A pyramid of foolishness

Many of the more sober critics of the US government's bailout package have realised the present economic turmoil is not a failure of capitalism, it's a failure of government, but they've still failed to get their head around the fundamental cause of the crisis, or of the bubble that set it off.

They've talked about Smart Growth and the dictatorship of the planners that locked up land and sent housing prices soaring in the more planned markets, but they haven't realised that it only 'directed' the inflationary bubble into housing; it didn't directly cause the bust.

They've talked about the complications of bundled securities that leave even the organisers of those securities clueless as to what they're really based on -- but they haven't understood that this was just a way bankers chose to deal with the flood of easy credit coming down the pike'; and they haven't yet understood that it was the flood of easy credit that was the primary problem.

They've talked about Jimmy Carter's Community Reinvestment Act and "community organisers" like Barack Obama who pushed indigent non-payers into sub-prime 'first-home,' 'easy credit,' 'low-doc' loans, without realising that without the flood of government credit, the number of sub-prime loans being made would have dried up like a pub without beer.

They've talked about Fannie and Freddie, which since 1938 (in the case of Fannie) have been accidents waiting to happen, but they've failed to notice that up until the latest blow out the accidents have only been small.

Each of the proponents of these points is correct in their analysis, at least as far as they go, but in ignoring all the other factors involved they don't go far enough, and in ignoring the more fundamental explanation -- that we've been floating a sea of counterfeit capital fed by a spigot of paper money, and jacked up by a fractional reserve banking system that "leverages" those paper dollars to turn the flood of paper into a tsunami, and every dozen years or so when the spigot is eventually turned off, we see another crisis -- the bubble blows out the same every time, it just blows out in different places.

As Hans Sennholz points out, the fundamental cause of the problem goes back several decades, nearly a century, all the way back to 1913, and the creation in the United States of "the Federal Reserve System," which was never anything but "a creature of politics." 

    It sprang from the most revolutionary single piece of legislation in American currency and banking history, the Federal Reserve Act of 1913.  It meant to improve the earlier financial system created by the National Banking Act of 1863 which placed the federal government in the very center of American money and banking.  Both Acts were designed to reform the market order which was deemed to be unstable and unresponsive to the needs of the federal government and the national economy. 
    Actually, they constituted early steps toward a hybrid fiat system which in time spread to all corners of the world.  It is neither a command system in the manner of radical socialism nor a market order on a gold standard; it probably is the most unstable financial system conceivable which no human being, no matter how brilliant and distinguished, could manage satisfactorily.
    The American money and credit system now resembles an inverted pyramid that rests on legal-tender Federal Reserve notes and credit.  These support various forms of bank money such as commercial bank deposits, savings accounts, large time deposits, and other liquid assets.  The base of some $672 billion may expand rather moderately, presently at some 6 percent a year or $40 billion; the layered superstructure of $8.333 trillion bank money (M3) may grow at a similar rate or $529 billion (as of 10/23/2002).  Commercial banks tend to "securitize" their loans, converting them into marketable securities for sale to investors which enables them to grant new loans in a continuing process of lending, securitizing, selling, and lending again. 
    Massive non-bank credit constitutes the upper layers of the money pyramid; there are Federal Home Loan Banks, thrift institutions, life insurance companies, brokerage firms, mutual funds and other credit grantors.  Last but not least, offshore banks in the Bahamas, the Cayman Islands, Panama, Hong Kong, and Singapore, enjoying favorable regulatory and tax treatment, provide the top layer of the multitrillion dollar money pyramid.  And high above the American pyramid hovers the international pyramid which builds on the U.S. dollar standard. 
    The Chairman and his fellow governors are expected to balance it all with their high-powered Federal-Reserve-dollar base.  They are expected not only to manage this monstrous pyramid of fiat money and fiduciary credit but also to safeguard the stability of the American economy, to maintain asset prices, protect the value of the dollar, and avoid the business cycle.  They are supposed to manage a monstrous structure which politicians built for their own use and glory.  That's too much to ask of any mortal.

You see, even if they had a clue, it would still be impossible.