The Myth that Laissez Faire Is Responsible for Our Financial Crisis

A long article by professor Reisman (a student of Ludwig von Mises) but an excellent one. Discusses derivatives, "credit default swaps," "collateralized debt obligations," the Federal Reserve's role in the current financial crisis, and more.

The “great new” historical myth is a great OLD one.

You know, how Hoover was a crazy laissez-faire type?
Just ignore the fact that he was basically FDR-lite (which makes sense, considering the first half of the depression was a Great Depression-lite until FDR pushed it further).

And definitely ignore the part where Hoover inflated the money supply by something like 2/3 during the 20s...

Agreed.

Hoover pushed what should have been a short nasty recession into a full-fledged depression; FDR entrenched the depression for ten years, making it officially the “Great Depression.”

Good article by George Reisman. Thanks for posting.

Socialist/collectivist/criminals are the root cause of every horror that innocent individuals experience.

Ping

Dumping loose credit into the financial market to prevent downturn is not a laissez-faire economics. In laissez-faire system, the economy is allowed to go down. This means that the world economy should have gone into recession back in 1998, when LTCM collapse broke.

Actually if that happened, we are in much better shape now.

Thanks for posting.

It is a good article. The author makes an excellent point that we do not have laissez faire. Hence laissez fair is not to blame. With the government spending 40% of our income, agencies like HUD, Government sponsored agencies, like Fannie Mae and Freddy Mac, laws such as the Community Reinvestment Act, etc. etc., this is anything but laissez fair. Furthermore we have evidence of HUD, GSEs, politicians, and others pressuring and intimidating financial institutions into making risky (high default rate) loans. It would make more sense to say “socialism is to blame for the financial crisis.” The author has a rock solid case here.

I think the article attempts too much for one article. The author uses the current crisis to make his points about fiat money, gold, and money creation. I understand these are important elements of the Austrian school of economics. They believe, based upon analysis of historical cases, that easy money leads to a boom-bust cycle. The bigger the boom, the bigger the bust. They see the same phenomenon in the current crisis. Maybe they are right. However, these Austrian views are controversial among economists, and they take time to develop. In my opinion, uniquely Austrian points should have been alluded to in this article, then examined fully in a separate article. The argument that laissez fair is not to blame may have been diluted by the extended discussion of Austrian themes. I think this would have been better packaged and presented as two articles instead of one.

By the way, I never read Misses as I acquired a Bachelor and Masters degree in economics. I have read him since. It is safe to say that he is the greatest economist never to have won the Nobel prize. He is greater than many who have received that recognition. His sin is that he opposed socialism when so many others embraced it whole or in part.

You’re a good person, ChessExpert. Thanks for your sympathetic post. I agree about Reisman’s article. He was actually a pupil (one of the youngest, I think) of Mises at NYU in the 1950s. Mises was Reisman’s dissertation advisor.

I certainly agree that this is a tendency — a bit utopian, if you ask me — of those who had long association with Ayn Rand (as Reisman did). The belief is, “If only we all lived in Galt’s Gulch, with a 100% gold-backed money supply, and Ayn Rand’s theory of concepts, we would never have inflation and depressions again.”

I realize that there is controversy, especially between the Chicago School and the Austrian School as to the ultimate cause of the business cycle. The Austrians claim that inflation of the money supply — injected at a specific point in the economy so that certain people or groups receive the new money first — causes capitalists to overinvest in the “higher order” capital goods as opposed to “lower order” consumer goods. Low interest rates also induce them to pay their expenses by taking out low interest loans — to be repaid out of EXPECTED profits — rather than to keep larger checking accounts on hand (in other words, the new money and the low interest rates induce them to over-leverage themselves). When the new fiat money has worked its way through the economy, raising all prices but some more than others, the whole pattern of EXPECTED consumption has changed. Capitalists realize that the expected demand for their end-user products doesn’t exist, so they now have to liquidate their investments in the capital goods market — usually requiring laying off workers and declaring bankruptcy. The bankruptcies usually occur because of the over-leveraging mentioned above: they have no cash in their accounts, their loans have come due (which they were expecting to be able to pay out of the future profits that the new money and spending led them to believe would be coming in).

According to a recent book by economist Mark Skousen (”Chicago & Vienna: Friends or Foes?”), there’s ample empirical evidence that this is precisely what happend during the recent Internet boom/bust of the late 1990s. Skousen claims that the Internet boom/bust revived serious interest among academic economists in the Austrian Business Cycle Theory.

The problem seems to have been that Mises was a crusty old Kantian who refused to believe that empirical evidence was necessary to prove or disprove a theory of economics; an attitude that prevented the general acceptance of the Austrian view into American academia. Mises believed that economics was one branch of a super, overarching, self-evident social science — similar to geometry — which he called “the science of human action” or “Praxeology.” Praxeology, which takes as its starting point human volition and goal-orientedness, would include all the social sciences: history, sociology, psychology, etc. and would, of course, exclude those sciences that dealt with things without volition and goals (physics, chemistry, etc.).

Reisman, however, is not a pure Austrian. He claims, in fact, that some of the ideas of the Austrians — especially the pure “time preference” theory of originary interest/profit is weak (the idea that interest originates in a present discount of future goods). Reisman is best known for integrating the Austrian perspective with much of the British classical school of thought, especially David Ricardo. He claims that Ricardo is probably the greatest of that school but is very difficult to read.

An economist that Reisman’s writings introduced to me was James Mill, father of John Stuart Mill. James Mill was a brilliantly clear writer, especially his pamphlet “Commerce Defended” in which he criticizes mercantile fallacies of overproduction and underconsumption. How odd to see these same fallacies repeated over a hundred years later in Keynes and Krugman.

A little on Mises: he escaped to the U.S. with a price on his head, considered a “dangerous radical” by the Nazi regime. In a way, he was a dangerous radical. Though very big in the 1920s, especially with his “Theory of Money and Credit” (which applied Menger’s concepts of subjective marginal utility to money), he and the Austrian views of Menger, Bohm-Bawerk, and Jevons, had fallen out of favor by the time WWII rolled around. He was given a “visiting professorship” at NYU school of business and accounting, though — shockingly — they never paid him a salary! Instead, he received a special stipend from various groups, among which was the National Association of Manufacturers. He was influential on a young business journalist named Henry Hazlitt who went on to write a famous little pop book on economics titled “Economics In One Lesson” as well as a big, difficult book debunking Keynes titled “The Failure of the New Economics.” Mises’s younger brother was a very famous applied mathematics professor and statistician at Harvard named Richard von Mises. Ludwig was married to a woman named Margit Sereny who had a daughter, Gitta, from a previous marriage. Gitta Sereny became a very well known journalist and historian on the Holocaust, and was one of the last to interview Albert Speer. She was also involved in a defamation lawsuit against the British fascist historian and Holocaust denier, David Irving.

I guess the family just can’t keep out of trouble.

By the way, another student of Mises you might like is Murry Rothbard. Start with his little pamphlet “What Has Government Done to Our Money.”

Anyway, thanks, again, for your post.