Hat tip to Reason Magazine:

George Bragues of Canada's Financial Post comments on "Paulson's Scheme" in which he says the anatomy of the current crisis represents analytical victory for the oft-overlooked school of economic thought known as the Austrian School of Economics. But, it won't be easy. Far too much of mainstream economic thought from Bernanke and Greenspan to Krugman and Stiglitz is totally "Non-Austrian" and simply cannot face the 800lb gorilla in the room because it renders silly, dangerous and woefully inadequate much of the over-used and over-trusted mathematical analytical tools that give far too many "modern economists" a false sense of wisdom in the face of ever growing complexity....complexity that is the result of becoming more astute in how to dodge, cover up, rationalize, "smooth out" and gloss over deviations and abuses of market fundamentals. But this astuteness in no way reconciles the fact that it is simply a dodge for all intents and purposes. A rodeo rider may become better at hanging on the the bucking bull and gaining a few extra seconds of seat time but that never obscures the fact that this skill is limited by the simple fact that the bull is stronger than him and he WILL FALL OFF. Market forces are likewise stronger economists. The problem with this relationship...as opposed to the one between the rider and bull....is that economists are able to obscure their limitations far longer than the rodeo rider. They can make things appear better than they seem and continue to cover the contradictions and implicit weaknesses in their actions. But in the end, their arrogance is always toppled by reality...a simple reality the Austrians stubbornly never lose sight of. Austrians see market fundamentals surrounding prices and the signals they carry to be iron-clad and they are correct in this stance.

And while I'm not an "Austrian" per se ( how can I be since I'm not an economist?), I do appreciate and fearfully respect this insight they have provided as much as I respect any simple law of physics that governs all mundane actions every day on this planet. Sometimes these price distortions are rather isolated and innocuous but other times they can be devastating writ large...like in monetary policy. To Austrians, interest paid for borrowed money is simply a price...just like any other price...whether it's for steel, rubber, apples, plastic or oil or what have you. And this price represents something very real. Price distortions become apparent quickly with things that have to be produced somehow and have multiple actors in profit/loss scenarios. Gas being sold at $1 a gallon right now would quickly show its bad effects. Producers and investors would lose money, we would run out of gas at the pumps and price signals for petroleum-based products would be sent into such a tail spinning whirlwind of confusion that I cannot even comprehend the implications. Same with other prices. But credit? It doesn't have the same physical constraints. Credit isn't tangible. It isn't something we "make" or rely on resources that require labor or other resources to produce. It may be real in some sense but it's abstract. It's easy "to make more" by simple fiat. It's almost like a promise. People have limitless ability to "make" promises. There are no supply constraints in MAKING promises. Delivering is another matter.

Arrogant economists have scoffed and laughed at these basic realities for decades. They have taught themselves so many theories and models (excuses) to make these basic insights seem simplistic or controllable or malleable. But they have only succeeded in giving the impression...not in making it reality.

Mr. Bragues opens his commentary by saying we have to "unravel the contradiction" taking place in the mainstream analysis of the financial crisis. The fact that many "experts" are finally acknowledging the loose monetary policy of Greenspan from 2001-2005 (and some would argue going back much earlier) represents an important victory for Austrian School Thought. And it is.

Says Bragues:

Austrian economists hold that downturns are the inevitable aftermath of loose monetary policy, thus opposing explanations typically heard prior to the current crisis that attributed recessions to price shocks, underconsumption or central bank tightening of monetary policy.But if, to rephrase a well-known Nixon quote, we are all Austrians now, it illogically only extends to the diagnosis of the crisis and not to the school's market-based cure. For it is just not consistent to simultaneously assign blame to Greenspan's easy money and then support government intervention to fix the damage, as so many of the business op-ed writers and talking heads on CNBC have.

As the Austrian tradition points out, the dilemma with easy money is that the central bank sets rates below that which the market would naturally set. The natural rate reflects people's willingness to trade present for future satisfactions. When the actual rate is established under this, entrepreneurs and firms are issued a false signal that people are willing to defer more consumption into the future than they really are. As a result, excess investments in capital goods industries, such as housing, are made on the expectation that these will pay off in the long-run. The boom ends when monetary conditions are tightened back to natural levels or the passage of time makes clear that the demand was never really there to sustain the investments made. At this point, a crisis takes place in which capital investments get liquidated and resources are shifted such that the economy's productive capacity more appropriately reflects people's time preferences.

But, as Bragues points out, most commentators resist following the Austrian logic through to its natural conclusion for fearing repeating the Great Depression. But this is a common misperception of the Great Depression: the idea that markets failed and that Hoover stood by with laissez-faire policies. The contrast between that and the truth is so stark as to be laughable. It shows that many either do not understand what laissez-faire is or that they consider what Hoover did to be somehow part of laissez-faire orthodoxy. Where they get this idea is beyond me.

The truth is that the Fed at the time did try to add liquidity, lowering its rediscount rate until late 1931 and continuously increasing reserves under its control. Money supply nevertheless fell, but that was because people lost faith in the financial system and hoarded currency. Meanwhile, Hoover met the downturn with interventionist gusto. He passed the Smoot-Hawley tariff to help domestic industries and obtained the co-operation of business leaders to support wages and investment. We haven't gone down this protectionist and corporatist road yet but Hoover's attacks on short selling and his creation of the Reconstruction Finance Corporation, which among other things loaned money to banks, bear an eerie resemblance to the current policy response.

"We might have done nothing",Hoover said, "[but] we determined that we would not follow the advice of the bitter-end liquidationists." Thus has the Bush administration decided as well, having successfully cajoled a recalcitrant Congress to follow Hoover's example.

Hoover scoffed at the ideas being championed by people like Hayek and Mises, who at the time, warned against intervention to prevent the market correction. The monetary inflation-fueled bubble from the 20s had burst and the results were inevitable. The last time prior to this that there was financial panic was in 1920 when the monetary inflation and intervention from WW1 finally lashed back and sent markets tumbling. But nothing was done to stop it. It was allowed to correct itself and it was over rather quickly. The young Fed at that time had still not totally understood its abilities to meddle and did little fix the problem it had caused. You would have that they would have learned their lesson and resisted further monetary inflation and loose credit in the ensuing 20s. You would have been wrong.