September 17, 2015

The best thing Rand Paul has said, and what he should have mentioned at the GOP debate

By In Blogs, C.Jay Engel

Rand Paul (with Mark Spitznagel) had an op-ed in Tuesday’s WSJ titled: “If only the Fed would get out of the way.”

He points out that, yes, an eventual rise in interest rates (whether today’s possible 25 basis points or something bigger in the future) will pop the stock market bubble, the markets could very well crash, and this is not at all a reason to keep interest rates artificially low.  Why? Paul and Spitznagel cite the Austrian School for support:

In their theory of business cycles, the Austrian economists Ludwig von Mises and Friedrich Hayek explained several decades ago that artificially cheap credit misleads entrepreneurs and investors into doing the wrong things—which in the current financial context includes making unsustainable, levered investments in risky assets, including companies loading up on debt to buy back and boost the price of their stock. Low interest rates may create an illusion of robust markets, but eventually rates spike, assets are suddenly revealed to be too highly priced, and debt unpayable. Many firms have to cut back production or shut down, unemployment rises and the boom goes bust.

The Austrian diagnosis leads to an unorthodox prescription: Rather than provide “stimulus” to boost demand during a slump, the Federal Reserve and Congress should stand aside. Recessions are a painful but necessary corrective process as resources—including labor—are guided toward more sustainable niches, in light of the errors made during the giddy boom period.

This is the best thing Rand Paul has said on the campaign trail– and thing that brings him closest to something his father, Ron Paul, might have said.  It is not “speculation” or “corporate greed” or a sudden case of “irrational exuberance” that causes economic booms and busts; it is the Federal Reserve’s manipulation of the price of credit, that is, the interest rates.  Such suppression of the natural rate of interest encourages the speculation and gives investors (gamblers) new and cheap money to play with, thereby adding to a very unstable asset price boom.  Such artificial growth feels good for a time, but a bust is inevitable. Therefore, the best thing to do is the let the market liquidate the bad debt and wipe out the misallocations as soon as possible. This serves to both allow the economy to actually recover sooner than later, and prevents the bad situation from getting worse.

Paul and Spitznagel also give a very short overview of the last several decades:

In 2000 the stock market, bloated by earlier Fed rate cuts, started falling when the tech bubble burst. Markets bottomed out in 2002, as the Fed slashed rates. Although people hailed then-chairman Alan Greenspan as “the Maestro” for providing a so-called soft landing, in hindsight he simply replaced the dot-com bubble with a housing bubble.

When the housing bubble eventually burst, the crisis was much worse than in 2000. When Lehman Brothers failed in September 2008, it seemed as if the whole financial infrastructure was in jeopardy. And Fed Chairman Ben Bernanke followed the same playbook: cut interest rates.

When near-zero-percent interest rates did not jump-start the economy, the Fed launched a series of “quantitative easing” (QE) programs, buying unprecedented amounts of Treasurys and mortgage-backed securities. The Fed has roughly quintupled its balance sheet, going from $905 billion in early September 2008 to almost $4.5 trillion today.

From Greenspan’s dot com and housing bubble to Bernanke’s attempt to prop up financial and capital markets everywhere to Yellen’s continuation of the same dangerous policies, we have been suffering under many years of cheap money and bubble finance.  This has nothing to do with the free market or “capitalism;” this has everything to do, as Rand Paul points out, with central bank shenanigans.  And as David Stockman points out, the victims in the Federal Reserve’s campaign has been savers and retirees.  Investors and those planning their financial future are having a very tough time getting through the mine field.

Written by C.Jay Engel

Editor and creator of The Reformed Libertarian. Living in Northern California with his wife, he writes on everything from politics to theology and from culture to economic theory. You can send an email to reformedlibertarian@gmail.com