I started to write a brief overview of the causes and possible solutions of our current economic crisis. In doing so I've become increasingly convinced that the real problem is ignorance. Ignorance of the teachings of people like Ludwig Von Mises and the "Austrian School" of economics has allowed the public to be confused by the misguided ideas of government officials.

For most of two generations, economists have been trained in a faulty theory of general economics and the business cycle. As a result, there are legions of Ph.D.s and a good smattering of Nobel Prize winners in economics who lack a fundamental understanding of the issues they claim expertise in. This is the result of the economic heresies of John Maynard Keynes and of various government and media sources promoting his ideas. The statement "A Nobel Prize winning economist is an expert who we should believe" represents a kind of fallacy of logic called an "appeal to authority". This means the statement is accepted based on the credentials of the person postulating it rather than on its own merits. Since World War II, economics departments at colleges and universities have been taken over by disciples of Keynes. This Keynesian view of economics is anathema to economics as a discipline of scientific inquiry. Imagine if universities exchanged their astronomy departments for astrology departments... now you have an idea as to what has happened in economics. In the Keynesian world, two plus two can equal five if the government says so. The positive view of government intervention in the markets postulated by Keynesianism has moved forward through the university system at the same time that higher education has become increasingly dependent on government handouts. No surprise there. In the real world, two plus two will always equal four no matter how many Ph.D.s claim otherwise.

As a result of acceptance of Keynesian confusion in economics, our central bank (the Federal Reserve System) was allowed to go on a massive credit expansion earlier in the decade. Discount rates were lowered from over 5 percent to under 2 percent and kept there for several years. The price of gold, which had remained stable at around $300 per ounce for over twenty years, rose to over $800. This fed an inflationary bubble that exhibited itself primarily in the housing market. Those who understand the business cycle as described by Von Mises and his followers know this to be a dangerous and harmful event, leading inevitably to a liquidation of the bad investments it has caused. Indeed, the United States entered a recessionary phase in late 2007. This was predictable. Unfortunately partisan politics and irrational fears have undermined the ability of government leaders to effectively deal with the advent of this liquidation phase.

A big part of the problem arose from the poor fiscal record of the Bush Administration and Republican Congress during the first years of this decade. Federal spending rose more quickly than at any time since the days of Lyndon Johnson under the auspices of this supposedly more fiscally conservative party. Government spending is the other devil, along with bank credit expansions, that undermine the economic vitality of a nation. Austrian economics explains this problem in simple terms. Government spending comes at the expense of private spending. The factors of production are finite at any given point in time. When government gathers them up they are not available to the private sector economy. Government spending is all consumption and waste. The more the government spends the more a nation's ratio between current consumption and savings is distorted in favor of current consumption. Savings fund the capitalization and growth of business and industry as well as the creation of long term durable goods such as housing. A reduction in the national savings rate leads to a slowing of the growth in the standard of living. Keynesians don't see things this way and argue for more government spending or for more consumer spending to cure recessions. As with their support of bank credit expansionism they have misunderstood fundamental concepts of economics and by their enormous influence in public policy brought us to the brink of real trouble.

When the crises became manifest the Republicans made political capital over the past Democrat support for policies furthering lending to low income people to buy housing. Groups such as ACORN were blamed for the crises in mortgage financing that brought down the financial markets. Democrats had their own partisan explanations blaming "deregulation" and the greed of the unregulated free market. Neither explanation explains the crises. The crises could not have happened without the bank credit expansion that resulted from Federal Reserve policy. Cheap money was the fuel for the bubble and crash. To the extent other explanations were contributory factors they were only contributory in the direction the bubble took and not to its inevitability or magnitude. Put another way if none of the factors blamed by Republicans and Democrats had existed (i.e. no change in regulations, no subprime loans), we would have had a bubble and crash anyway, just in a differing way. Without the bank credit expansion the real sluggishness of the economy throughout the Bush years due to the excessive rise in federal spending would have been seen. Instead the bank credit expansion masked as well as exacerbated the fundamental problems and allowed them to fester until a genuine crises occurred.

Keynesian ideas now hold sway in Washington in terms of how government should respond to the crises. This portends disaster. The correct response to the credit crises is to cut government spending and taxing in relation to the reduced economy. Government spending is always a drag on the economy. However, what is being discussed are a massive government infrastructure spending plan and more credit expansion from the Federal Reserve System. Keynesians support government spending increases by arguing that the factors of production are being under used by the private sector. They believe that the government needs to step and spend to put unused labor and capital to work. Then, they continue, the purchasing power of the now employed workers will drive consumer spending up and create a recovery. This is false. The recovery will occur if the costs of labor and capital are allowed to fall on their own in response to the reduced demand caused by the liquidation of bad investments. The lowering of these costs will allow for new growth with a stronger financial basis than growth fueled by the illusion of profits generated by more credit expansions. Increasing government spending will make the economy less efficient and retard, not stimulate, the purchasing power of consumers. This is because the inefficient and wasteful use of resources by government will impede the creation of more goods and services people want and need. The only positive note here is the large number of Republicans in Congress who voted against the bailout policy in opposition to the Bush Administration. This is a sign that at least some Republicans may now understand that being a fiscal conservative requires more than simply voting for various tax cuts.

The policies being advocated by the Keynesians now were attempted during the Hoover Administration in response to the 1929 stock market crash. They had predictable results then as the economy, instead of having a brief recession and turn around, collapsed into an abyss from which it did not begin to recover until after World War II. The purchasing power argument was one of President Hoover's favorites. It was behind his disastrous policy to hold up hourly wages during the 1929 to 1932 contraction. The result of this wrongheaded policy was unemployment that passed 20 percent by 1932. Any economics teacher should be able to explain why. Supply and demand apply to the labor market just as to every other section of the economy. When you attempt to hold up sale prices in response to falling demand your sales plummet. The same is true with wages in a recession.

Economics is a science. It is not Republican. It is not Democrat. It is a discipline of rational inquiry that everyone should respect. I've never claimed to be an authority in the many complex issues presented. However, compared to what I see every day in the headlines I'm a regular Einstein!

-GIR-

Tracy Ryan is a past Chair of the Libertarian Party of Hawaii and was their candidate for Governor in 2002. Active in the community, she has also been involved with issues as diverse as fighting the van cams and the reform of drug and prostitution laws. She has also served on the Makiki Neighborhood Board.