The world economies were withering in financial pain after the economic crisis of 2007-2008. If there was anything more threatening than the suffering we went through, it was the belief held universally, that the crisis was born out of the excesses of the free market, or human “greed”. There can be no notion which is so far from the truth. As some sound economists had pointed out, “to blame the crisis on ‘greed’ is tantamount to blaming plane crashes on gravity”. Economic depressions are caused, not by anything inherent in the free markets, but due to government meddling in the economy-specifically, credit expansion steered by the central bank.
If there was one thing in common between the intellectuals who blamed the crisis on the free market, it was their complete lack of understanding of economics and the structure of a free market economy. Under a free market economy, all property will be privately owned with no external control or regulation. It was ridiculous to blame the crisis on the free market, when a free market never existed anywhere in the first place. In the United States, government extorts a large part of personal income in the form of taxes and there are several other rules and regulations which tamper with the functioning of the free market.
It had also become customary to point out that we got there due to the deregulation that happened in the past three decades. When they talk of deregulation, what enemies of liberty mean is not genuine deregulation. The federal register has tens of thousands of pages of government regulations, of which, ten thousand pages were added in the past three decades. The financial and housing system is highly regulated by the Government, and there was never ever a free market in any of these sectors. Fannie Mae and Freddie Mac were government-sponsored, government regulated mortgage giants. Banks are chartered and regulated by the Government. In all the years before the crisis, the Government promoted increased home ownership through loose monetary policy. Artificially low interest rates wouldn’t have been possible in the absence of the Federal Reserve. The existence of the Federal Reserve and the Securities and Exchange Commission is totally incompatible with the structure and principles of a free market economy.
To make any sense of the phenomenon of economic depressions, one should first have a strong causal theory which explains boom-bust cycles. At any point in time, a particular amount of money would be directed to investment and savings and the rest is spent on consumption. This investment-consumption pattern which emerges would be decided by the collective time preference of the people. If the time preference is low, the investment-consumption proportion would be high and if the time preference is high, it would be low. The boom starts when the banking system prints money, and lend it at an interest rate which is too low to businessmen and the general public. The new money which is injected in to the economy artificially lowers the rate of interest. This artificial lowering of the interest rates makes several projects appear profitable to businessmen when it wouldn’t have happened so in the absence of credit expansion. If the interest rates had fallen genuinely, due to lower time preference of people, and were backed by real savings, there will not be a business cycle. But, the artificial lowering of the interest rates sends misleading signals to businessmen about the real savings-consumption pattern of individuals. Businessmen are conned into thinking that there are more savings, when there aren’t. This sends a definite signal to entrepreneurs that consumers are bound to ask for more and more goods and services in the future. With the aim of satisfying the future demands of consumers, entrepreneurs start new long term capital projects (an investment in the higher orders of production) in present time which will enable them to meet the future demand of consumers. This leads to mal-investments. The recession is the absolutely necessary part of liquidating these mal-investments.
It can’t be emphasized more that the recession is the markets readjustment process, and is to be embraced. Painful as they are, business failures and bankruptcies are to be celebrated, as the market is in the process of correcting its own boom-phase errors. There is no reason at all for the recession to last for a significantly long period of time if the government doesn’t interfere with the markets correction process. Government bailouts are neither necessary, nor just. Governments resort to various courses of action during a depression and each and every one them is a wrong course to take. Preventing or delaying the liquidation process prolongs the depression. Further Inflation leads to more mal-investment, and this keeps down the interest rate. Keeping wage rates up aggravate the unemployment problem. Propping up prices create unsaleable surpluses. Subsidization of unemployment prolongs it. Stimulation of consumption discourages savings.