Subject: Roubini's Reputation and the Real Cause of the Business Cycle
Date: Fri, 9 Jul 2010 13:27:00 -0400
Re: The Real Cause of the Business Cycle
In his review of "Crisis Economics" by Nouriel Roubini and Stephen Mihm, Mr. David M. Smick calls Mr. Roubini a "media superstar" for his 2006 claim that the U.S. was in a housing bubble. If one goes to Mises.com and searches on "housing bubble", one will find over 1,200 entries, many of which go back to 2003. Austrian economists have been right about this crisis from the beginning, because they understand the true nature of the business cycle, so ably explained by Professor Gary Wolfram elsewhere in the same NR issue. (See "Your Money Back") According to Mr. Smick's review, Mr. Roubini claims that "Crises--unsustainable booms...are hard-wired into the capitalist genome." Wrong. The boom/bust business cycle is caused by an extension of bank credit not backed by real savings. Banks are tempted to extend credit in an unsustainable manner due to their right to engage in fractional reserve banking. This is the primary source of the boom. In the nineteenth century two crucial court cases in England gave banks unprecedented legal protections. British courts ruled that bank demand deposits were loans and not bailments. In other words, the banker was not required to keep standard money in his vaults equal to the amount of money entrusted to him by his depositors. Unlike a grain elevator operator, for example, the banker could lend out his customers' demand deposits for his own benefit, meaning that there can be two or more claims upon the same money. Of course this is the very definition of fraud, but the British courts ruled otherwise, and the American courts followed British precedence. Although fractional reserve banking may be legal it is not immune to the law of economics, which punish bankers for making loans with demand deposits and not savings deposits. As Michael McKay explains in his wonderful little book, "Secrets About Money that Put You at Risk", it is as if the bank creates multiple owners of the same horse, who may have no conflict until they decide to have a horse race. The real problem is one of a violation of property rights, which is not just a legal problem but also an economic one. Expansion of the money supply not backed by a commodity creates claims upon existing property for which no one has given consideration. It is theft through the banking system, and eventually it becomes apparent that there are not enough resources to honor all the claims. This is the beginning of the bust phase, and attempts to keep the bubble inflated are futile and cause even more damage. Therefore, don't expect a recovery until the government stops manufacturing claims via its inflation machine par excellence; i. e., the Fed.