The Free Market 21, no. 3 (March 2003)
The once unsoiled House of Greenspan, feted as it was by the yeomen of the New Economy with its attendant mythology, now finds itself smeared by criticism that it created the stock market boom and is therefore responsible for the bust that has naturally followed.
In Austrian circles, such criticism has long been a staple of economic and political commentary. Only in the aftermath of the boom has the mainstream press second-guessed their beloved maestro.
Greenspan and his men will not go quietly, however. Rather than suffer the slings and arrows of outrageous fortune, the House of Greenspan has decided to take arms against a sea of troubles—to defend its actions in the past several years. The crumbling reputation of the suddenly mortal chairman and his house is not without defenders.
As the Washington Post recently reported, “The Federal Reserve Board has recently waged a vigorous campaign of defense, arguing that it was better to have boomed and busted than never to have boomed at all.” Poetic perhaps, but is it sound?
The Post quoted two defenders of the Fed, Ben Bernanke and Alan Blinder.
Ben Bernanke, the Fed’s newest member, offered the view in a recent speech that “preventing the boom in stock prices between 1995 and 2000, if it could have been done, would have throttled a great deal of technological progress and sustainable growth in productivity and output.” To this way of thinking, the benefits of the boom outweigh the supposed short-lived sting of the bust.
And Alan Blinder, former Fed vice chairman adds, “As far as I can see, the damage to the real economy and to the financial system has been somewhere between little and none.” The consequences of the boom-bust phenomenon are trivialized by Blinder and are seen as having little real cost or impact.
What follows is a look at Bernanke and Blinder’s points with regard to the question: Is it better to have had the boom and the bust, rather than never to have boomed at all—assuming that there is a choice in the matter (there is, but more on that later).
We will skirt the issue as to the exact causes of the boom, which have been covered many times before, in expert fashion, by Mises Institute writers, among others. We will take for granted that the boom was artificially created or stimulated by policies of credit expansion, which is in essence the message of Austrian business cycle theory.
Accepting this as our premise, we can proceed with what is the hallmark of any boom. The boom is characterized by malinvestment. This wonderfully descriptive term was adopted by Austrian writers, such as Mises and Rothbard, and is still used today to describe investments that later prove to be unprofitable. As Mises saw it, malinvestments were investments in the “wrong lines,” an “expansion of investment on a scale for which the capital goods available do not suffice.” All malinvestments, Mises wrote, must fail sooner or later.
Malinvestments, then, are in need of eventual liquidation. By definition, they are mistakes. They are the miles of fiber optic cable, laid down during the boom, that now lie unused or “dark” as the techies say. They are the failing dot coms. They are the excess inventory of routers and microchips, the empty office buildings and idle plants and factories.
That such a boom led to innovations and increases in productivity and output is not a sound reason to support Fed-induced booms. Innovations not supported by the market are wasted uses of precious capital.
Consider that Americans surely have the collective resources to establish a regular charter flight from here to the moon and back again, if so desired. Obviously the marketplace, whose participants have other priorities, does not support such a venture. Enterprises of all kinds continue to use older technology when better technology is available because investments in new technology have a cost. In many cases, it is a better use of resources to continue with the older way. The incremental cost of upgrading can be too large. There is always a shelf full of new innovative technologies that are not yet economically feasible.
The same could be said for increases in productivity or output that exceed what the market would otherwise have produced. It is a losing proposition to make unprofitable investments for the sake of increasing output and productivity.
Bernanke fails to make a valid comparison when in defending the innovations of the boom he implies a comparison with what technology and productivity were prior to the boom. He has to consider what might have happened if there were never a boom, something the best of seers will never know definitely, but which in a general way, we can understand. As Mises elegantly put it:
“The pace of progress is so rapid that, in the course of a boom period, it may well outstrip the synchronous losses caused by malinvestment and overconsumption. Then the economic system as a whole is more prosperous at the end of the boom than it was at the beginning; it appears impoverished only when compared with potentialities which existed for a still better state of satisfaction.”
In other words, Bernanke nor anyone else can know for sure what those potentialities were. We know only that the boom harbored innovations and other advances, and also destroyed capital in the process.
Blinder’s defense is one that trivializes the destruction of capital itself, one that diminishes the effects of the contraction. Apparently to Blinder’s eyes, capital grows on trees, is as common as starlings, as plentiful as summer weeds. He references a real economy that is somehow apart from what happened in the stock market. Is the stock market not real? Is it somehow part of a fake economy? The stock market was and is real, and the boom led to the creation of many new ventures and an expansion of investment that otherwise would not have occurred.
Witness the record bankruptcies in 2002 alone. According to Reuters, “U.S. public companies have shattered bankruptcy records for the second straight year. . . . All told, 186 public companies with a staggering $386 billion in assets filed for bankruptcy in 2002.” That $386 billion is the highest asset total ever, surpassing the prior year’s total of $259 billion. Among the wreckage were five of the 10 largest bankruptcies ever—including such New Economy darlings as WorldCom and Global Crossing.
Reuters presses on, the “reasons for the bankruptcy wave are no secret. After a dizzying run-up in stock prices in the late 1990s, investors and banks showered companies with cash, betting on growth that never materialized.” It never materialized because the opportunities of the boom were illusory; the capital was not there to support it.
Even after two years of this carnage, the damage still may not be over. More bankruptcies are expected. The bankruptcies today have created a widening ripple effect. Debt-laden retailers and power companies are among the walking wounded with buzzards circling overhead. One of the largest Burger King franchises in the country already declared bankruptcy in December. Reuters also notes that “defaults by convenience stores and service stations also have been on the rise.”
Who knows what the final tally will be when all is said and done? The fact is that the boom and bust have real consequences and real costs.
As Mises wisely observed, the “final outcome of credit expansion is general impoverishment . . . the immense majority foot the bill for malinvestments and the overconsumption of the boom episode.”
It is a somewhat comedic exercise to peruse the speeches made by the Fed governors, who all so solemnly and earnestly pontificate on the economy. They analyze monetary policy and their “tools” with all seriousness, as if they were the real levers by which the economy is guided and by which standards of living are improved. The Fed governor of today reminds one of the rooster in children’s tales, who thought that the sun rose because it crowed.
Earlier, the assumption was made that we have a choice. We can have the boom and bust phenomenon, or not. The “or not” is the other side of the river. It is the Rivendell, which Fed governors, like ringraiths, dare not cross into. For on that side of the river is the inescapable conclusion that the Fed itself is a source of instability and that it should be eliminated. A sound monetary system, based on a gold standard and no fractional reserves, would inhibit the meddling of governments and credit expansion.
Will human beings still speculate? Of course they will. Is there any guarantee that tulip bulbs or stocks can’t one day become (again) the coveted treasure of human hearts? No, of course not. But a sound monetary system is the first step toward eradicating the economy-wide bust. As Mises observed, “A certain amount of malinvestment is unavoidable. What has to be done is to shun policies like credit expansion which artificially foster malinvestments.”
In his own Jackson Hole speech in 1999, Greenspan admitted, “shifts in the stock market value of firms will doubtless continue to remain important influences on our economies.” It would seem, then, that boom-bust phenomenon should not be taken lightly. Rather than expend all their mental energy on monetary policy tools and strategies, the Fed governors would be better off relinquishing their reins and dismantling the massive banking cartel of the Federal Reserve. But, as Voltaire put it, “it is hard to free fools from the chains they revere.”
Christopher Mayer is a commercial lender in Maryland (cwmayer@provbank.com)
