Tom Woods on the causes of the crisis

For those with the spare time, this is a great and enjoyable lecture by Thomas Woods, explaining the causes of the economic crisis we are in. He rightly places the blame at the policies (and indeed, the existence of) the US Federal Reserve, above all other causes.

He expands on the ideas of the Austrian Theory of the Business Cycle, and quotes Ludwig von Mises analogy of a master builder:

The whole entrepreneurial class is, as it were, in the position of a master builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master builder’s fault was not overinvestment, but an inappropriate employment of the means at his disposal.

It is this malinvestment that the Austrian school argues is the problem. When interest rates are artificially lowered by a central bank, long term projects appear profitable that previously would have appeared unprofitable. However, as the time preference of the population has not changed, and hence the pool of real savings has not increased to fund this, when these projects near completion they discover that they are out of resources.

Interest rates have a crucial role in coordinating investment with time, and in a free market they would accurately represent the time preference of the population. When a central bank artificially changes interest rates this gives false signals to investors and entrepreneurs, since the time preference of the population has not changed.

As Tom Woods explains, there were certainly other factors in creating this crisis, such as the Community Reinvestment Act, Fannie Mae and Freddie Mac, but by themselves they are not a sufficient explanation. I would argue these factors explain why the crisis showed up primarily in the housing market. Previously, such central banks interventions showed up as a stock market boom in the 1920s or a dotcom bubble in the 1990s. Even going all the way the way bank to Tulip Mania we see the impact of an inflated money supply. In each case, it is central banks, and those running them, who are primarily to blame.

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One Response to Tom Woods on the causes of the crisis

  1. Pingback: Political Posting, Inflation and Interest Rates « A Libertarian Journey

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