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1、Financial Crisis and Recession The severe financial crisis and resulting worldwide economic recession we have been forecasting for years are finally unleashing their fury. In fact， the reckless policy of artificial credit expansion that central banks (led by the American Federal Reserve) have permit
2、ted and orchestrated over the last fifteen years could not have ended in any other way.The expansionary cycle that has now come t0 a close was set in motion when the American economy emerged from its last recession in 1992 and the Federal Reserve embarked on a major artificial expansion of credit an
3、d investment， an expansion unbacked by a parallel increase in voluntary household saving. For many years， the money supply in the form of banknotes and deposits (M3) has grown at an average rate of over ten percent per year (which means that every six or seven years the t0tal volume of money circula
4、ting in the world has doubled). The media of exchange originating from this severe fiduciary inflation have been placed on the market by the banking system as newly created loans granted at extremely low (and even negative in real terms) interest rates. The above fueled a speculative bubble in the s
5、hape of a substantial rise in the prices of capital goods， real-estate assets， and the securities that represent them and are exchanged on the st0ck market， where indexes s0ared.Curiously， as in the “roaring” years prior t0 the Great Depression of 1929， the shock of monetary growth has not significa
6、ntly influenced the prices of the subset of goods and services at the final-consumer level of the production structure (approximately only one third of all goods). The decade just past， like the 1920s， has seen a remarkable increase in productivity as a result of the introduction on a massive scale
7、of new technologies and significant entrepreneurial innovations which， were it not for the “money and credit binge，” would have given rise t0 a healthy and sustained reduction in the unit price of the goods and services all citizens consume. Moreover， the full incorporation of the economies of China
8、 and India int0 the globalized market has gradually raised the real productivity of consumer goods and services even further. The absence of a healthy “deflation” in the prices of consumer goods in a period of such considerable growth in productivity as that of recent years provides the main evidenc
9、e that the monetary shock has seriously disturbed the economic process.Economic theory teaches us that， unfortunately， artificial credit expansion and the (fiduciary) inflation of media of exchange offer no shortcut t0 stable and sustained economic development， no way of avoiding the necessary sacri
10、fice and discipline behind all voluntary saving. (In fact， particularly in the United States， voluntary saving has not only failed t0 increase， but in s0me years has even fallen t0 a negative rate.)Indeed， the artificial expansion of credit and money is never more than a short-term s0lution， and oft
11、en not even that. In fact， t0day there is no doubt about the recessionary consequence that the monetary shock always has in the long run： newly created loans (of money citizens have not first saved) immediately provide entrepreneurs with purchasing power they use in overly ambitious investment proje
12、cts (in recent years， especially in the building sect0r and real-estate development). In other words， entrepreneurs act as if citizens had increased their saving， when they have not actually done s0.Widespread discoordination in the economic system results： the financial bubble (“irrational exuberan
13、ce”) exerts a harmful effect on the real economy， and s0oner or later the process reverses in the form of an economic recession， which marks the beginning of the painful and necessary readjustment. This readjustment invariably requires the reconversion of the entire real productive structure， which
14、inflation has dist0rted.The specific triggers of the end of the euphoric monetary “binge” and the beginning of the recessionary “hangover” are many， and they can vary from one cycle t0 another. In the current circumstances， the most obvious triggers have been the rise in the price of raw materials，
15、particularly oil， the subprime mortgage crisis in the United States， and finally， the failure of important banking institutions when it became clear in the market that the value of their debts exceeded that of their assets (mortgage loans granted).At present， numerous self-interested voices are dema
16、nding further reductions in interest rates and new injections of money， which permit those who desire it t0 complete their investment projects without suffering losses.Nevertheless， this “flight int0 the future” would only temporarily postpone problems at the cost of making them far more serious lat
17、er. The crisis has hit because the profits of capital-goods companies (especially in the building sect0r and in real-estate development) have disappeared due t0 the entrepreneurial errors provoked by cheap credit， and because the prices of consumer goods have begun t0 rise faster than those of capit
18、al goods.At this point， an inevitable， painful readjustment begins， and in addition t0 a drop in production and an increase in unemployment， we are now seeing a very harmful rise in the prices of consumer goods (stagflation).The most rigorous economic analysis and the coolest， most balanced interpre
19、tation of recent economic and financial events lead inexorably t0 the conclusion that central banks (which are in fact monetary central-planning agencies) cannot possibly succeed in finding the most advantageous monetary policy at every moment. This is exactly what became clear in the case of the fa
20、iled attempts t0 plan the former Soviet economy from above.To put it another way， the theorem of the economic impossibility of s0cialism， which the Austrian economists Ludwig von Mises and Friedrich A. Hayek discovered， is fully applicable t0 central banks in general， and t0 the Federal Reserve and
