Clusterstock Book Club: Did The Fed Cause The Recession?

Historian Tom Woods has an important new book out titled Meltdown. It’s the first book we’ve seen that takes the perspective of Austrian economics and applies it to the current crisis.  It has already hit the New York Times best seller list.

We decided we wanted to make Meltdown be the first book we read as part of our Clusterstock book club.* Today and tomorrow we’ll run excerpts from the book. Our first introduces the basic concept of how the Fed creates the boom-bust business cycle.

Since the fall of 2008, as the stock market plummeted, companies folded, and economic fear and uncertainty began to spread, Americans have been bombarded with a predictable and relentless refrain: the free-market economy has failed.

The government’s course of action in the face of the sinking economy has been just as predictable. First, government officials misdiagnosed the problem, exonerating themselves of any blame and pinpointing various bogeymen instead. For guidance, they turned to studying the causes and cures of the Great Depression—which they of course got all wrong. Then they drew an analogy between (their misinterpretation of) the current situation and (their misinterpretation of) the Great Depression.

Next, Americans were told that in order to prevent another Great Depression, the government had no choice but to implement the same policies that failed to lift the country out of the actual Great Depression. Finally, it was time for our wise rulers to set about making things worse, beginning with (but not confining themselves to) a massive and unprecedented string of bailouts. Depressed economic conditions will thereby persist longer than they would have if the market had been allowed to function.

Almost nobody in Washington, and precious few elsewhere, has been willing to question the greatest single government intervention in the economy, and the institution whose fingerprints are all over our current mess: America’s central bank, the Federal Reserve System. The Fed is hardly ever mentioned in connection with the crisis, except perhaps as our saviour . Major newspapers, magazines, and websites purport to dissect the crisis and identify its causes without mentioning the Fed at all. That’s nothing new: there has been no serious discussion of the Federal Reserve in public life for the nearly one hundred years since its creation. The Fed is a wonderful thing, and that’s that.

The Fed’s policy of intervening in the economy to push interest rates lower than the market would have set them was the single greatest contributor to the crisis that continues to unfold before us. Making cheap credit available for the asking does encourage excessive leverage, speculation, and indebtedness. Manipulating interest rates and thereby misleading investors about real economic conditions does in fact misdirect capital into unsustainable lines of production and discombobulate the market.

Imagine that.

As we’ll see, the Fed’s intervention into the economy can give rise to the boom-bust cycle, making us feel prosperous until we suffer the inevitable crash. The free market is inevitably blamed for that crash. No one even thinks to point the finger at Washington and the Fed. And that is part of what makes it so insidious. These artificial booms, wrote economist Henry Hazlitt decades ago, must end “in a crisis and a slump, and . . . worse than the slump itself may be the public delusion that the slump has been caused, not by the previous inflation, but by the inherent defects of ‘capitalism.'”

The Fed is the elephant in the living room that everyone pretends not to notice. Even many of those who blame government for the current mess leave the Fed out of the picture altogether. The free market, meanwhile, takes the blame for the destructive consequences of what it does. This charade has gone on long enough. It’s time to consider the possibility that maybe the elephant, and not little Johnny, is the one breaking all the furniture.

If you want to read more from the New York Times bestseller, Meltdown, click here for a free chapter.

[*Editors note: Tom Woods and I are old friends. My brother Tim Carney edited this book when he worked for the publisher, although he has since left. The publisher is an advertiser on Business Insider and Clusterstock. They have sponsored this edition of the book club.]

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