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September 18, 2008

What can we say?

Quote of the Day:

If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.
— attributed to Milton Friedman

Subject: What can we say?

The biggest story of the week is the meltdown in the stock market and among certain kinds of financial institutions. And yet, except for our action items on the Fannie Mae and Freddie Mac bailout we’ve been largely silent on this issue. Why?

We’ve been silent because it’s unclear to us what action to suggest that is consistent with the “evolutionary approach” we like to take here at Downsize DC.

It seems clear to us that credit expansion under the Greenspan Federal Reserve made a major contribution to the creation of a price bubble in the housing sector, and it’s certainly clear that the current meltdown derives almost entirely from the bursting of that bubble. What is less clear is what policies to propose to prevent future such bubbles

We have two “Federal Reserve” bills by Congressman Ron Paul that we’ve promoted, but both of these bills deal with controlling the Fed’s ability to inflate the money supply, but not with the Fed’s ability to inflate and distort the credit market. It’s the credit aspect of the Fed’s powers that seems to have been crucial in the creation of the current troubles.

As far as we can tell the Fed has actually been fairly moderate in terms of expanding the monetary base. This is reflected not only in the statistics for the monetary base, but also in the fact that the official reports of broad-based price inflation have remained fairly low. But the story is quite different when it comes to credit.

We’ve had long periods when the Fed has offered credit at the unrealistic rate of 1% interest, and the rate is set at 2% today. It should be easy to see how such low rates could encourage economic behavior that would never occur if credit was priced at real market rates. Sadly, neither of the Ron Paul bills we’ve promoted deal with this problem directly.

To deal with the Fed’s ability to inflate and distort credit markets we would probably have to . . . abolish the Fed.

Such a thing is unlikely to happen in a direct way, given how entangled the Fed is with every aspect of our economy. Some evolutionary approach would probably be required, and we are unable to conceive what that approach would be. We need an approach that would actually set the Fed on the path to irrelevance and eventual termination (like Ron Paul’s bills would do to fiat currency). Plus . . .

We have a large challenge before us — pass the “Read the Bills Act” and the “One Subject at a Time Act.” It would be much more difficult to pass legislation that will lead to the eventual dissolution of the Federal Reserve.

All of these considerations make the current “crisis” largely impervious to citizen action. The best we can do is address the problem at the margins. This is why we’ve focused our attention on Fannie Mae and Freddie Mac, because they too have distorted the housing market, contributing to the creation of the bubble that is now bursting.

Whenever government policies encourage certain kinds of economic activity beyond what would happen in the a truly free market, bubbles and busts become more likely. Fannie Mae and Freddie Mac were created to make it easier for people to buy homes. They thereby contributed, at the margin, to the run-up in housing prices.

In a true free market the demand for homes would be a function of individual incomes and savings. Government mortgage guarantees make it more likely that people will be able to buy homes that their incomes and savings cannot justify. This increases the demand for housing, leading to price inflation in the housing sector, and an increased likelihood of an eventual bust.

It’s important to note how Federal Reserve credit expansion, and government guarantees, have a tendency to focus problems in the housing sector. We’ve been here before, with the S&L busts that afflicted the late 80s and the early 90s. But remember, we survived those problems and then moved to new heights of wealth and prosperity. We’ve also been able to survive the past few stock market busts with little difficulty. Therefore . . .

As we look at the size of the current problem in relation to the size of past problems we see reasons to be confident. Do not despair. Yes, things are not good at the moment, but you live in a wealthy and robust society, built by entrepreneurs, small business owners, and a highly productive/creative workforce. We will both survive and thrive, in spite of all the messes the government makes!

We wish we had more to offer you. Perhaps we will, at some point. We are monitoring the issue closely. As for now, we must continue to focus on building our army and on promoting proposals that will give us more leverage over Congress. That’s what matters most.

Toward this end the only action item we have to suggest today is that you make an investment in our future. If you like our approach to things then we need your financial support to bring that approach to the attention of more people. You can contribute here.

Keep your head up. And thanks for being a part of the growing Downsize DC army.

Jim Babka
President, Inc.

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