The Best of Both Worlds?

Recently my web-based principles of economics class completed its work. The final weekly online conference was on Federal Reserve monetary policy. The class collectively was quite approving of Fed policy and performance. Most believed in the hypothesis that the Fed was responsible for our long-running economic prosperity and that the Fed could keep prosperity going indefinitely. Most believed that Fed had done a good job in controlling inflation. In short they believed, through its wisdom, the Fed had achieved the best of both worlds – low inflation and prosperity.

This collective optimism was in spite of the fact that the class was assigned to read material that argued that Fed policy was partially responsible for the housing bubble and that the consequences of the housing bubble would eventually cause serious problems in the economy. This collective optimism was in spite of a huge federal debt that only mirrored the absence of savings among households.

None of my observations are meant to be critical of my class. My class was just reflecting the current optimism of the larger cohort to which they belong. My class was an MBA class; in general, professionals are doing quite well in today’s economy.

The optimism of this web class has coincided, not so coincidentally, with all-time highs in the stock indices and the longest bull-run in the Dow Jones index in over 80 years. Given that, it shouldn’t be surprising that my MBA class is feeling quite optimistic.

Robert Prechter has observed, “It is nearly impossible to find a treatise on macroeconomics today, that does not assert or assume that the Federal Reserve Board has learned to control both our money and our economy. Many believe that it also possesses immense power to manipulate the stock market.”

Now the truth is of course, human beings never have the power to control what is essentially uncontrollable. Even a cursory study of economic history shows that economic cycles are part of life. These cycles tend to coincide, Robert Prechter argues, with the ebb and flow of collective optimism and pessimism. Peaks in the stock market tend to coincide with the peaks in optimism. When optimism is at its peak, the belief that human beings can control what is inherently uncontrollable is also at its peak. It is only in a bear market, when human beings are collectively pessimistic, that people lose their belief in the power of human beings to control what is essentially uncontrollable. At that point they tend to lash out with recriminations and blame.

Long ago, economist Ludwig Von Mises pointed out that bank credit expansion orchestrated by the Fed leads to what Von Mises called malinvestment. Ultimately malinvestment has to be liquidated. Further credit expansion can only postpone – but not prevent – the liquidation stage of the business cycle. In other words, Fed credit expansion led to the manic run-up in housing prices and has only postponed – but can not eliminate – the liquidation stage of the business cycle.

Von Mises has written that, “There is no means of avoiding the final collapse of a boom brought about by credit expansion.” To human beings who are blinded by the collective arrogance that comes from believing that they can control the uncontrollable, Von Mises’ statement may seem like narrow-minded folly.

When this economic cycle turns, the blame and recriminations will be enormous. Many believe that they are living a life-style has been well-earned and well-deserved. In some cases it has been, but in many cases it has been financed by a mountain of debt and subsidies. This won’t stop the blame. The blame will be absurd for, as has been observed, “blame is the act of accusing the mirror for the content of the reflection.”

In other words, the hubris of politicians and Fed chairmen is only a reflection of our own hubris. As a society we have collectively spent beyond our means and have had the arrogance to believe that there will never be any consequences.  For now we continue to live under the illusion that the “best of both worlds” can continue indefinitely.

 

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2 Responses to The Best of Both Worlds?

  1. Melissa says:

    You speak such truth. Arrogance is the perfect word to describe this feeling everyone has that they “deserve” to make 15% profit over last year on their house. There are so many responsible in this game – the Fed, the lenders, the realtors, right down to the consumers. I remember when I bought my condo, I wrote a full price offer. They had no other offers and yet, they had the nerve to ask me to escalate $10,000 to “prove I want it.” I told them to get lost. Well, I told them to get lost using the “F” word, which my agent didn’t transcribe exactly. My point was: I don’t believe in escalation, but I REALLY don’t believe in bidding against myself, I would be an idiot to do this. I walked away, and they ended up coming back at me and accepting the offer anyway. The guy was making $200,000 in 4 years time, how could he even ask for another $10,000? Everyone is at fault here.

  2. Barry Brownstein says:

    Melissa,

    I hope I am wrong. Even those, such as yourself, who didn’t play the game will feel the effects when this mountain of debt is liquidated. The entitlement belief that you describe has corroded our prosperity. Brian Tracy’s recent book on the subject, “Something For Nothing” is excellent.

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