DCRepublican.com

Thu 9 Oct 2008

One year ago today, the Dow Jones Industrial Average (DJIA) reached one of it’s highest points in history, closing at 14,164.53. What a difference one year makes. Today, the DJIA closed at 8,579.13, meaning that over the past year the DJIA has dropped more than 5,500 points (or -39.45%).

It looks even scarier when graphed:

The National Association of Securities Dealers Automated Quotations (NASDAQ) Composite Index is down to 1,645.12 from an almost record high of 2,811.61, which represents a decline of 1,158.79 points, or -41.33%.

To be honest, I’m curious to see what sort of tricks Big Bank Hank (Henry Paulson) and Big Ben Bernanke will pull out to try and create the illusion that the markets will see a quick recovery.

Congress was told that they had to pass the controversial Wall Street Bailout package immediately to prevent financial meltdown. This led to the House and Senate leadership blocking debates and amendments, requiring members of Congress to make a vote that many might regret if the markets stay below 10,000 as Election Day nears.

What’s most interesting to me is how many parallels today’s economy shares with the Great Depression. In the late-1920’s, it was Austrian economists that predicted disaster was coming, but nobody listened. Unfortunately, the same thing seems to be happening today.

Austrian School Explanation of Great Depression (via-Wikipedia.org):

Austrian School explanations

Another explanation comes from the Austrian School of economics. Theorists of the “Austrian School” who wrote about the Depression include Austrian economist Friedrich Hayek and American economist Murray Rothbard, who wrote America’s Great Depression (1963). In their view, the key cause of the Depression was the expansion of the money supply in the 1920s that led to an unsustainable credit-driven boom. In their view, the Federal Reserve, which was created in 1913, shoulders much of the blame.

In opinion, Hayek, writing for the Austrian Institute of Economic Research Report in February 1929 predicted the economic downturn, stating that “the boom will collapse within the next few months.”

Ludwig von Mises also expected this financial catastrophe, and is quoted as stating “A great crash is coming, and I don’t want my name in any way connected with it,” when he turned down an important job at the Kreditanstalt Bank in early 1929.

One reason for the monetary inflation was to help Great Britain, which, in the 1920s, was struggling with its plans to return to the gold standard at pre-war (World War I) parity. Returning to the gold standard at this rate meant that the British economy was facing deflationary pressure. According to Rothbard, the lack of price flexibility in Britain meant that unemployment shot up, and the American government was asked to help. The United States was receiving a net inflow of gold, and inflated further in order to help Britain return to the gold standard. Montagu Norman, head of the Bank of England, had an especially good relationship with Benjamin Strong, the de facto head of the Federal Reserve. Norman pressured the heads of the central banks of France and Germany to inflate as well, but unlike Strong, they refused.Rothbard says American inflation was meant to allow Britain to inflate as well, because under the gold standard, Britain could not inflate on its own.

In the Austrian view it was this inflation of the money supply that led to an unsustainable boom in both asset prices (stocks and bonds) and capital goods. By the time the Fed belatedly tightened in 1928, it was far too late and, in the Austrian view, a depression was inevitable.

The artificial interference in the economy was a disaster prior to the Depression, and government efforts to prop up the economy after the crash of 1929 only made things worse. According to Rothbard, government intervention delayed the market’s adjustment and made the road to complete recovery more difficult.

Furthermore, Rothbard criticizes Milton Friedman’s assertion that the central bank failed to inflate the supply of money. Rothbard asserts that the Federal Reserve bought $1.1 billion of government securities from February to July 1932, raising its total holding to $1.8 billion. Total bank reserves rose by only $212 million, but Rothbard argues that this was because the American populace lost faith in the banking system and began hoarding more cash, a factor quite beyond the control of the Central Bank. The potential for a run on the banks caused local bankers to be more conservative in lending out their reserves, and this, Rothbard argues, was the cause of the Federal Reserve’s inability to inflate.

Of course, there are always some experts who disagree that another “Great Depression” could happen.

One cant help but think of one of William Shakespeare’s most memorable lines from of the The Tempest, “what’s past is prologue” when analyzing this crisis and those who think this is something that you can just throw money at. Today more than ever, this line seems to be extremely fitting.

Regardless of what some “experts” have said, I’m convinced that this is only the beginning.