIG) and also propping up central banks in Europe, he has been spreading dollars all over the world in the belief that a shower of paper money can save the day.

By doing so, he not only rewards those who made bad investment decisions — investments that still must be liquidated if the economy is to have a true recovery — he also punishes people who did not go down the path of malinvestment. That is something that is overlooked both in the general media and in the financial media: few journalists (and, for that matter, few mainstream economists) can understand the opportunity costs involved because they concentrate on what is seen, not what is unseen (to paraphrase the great Frédéric Bastiat).

Yet in order to understand what is needed to end this economic debacle, we have to understand that difference between the seen and unseen. Furthermore, we have to understand fully that no genuine economic recovery has ever been built on a blizzard of new paper money.

First, if there is to be a real recovery, the government and its central bank must stop encouraging the massive malinvestments that currently are blocking economic growth. That means an end to attempts to reflate the housing market, an end to bailouts, an end to propping up banks that are teetering on insolvency, and an end to the numerous “stimulus” projects that politicians claim will bring back prosperity.

Second, the administration needs to end its delusions about the efficacy of “green jobs” and “high-speed rail,” as though it is possible for a government to subsidize an economy into prosperity. A prosperous economy also has opportunities for real profit, and the Obama playthings of “high-speed rail” and “green jobs” stay alive only by cannibalizing those entities that are profitable.

As I noted earlier, entrepreneurs make profits by directing resources from lower-valued to higher-valued uses, as determined ultimately by consumers. By forcing subsidized ventures upon the economy, Obama is directing resources from higher-valued to lower-valued uses, which means that real economic opportunities are lost. There is no way around this simple fact, and no amount of political rhetoric can change the immutable laws of economics.

Yet, if this economy is to have a real recovery, as opposed to a repeat of recession, inflationary “recoveries,” and then recession again, the government must stop trying to impose political “solutions” on the U.S. economy. In the short run, that will mean that the malinvestments pushed by the Obama administration, from electricity-producing windmills to “Government Motors,” either will go out of business altogether or will have to be revamped in order to remain economically afloat.

In the long run, the U.S. economy will have a chance to grow — and continue to grow. If those who govern us continue on the current path, however, fate will not be kind. There is a way out — but it is the way of free markets, free prices, and private property as well as the end of heavy-handed government interventionism.

Part 1 | Part 2

This article originally appeared in the June 2011 edition of Freedom Daily.

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    William L. Anderson teaches economics at Frostburg State University in Maryland.