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The Fatal Cure

Libertarians are half right and half wrong when it comes to their explanations regarding the causes and cures for the global economic crisis that began eight years ago. Drawing on the teachings of the great Austrian Economist, Ludwig von Mises, they are right in blaming this crisis on the explosion of credit that occurred after the United States stopped backing dollars with gold in 1968. Total credit (which equals total debt) first went through $1 trillion in 1964. By 2007, it had expanded 50 times to $50 trillion. Today it is nearly $65 trillion. All that debt (government debt, household sector debt, corporate debt and financial sector debt) blew the United States and the world into a giant credit bubble. It would have been much better if the US had continued to back dollars with gold. That would have prevented this global credit bubble from forming. In that case, we would not be in such a mess today - at risk of collapsing into a new Great Depression. The Libertarians are 100% right about that.

But we can't turn the clock back to 1968. The credit genie got out of bottle a long, long time ago. Our world is built on that credit. The Libertarians loudly advocate popping the credit bubble. That "cure" is wrong; and not just a little wrong. It is so wrong that if that policy were adopted, it could very possibly destroy our civilization.

The Libertarian "pop to bubble cure" would have a disastrous result very much like that which would follow if someone who had gone far up into the sky in a hot air balloon became frightened and decided to pop the hot air balloon. If he does, he will crash to earth and die. The Libertarian "cure" is fatally wrong.

It is easy to understand their confusion. If credit is responsible for causing the global economic crisis (and it is), then, surely, reducing credit must be the correct policy, according to the Libertarian reasoning. But, again, that's wrong. Imagine a swimmer who has swum too far out into the ocean. Now, she realizes she has gone too far from shore and is in danger. Swimming got her into this dangerous situation. To stop swimming is not the correct response. It's too late for that. If she stops, she will drown.

Much of the Libertarian "pop the balloon, stop swimming cure" is founded on an argument made by Libertarian Murray Rothbard in his book American's Great Depression, published in 1963. There he blamed President Herbert Hoover for making the Great Depression worse and more protracted, not by doing too little to support the economy (as was commonly understood), but by initiating too much government support for the economy as it was collapsing.

Rothbard presented his case very forcefully and with great conviction. But his arguments were very weak. They were also completely incorrect. We can see this by comparing what the government did to support the economy between 1929 and 1933 (when Hoover was President), with what the government did between 2008 and 2012 (during the Bush and Obama administrations); and by comparing the results of each of those policies.

During the first period, the government ran a budget surplus of 0.8% of GDP in 1930 and deficits of 0.5% of GDP in 1931, 4.0% in 1932 and 4.5% in 1933 (for an average deficit of 2.1% of GDP a year for those four years). The Fed's balance sheet was roughly the same size in 1933 as it was in 1929. The government did not bail out the banks or their depositors.

During the second period, the government ran budget deficits of 9.8% of GDP in 2009, 8.7% in 2010, 8.5% in 2011 and 6.8% in 2012 (for an average deficit of 8.5% of GDP per year). The Fed's balance sheet expanded by $2 trillion, more than tripling in size. The government bailed out the banks and their depositors.

Between 1929 and 1933, the US economy shrank by 45% (in nominal terms), unemployment rose to 25% and roughly one-third of all the banks failed. Global trade broke down. The stock market fell 87% and did not recover to its 1929 high until 1954. The Great Depression did not end until World War II started. It only ended then because US government spending increased by 900% during the war. The budget deficit peaked at 30% of GDP in 1943.

Between 2008 and 2012, the US economy grew by 1% (in nominal terms). Unemployment rose to 10% in 2009 but fell to 6.7% by the end of 2012. The stock market fell 49% by February 2009, but recovered by February 2013. It's now 32% above its 2007 high. International trade did not break down. World War III did not happen.

The lesson is clear: keeping the bubble inflated is better than popping the balloon. Continuing to swim is better than sinking. Life is better than death. The Libertarian cure is fatal. We must reject it.

Over the next couple of days I will be uploading a new Macro Watch video laying out all the facts proving that Rothbard's conclusions in his book, American's Great Depression, are dangerously wrong. If you would like to see the evidence, click on the following link to subscribe to Macro Watch:

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