On April 10, 2010, I sent an e-mail to Mark Guthner, CFA and owner of the blog entitled The Angry Grapes: Chronicling the Great Depression 2.0, asking that he take a look at my Google Knol entitled The Bull Market Caused the Economic Crisis. Set forth below is the text of the e-mail he sent on April 10 in response.
I have read ‘The Bull Market Caused the Economic Crisis” and I have a few comments.
The first being, what caused the big stock market boom in the first place?
To my way of thinking there are 2 factors to consider.
1) Mass social mood became very positive. When people are in a good mood, they start businesses, buy stocks, prefer feel good movies, counties cooperate with each other, trade freely, spend freely as they do not worry about the future, etc. Within this backdrop, people are more risk tolerant or even risk seeking. So people were inclined to buy stocks. At the extreme, they do not care about pricing risk.
2) The great enabler of this process was extraordinarily easy monetary policy. The Fed grew the monetary base very rapidly. (In a fiat currency system, observing interest rates is of no use in judging monetary policy. It’s a decoy.) The result of the rapid growth in the monetary base is to suppress interest rates. This causes market actors to borrow more and save less. In the U.S. we went to an extreme as the savings rate went below zero. Because we borrowed and spent as a nation, we consumed all our capital. [The present value of total government liabilities less expected tax revenues for the next 100 years is over $100 trillion. Total value of assets in the private sector less debt is something like $60 trillion.]
The reason we are crashing now is that we ran out of capital and social mood darkened. There is a second piece to this puzzle. The low interest rates encourage people to invest in low returning projects, either directly (real estate) or through stock (dot bombs). This malinvestment gets washed out once it becomes clear that one cannot get a return on these lousy investments. This is where we are now. For a more comprehensive explanation, I suggest you read Thomas Wood’s book, Meltdown.
I agree with your statement that the conventional explanation of the econ crisis is unsatisfying. Conventional wisdom is built on a Keynesian foundation which I believe is wrong about just about all things economic. However, I disagree with the proposition that the stock market boom was the cause of the current mess, I see it as a symptom of easy monetary policy that produces a boom bust cycle.
Thanks for the heads up. I see there is a great deal to read at knol. It will take me quite some time to get through it.