21、(at one time) Alan Greenspan and (currently) Ben Bernanke in particular. According t0 this theorem， it is impossible t0 organize s0ciety， in terms of economics， based on coercive commands issued by a planning agency， since such a body can never obtain the information it needs t0 infuse its commands
22、with a coordinating nature. Indeed， nothing is more dangerous than t0 indulge in the “fatal conceit” t0 use Hayeks useful expression of believing oneself omniscient or at least wise and powerful enough t0 be able t0 keep the most suitable monetary policy fine-tuned at all times. Hence， rather than s
23、0ften the most violent ups and downs of the economic cycle， the Federal Reserve and， t0 a lesser extent， the European Central Bank， have most likely been their main architects and the culprits in their worsening.Therefore， the dilemma facing Ben Bernanke and his Federal Reserve Board， as well as the
24、 other central banks (beginning with the European Central Bank)， is not at all comfortable. For years they have shirked their fiduciary responsibility， and now they find themselves in a blind alley. They can either allow the recessionary process t0 begin now， and with it the healthy and painful read
25、justment， or they can procrastinate with a “hair of the dog” cure. With the latter， the chances of even more severe stagflation in the not-t0o-distant future increase exponentially. (This was precisely the error committed following the st0ck market crash of 1987， an error that led t0 the inflation a
26、t the end of the 1980s and concluded with the sharp recession of 1990-1992.)Furthermore， the reintroduction of a cheap-credit policy at this stage could only hinder the necessary liquidation of unprofitable investments and company reconversion. It could even wind up prolonging the recession indefini
27、tely， as occurred in the Japanese economy， which， after all possible interventions were tried， ceased t0 respond t0 any stimulus involving credit expansion or Keynesian methods.It is in this context of “financial schizophrenia” that we must interpret the latest “shots in the dark” fired by the monet
28、ary authorities (who have two t0tally contradict0ry responsibilities： both t0 control inflation and t0 inject all the liquidity necessary int0 the financial system t0 prevent its collapse). Thus， one day the Fed rescues AIG， Bear Stearns， Fannie Mae， and Freddie Mac， and the next it allows Lehman Br
29、others t0 fail， under the amply justified pretext of “teaching a less0n” and refusing t0 fuel moral hazard. Finally， in light of the way events were unfolding， the US government announced a $700 billion plan t0 purchase illiquid (i.e.， worthless) assets from the banking system. If the plan is financ
30、ed by taxes (and not more inflation)， it will mean a heavy tax burden on households， precisely when they are least able t0 bear it.In comparis0n， the economies of the European Union are in a s0mewhat less poor state (if we do not consider the expansionary effect of the policy of deliberately depreci
31、ating the dollar， and the relatively greater European rigidities， particularly in the labor market， which tend t0 make recessions in Europe longer and more painful). The expansionary policy of the European Central Bank， though not free of grave errors， has been s0mewhat less irresponsible than that
32、of the Federal Reserve. Furthermore， meeting the requirements for admission t0 the euro currency bloc (convergence) involved a healthful and significant rehabilitation of the chief European economies. Only a few countries on the periphery， like Ireland and especially Spain， engaged in considerable c
33、redit expansion from the time they initiated their processes of convergence.The case of Spain is paradigmatic. The Spanish economy underwent an economic boom that was due， in part， t0 real causes (liberalizing structural reforms which originated with Jos Mara Aznars administration). Nevertheless， th
34、e boom was als0 largely fueled by an artificial expansion of money and credit， which grew at a rate nearly three times the corresponding rates in France and Germany.Spanish economic agents essentially interpreted the decrease in interest rates which resulted from the convergence process in the easy-
35、money terms traditional in Spain： a greater availability of easy money and mass requests for loans from Spanish banks (mainly t0 finance real-estate speculation)， loans which these banks have granted by creating the money ex nihilo while European central bankers looked on unperturbed. When faced wit
36、h the rise in prices， the European Central Bank has remained faithful t0 its mandate and has decided not t0 lower interest rates despite the difficulties of those members of the Monetary Union which， like Spain， are now discovering that much of their investment in real estate was in error and are he
37、ading for a lengthy and painful reorganization of their real economy.Under these circumstances， the most appropriate policy would be t0 liberalize the economy at all levels (especially in the labor market) t0 permit the rapid reallocation of productive fact0rs (particularly labor) t0 profitable sect
38、0rs. Likewise， it is essential t0 reduce public spending and taxes， in order t0 increase the available income of heavily indebted economic agents who need t0 repay their loans as s0on as possible. Economic agents in general and companies in particular can only rehabilitate their finances by cutting
39、costs (especially labor costs) and paying off loans. Essential t0 this aim are a very flexible labor market and a much more austere public sect0r. These fact0rs are fundamental if the market is t0 reveal as quickly as possible the real value of the investment goods produced in error and thus lay the foundation for a healthy， sustained economic recovery in a future that， for the good of all， we hope is not t0o distant.
