If one is to believe the mainstream print media, the current economic crisis is all about a lack of regulation in the financial markets and we need massive government spending to "stimulate" the economy. Keynesian ideas, which have in fact guided US monetary policy for decades, are suddenly receiving a public revival despite the 1970s stagflation debacle, their failure to bring the US out of the Great Depression, and their dramatic failure in turning around the Japanese economy over the last two decades. Indeed, just today (Feb 21) President Obama announced middle class tax "refunds" will quickly find their way into consumer hands so they can "spend" more. He is also planning a massive increase in public works spending while commentators like economist Paul Krugman are suggesting he should augment these totals with 50% more spending yet. And still, the markets, which had recovered slightly in January, continue to drop. If there were any validity to Keynesian thought at all, the US would be beginning the greatest economic revival in history. But it appears instead that we are beginning the long process of turning a housing recession into a full blown depression, with hardly a whisper of alternative analysis. Still, for those with ears to hear, as it were, Thomas Woods offers here an alternative "free market" appraisal of the current economic crisis. However, in doing so he has violated one of the cardinal rules of history by writing a quick analysis of events. As an example of immediate historical anaysis, I think this one is pretty good, but the book does have a few deficiencies.
In brief, Wood's argument is that "conservatives" do in fact share a significant portion of the blame for the present crisis. This is not because, as the cannard goes, they "deregulated" the economy. Indeed, regulatory spending during the Bush presidency went up 65% in real terms, a fact that I am amazed escaped any notice in this book. (See Jan Reason Magazine, "Is Deregulation to Blame?") Nor is it because the Democrats somehow prevented them from providing enough oversight into Fanny Mae and Freddie Mac, two supposedly private companies which would never have existed were it not for their creation by government fiat. The real reason is because they allowed, and even collaborated in, a massive increase in currency inflation under Chairmans Greenspan and Bernacke and refused to heed warning signs about the consequent housing market bubble. Despite Republicans' recent discovery that the Community Reinvestment Act has been used of late to offer loans to people who obviously were not qualified for them, the fact is that "conservatives" have been just as guilty about manipulating markets as liberals have for the last two decades and neither will own up to real problem: our Federal Reserve System does not limit crises like these. It creates them.
In fingering the Fed as the cause of the current crisis, Woods is siding with a long line of dissenting economists popularly known as the Austrian School. These economists argue, in brief, that the boom and bust cycles of free economies (command economies avoid the cycle by remaining in virtually permanent depressions) are due to artificial increases in and contractions of the credit market, usually caused by government manipulation of the money supply. In Austrian theory interest rates are important because they reflect what consumption a person is willing to give up in the present for some future gain. One would not "borrow" to create a new product unless one had a reasonable expectation that the return would be greater than the interest rate. Of course, an entreprenuer could be wrong in her analysis, but the prevailing intrest rate still guides investment in the economy as a whole. Bad investments are quickly liquidated, and capital flows to new opportunities. But if markets are manipulated, say by inflationary policies, it is difficult to know if new investments are really that valuable, or just appear to be. Once money circulates through the economy and prices rise, it becomes obvious which investments were legitimate which were not, but in the meantime, there is a massive misalignment of resources, a problem the market "solves" with a recession.
Austrian theory does a very good job, as it happens, of explaining both the "dot com" bust of 2000 and the housing crisis of 2007-08. But the solutions Austrian theory proposes are politically unpopular, or perhaps more honestly, they are unpopular among the political class. The ideal solution is for government to stay out of the way and let the economy heal itself. Alas, that solution has not been tried since the 1920-21 depression, where it worked wonders in turning around a moribound economy. Instead, government officials like to take action and "do something" (ie. reward their political cronies under the guise of promoting the public good) and so they soak up useful capital for wasteful spending projects (more windmills anyone?) at precisely the time that capital is at a premium even for profitable pursuits. Governments also encourage more consumer spending (saving would do more good) and generally tax healthy businesses to subsidize those that should have been allowed to go bankrupt. Naturally, such policies accerbate the depression, but at least a few individuals benefit from them and government officials can proclaim their "successes" with these public examples. The private suffering their policies provoke are largely unnoticed and rarely connected to these policies.
To make sure that these consequences are brought home to people, Woods examines the two instances in history when Keynesian policies were most thoroughly employed: the Great Depression, and Japan from 1989 to the present. In both cases, Keynesian policies were practiced to the hilt and yet in both instances, the depression lingered on with no "real" success changing the economic crisis. This is because the problem was not with the crisis per se, but rather with the misallocation of resources from the preceding artificial "boom." A steadfast refusal to permit the reallocation of resources will simply prolong the situation, but that is exactly what governments do. There is, of course, a modern myth that the failure of the New Deal to solve the problems of the depression is just a modern right wing fantasy. The reality of course is that the New Dealer's themselves recognized their policies were a failure, and I was pleased to see Woods quote Secretary Henry Morganthau to this effect, "We have tried spending money. We are spending more than we have ever spent before and it does not work..." (p. 149) But just to make sure the point is not missed by naive revisionists like Paul Krugman, who is if anything even more of an embarassment to the Nobel committee than Al Gore, Woods goes on to recount the experience of Japan with their 10 bailouts, decades of 0 interest rates, and a depression that is now worse than our own of the 30s. None of which will make any difference to the true believers. Indeed, Krugman insists Japan should have spent even more, though how much more he cannot specify.
And that leads to the ultimate problem with this otherwise nice little book. It is a rush job hoping to influence a debate that is already pretty much over. People overwhelmingly opposed the first 700 billion dollar bailout and it was voted through with strong bipartisan support. Many opposed the second as well, but it is even larger and already signed into law. Yes, House Republicans suddenly rediscovered their small government principles now that they are such a tiny minority their vote no longer matters. This hardly inspires much confidence in their future probity. But in the meantime, we have years of mismanagement (at best) before us and the likelyhood is decent for a prolonged recession, at the very least. Woods of course provides a few modest suggestions for real change: allow businesses to fail, cut government spending, deregulate, but "change" was never an actual goal of the electorate this last election. Had it been, we would have Ron Paul as President. But in trying to influence a debate that is for the most part over, Woods did not do his thesis the justice it deserves. As I noted at the start of my review, he does not touch upon the massive regulation of the economy under the Bush administration which contributed to this crisis. And he barely mentions the wild misappropriations of the first 700 billion package. How could he? Despite the fact we all knew they were coming (and this latest "stimulus" is probably worse) we are only now finding out the details behind this scandal. Part of the problem with writing history as it happens is that many of the most important details will be left out, either due to haste or necessity.
Thomas Woods is a top notch historian. He is certainly a better writer than the majority of American historians today. But valuable as this book is, it is incomplete. We know the effects of Bush Obama policies will be detrimental to the economy--indeed, they already are. But we do not know how this detriment will play out. Indeed, Americans are probably the preeminent entreprenuers in the world. A new industry in an as yet unrecognized, and hence unregulated, field may develop that will save this economy, much as the internet came in on the heels of federal mismanagement following the Savings and Loan debacle. The resulting wealth creation overwhelmed the government mismanagement that could have lead to a deeper recession or depression. And something similar may yet happen. It is more likely here than in Japan, I would suspect. Careful historians do not have to debase themselves into public pundits like Krugman does. I suspect that in two years time, this good book could have been a great book, explaining (not predicting) either a great depression, or a miracle of American individualism that somehow avoided it, and in either case it would have been a more effective warning against the failed policies of the past than this one, good as it is, could ever hope to be.