As promised, I’m going to share my understanding of what caused our current financial mess. Don’t fret; I will keep this simple and hopefully interesting. And as I explained before, I do NOT believe this mess was caused by evil men on Wall Street and incompetent CEOs running corporate America.
To do this topic justice I have to mention a man named Milton Friedman. He was one of the most prominent economists of the 20th century. He, unlike most mainstream economists, blamed the Great Depression on The Federal Reserve (the guys who make our money). Milton’s explanation was something like this:
During the Roaring ‘20s, the Federal Reserve was busy pumping “easy money” into the nation’s banking system, distorting price signals, and sending a false message of prosperity to Wall Street tycoons, who responded by engaging in highly speculative lending practices.
Sound familiar? Now, don’t buy into this explanation just because it came from Friedman—decide for yourself if it makes sense. With that said, however, I have to share an interesting little tid-bit. Ben Bernanke, a scholar of The Great Depression and the current chair of the Federal Reserve, acknowledged and confirmed Friedman’s stance when he spoke at Friedman’s 90th birthday party:
“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna [Milton's academic partner]: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
So, according to Mr. Friedman and Mr. Bernanke, the Fed caused the market crash of 1929. Did they do it again in 2008? I don’t know all the details of how the Federal Reserve operates, but I tend to believe they did. Let me share a few memories from recent history, you will probably remember too:
- 9/11 caused a dip in the stock market that gave everyone a solid scare.
- The Federal Reserve reacted by lowering the prime interest rate (they do this by adjusting the money supply like Friedman explained).
- The lower interest rate and “easy money” encouraged Americans to buy more cars, houses, and just about everything else.
- Home builders reacted by building loads of new homes. Auto manufacturers reacted by ramping up production and inventory.
- The lower interest rates caused Wall Street investors to take on investments that were far too risky. The low interest rates made those investments seem smart.
- In 2008, the illusion of prosperity came to an end.
- Now we realize all that wealth was just borrowed money. Now the creditors are all calling for it and many of the debtors don’t have it.
- Now we have an overstock of houses, cars, and most other consumer goods. People simply can’t afford them.
- Now companies are being forced to lay off thousands of people as they try to bring production and inventory back to a reasonable level.
Note: These memories are not meant to explain the whole scenario leading up to or following the crash. They are simply some of the things I remember that seem to indicate this mess was really caused by the Federal Reserve.
So, put aside any Liberal vs Conservative biases and ask yourself if this explanation makes sense. For me, it’s the best explanation I have found. How about you?
Next week: How did we respond to the crash of 1929? Was it right? How does it resemble our current reaction?
