2002 Ron Paul 78:1
Mr. PAUL. Mr. Speaker, as the attached article
(“A Classic Hayekian Hangover”) by
economists Roger Garrison and Gene Callahan
makes clear, much of the cause for our
current economic uneasiness is to be found in
the monetary expansion over most of the past
decade. In short, expansion of the money supply
as made possible by the policy of fiat currency,
leads directly and inexorably to the kind
of problems we have seen in the financial
markets of late. Moreover, if we do not make
the necessary policy changes, we will eventually
see similar problems throughout the entire
economy.
2002 Ron Paul 78:2
As the authors point out, our ability to understand
the linkage between inflated money
supplies and subsequent economic downturns
is owing to the ground breaking work of the
legendary economists of the Austrian school.
This Austrian Business Cycle (or “ABC”) theory
has long explained the inevitable downside
that attends to a busting of the artificial bubble
created by inflationary fiat monetary practices.
2002 Ron Paul 78:3
In the current instance, the fact that there
has been nearly a decade of significant increases
in the seasonally adjusted money
supply, as measured by MZM (as shown by
the chart included with the article), serves as
a direct explanation for the over capitalization
and excess confidence which we have seen
recently leaving financial markets. In short, as
this article shows, the Austrian theory alone
understands the causes for what has been
termed “irrational exuberance” in the financial
markets.
2002 Ron Paul 78:4
Mr. Speaker, I wish to commend the authors
of this fine article as well as to call it to the attention
of my colleagues in hopes that we will
not merely understand its implications but also
that we find the courage to change monetary
policy so that we will not see a repeat performance
of this year’s market volatility.
A CLASSIC HAYEKIAN HANGOVER
(By Roger Garrison and Gene Callahan)
Are investment booms followed by busts
like drinking binges are followed by
hangovers? Dubbing the idea “The Hangover
Theory” (Slate, 12/3/98), Paul Krugman has
attempted to denigrate the business-cycle
theory introduced early last century by Austrian
economist Ludwig von Mises and developed
most notably by Nobelist F. A. Hayek.
2002 Ron Paul 78:6
Yet, proponents of the Austrian theory
have themselves embraced this apt metaphor.
And if investment is the intoxicant,
then the interest rate is the minimum drinking
age. Set the interest rate too low, and
there is bound to be trouble ahead.
2002 Ron Paul 78:7
The metaphorical drinking age is set by —
and periodically changed by — the Federal
Reserve. In our Fed-centric mixed economy,
the understanding that “the Fed sets interest
rates” has become widely accepted as a
simple institutional fact. But unlike an actual
drinking age, which has an inherent degree
of arbitrariness about it, the interest
rate cannot simply be “set” by some extramarket
authority. With market forces in
play, it has a life of its own.
2002 Ron Paul 78:8
The interest rate is a price. It’s the price
that brings into balance our eagerness to
consume now and our willingness to save and
invest for the future. The more we save, the
lower the market rate. Our increased saving
makes more investment possible; the lower
rate makes investments more future oriented.
In this way, the market balances current
consumption and economic growth.
2002 Ron Paul 78:9
Price fixing foils the market. Government
mandated ceilings on apartment rental
rates, for instance, create housing shortages,
as is well known by anyone who has gone
apartment hunting in New York City. Similarly,
a legislated interest-rate ceiling would
cause a credit shortage: The volume of investment
funds demanded would exceed people’s
actual willingness to save.
2002 Ron Paul 78:10
But the Fed can do more than simply impose
a ceiling on credit markets. Setting the
interest rate below where the market would
have it is accomplished not by decree but by
increasing the money supply, temporarily
masking the discrepancy between supply and
demand. This papering over of the credit
shortage hides a problem that would otherwise
be obvious, allowing it to fester beneath
a binge of investment spending.
2002 Ron Paul 78:11
An artificially low rate of interest, then,
sets the economy off on an unsustainable
growth path. During the boom, investment
spending is excessively long-term and overly
optimistic. Further, high levels of consumer
spending draw real resources away from the
investment sector, increasing the gap between
the resources actually available and
the resources needed to see the long-term
and speculative investments through to completion.
2002 Ron Paul 78:12
Save more, and we get a market process
that plays itself out as economic growth.
Pump new money through credit markets,
and we get a market process of a very different
kind: It doesn’t play itself out; it does
itself in. The investment binge is followed by
a hangover. This is the Austrian theory in a
nutshell. (Ironically, it is the theory that
Alan Greenspan presented forty years ago
when he lectured for the Nathaniel Branden
Institute.) We believe that there is strong
evidence that the United States is now in the
hangover phase of a classic Mises-Hayek
business cycle.
2002 Ron Paul 78:13
In recent years money-supply figures have
become clouded by institutional and technological
change. But in our view, a tale-telling
pattern is traced out by the MZM data
reported by the Federal Reserve Bank of St.
Louis. ZM standing for “zero maturity,” this
monetary aggregate is a better indicator of
credit conditions than are the more narrowly
defined M’s.
2002 Ron Paul 78:14
After increasing at a rate of less than 2.5%
during the first three years of the Clinton
administration, MZM increased over the
next three years of the Clinton administration,
MZM increased over the next three
years (1996–1998) at an annualized rate of over
10%, rising during the last half of 1998 at a
binge rate of almost 15%.
2002 Ron Paul 78:15
Sean Corrigan, a principal in Capital Insight,
a UK-based financial consultancy, has
recently detailed the consequences of the expansion
that came in “. . . autumn 1998,
when the world economy, still racked by the
problems of the Asian credit bust over the
preceding year, then had to cope with the
Russian default and the implosion of the
mighty Long-Term Capital Management.”
Corrigan goes on: “Over the next eighteen
months, the Fed added $55 billion to its portfolio
of Treasuries and swelled repos held
from $6.5 billion to $22 billion . . . [T]his
translated into a combined money market
mutual fund and commercial bank asset increase
of $870 billion to the market peak, of
$1.2 trillion to the industrial production
peak, and of $1.8 trillion to date — twice the
level of real GDP added in the same interval”
(http://www.mises.org/
fullarticle.asp?control=754).
2002 Ron Paul 78:16
The party was in full swing, and the Fed
kept the good times rolling by cutting the
fed funds rate a whole basis point between
June 1998 and January 1999. The rate on 30-
year Treasuries dropped from a high of over
7% to a low of 5%. Stock markets soared.
The NASDAQ composite went from just over
1000 to over 5000 during the period, rising
over 80% in 1999 alone. With abundant credit
being freely served to Internet start-ups,
hordes of corporate managers, who had
seemed married to their stodgy blue-chip
companies, suddenly were romancing some
sexy dot-com that had just joined the party.
2002 Ron Paul 78:17
Meanwhile consumer spending stayed
strong — with very low (sometimes negative)
savings rates. Growth was not being fueled
by real investment, which would require forgoing
current consumption to save for the
future, but by the monetary printing press.
2002 Ron Paul 78:18
As so often happens at bacchanalia, when
the party entered the wee hours, it became
apparent that too many guys had planned on
taking the same girl home. There were too
few resources available for all of their plans
to succeed. The most crucial — and most general
— unavailable factor was a continuing
flow of investment funds. There also turned
out to be shortages of programmers, network
engineers, technical managers, and other
factors of production. The rising prices of
these factors exacerbated the ill effects of
the shortage of funds.
2002 Ron Paul 78:19
The business plans for many of the
startups involved negative cash flows for the
first 10 or 15 years, while they “built market
share.” To keep the atmosphere festive, they
needed the host to keep filling the punch
bowl. But fears of inflation led to Federal
Reserve tightening in late 1999, which helped
bring MZM growth back into the single digits
(8.5% for the 1999–2000 period). As the
punch bowl emptied, the hangover — and the
dot-com bloodbath — began. According to research
from Webmergers.com, at least 582
Internet companies closed their doors between
May 2000 and July of this year. The
plunge in share price of many of those still
alive has been gut wrenching. The NASDAQ
retraced two years of gains in a little over a
year.
2002 Ron Paul 78:20
During the first half of 2001, the Fed demonstrated
— with its half-dozen interest-rate
cuts and a near-desperate MZM growth of
over 23% — that you can’t recreate euphoria
in the midst of a hangover.
2002 Ron Paul 78:21
It all adds up to the Austrian theory. As a
final twist to our story, we note that
Krugman, who before could only mock the
Austrians, has recently given us an Austrian
account of our macroeconomic ills. In his
“Delusions of Prosperity” (New York Times,
8/14/01), Krugman explains how our current
difficulties go beyond those of a simple financial
panic:
2002 Ron Paul 78:22
“We are not in the midst of a financial
panic, and recovery isn’t simply a matter of
restoring confidence. Indeed, excessive confidence
[fostered by unduly low interest
rates maintained by rapid monetary
growth? — RG & GC] may be part of the problem.
Instead of being the victims of self-fulfilling
pessimism, we may be suffering from
self-defeating optimism. The driving force
behind the current slowdown is a plunge in
business investment. It now seems clear that
over the last few years businesses spent too
much on equipment and software and that
they will be cautious about further spending
until their excess capacity has been worked
off. And the Fed cannot do much to change
their minds, since equipment spending [at
least when such spending has already proved
to be excessive — RG & GC] is not particularly
sensitive to interest rates.”
2002 Ron Paul 78:23
With Krugman on the verge of rediscovering
the policy-induced self-reversing
process that we call the Austrian theory of
the business cycle, we confidently claim that
current macroeconomic conditions are best
described as a classic Hayekian hangover.
The Austrian theory, of course, gives us no
policy prescription for converting this ongoing
hangover into renewed euphoria. But it
does provide us with the best guide for avoiding
future ones.
