The dis­as­ter of 2008: why it can hap­pen again.


CouNT­LeSS CoM­MeN­TARIeS and ar­ti­cles are mark­ing the tenth an­niver­sary of the panic of 2008. Yet al­most all ig­nore the root cause of the cri­sis: a weak dol­lar. A wob­bly, volatile cur­rency al­ways begets eco­nomic up­heavals. If we don’t grasp that fun­da­men­tal les­son, we will in­evitably get into trou­ble again, big time, in the fu­ture.

More­over, these ret­ro­spec­tives over­look or down­play two other ma­jor blun­ders by the fed­eral govern­ment. Here are the three. • Dam­ag­ing the dol­lar. Pre­cip­i­tated by the pop­ping of the high-tech bub­ble, the econ­omy weak­ened in 2000 and went into a for­mal re­ces­sion the fol­low­ing year. In re­sponse, the Fed­eral Re­serve started to cut in­ter­est rates. Then it and the Trea­sury De­part­ment (which by law is in charge of the dol­lar) be­gan to un­der­mine the value of the green­back.

That was a cat­a­strophic mis­take. The the­ory be­hind this move was that a grad­ual de­val­u­a­tion of the dol­lar would boost ex­ports, which would help stim­u­late the econ­omy. That the­ory is non­sense: Coun­tries with un­sta­ble cur­ren­cies al­ways, over time, roundly un­der­per­form those with sound cur­ren­cies. Com­pare Switzer­land, which has had the best­man­aged cur­rency over the past 100 years, with Ar­gentina, which has had one of the worst. Switzer­land has ex­panded im­pres­sively, while Ar­gentina has stag­nated, even though it was once a global eco­nomic pow­er­house.

The rea­son for such a dra­matic di­ver­gence is sim­ple. Progress de­pends on in­vest­ing, and pro­duc­tive in­vest­ing is aided im­mea­sur­ably when money’s value is sta­ble, just as mar­kets op­er­ate far more ef­fi­ciently and fruit­fully when there are fixed weights and mea­sures for com­modi­ties. For ex­am­ple, the amount of liq­uid that con­sti­tutes a gal­lon doesn’t fluc­tu­ate. Money mea­sures value the way a yard­stick mea­sures length.

Funny money dis­torts prices, which are the ab­so­lutely cru­cial con­vey­ors of in­for­ma­tion—sup­ply and de­mand—that en­ables free mar­kets to func­tion. Like a virus in a com­puter, a dis­torted cur­rency cor­rupts the in­for­ma­tion. As the green­back was grad­u­ally gut­ted, com­mod­ity prices soared. oil gushed from $20 to $25 a bar­rel to over $100. Gold bal­looned from un­der $300 an ounce to a peak of $1,900. When money be­comes un­re­li­able, peo­ple turn to hard as­sets. The most dra- matic, de­struc­tive ex­am­ple of that process was in the hous­ing mar­ket. To one de­gree or an­other, other cur­ren­cies fol­lowed the dol­lar’s bad ex­am­ple. Thus, the ar­ti­fi­cial hous­ing ex­pan­sion—and bust—be­came a world­wide oc­cur­rence.

• Washington’s in­con­sis­tency brings on fi­nan­cial mar­ket paral­y­sis. The in­evitable reck­on­ing turned into a panic that nearly brought the fi­nan­cial sys­tem into cat­a­strophic car­diac ar­rest. In the spring of 2008 Wall Street’s fifth-largest in­vest­ment bank col­lapsed, loaded with junk mort­gages and other ques­tion­able as­sets. Bear Stearns was hardly a linch­pin in­sti­tu­tion, yet the Bush ad­min­is­tra­tion de­cided to bail out the firm’s cred­i­tors. The two po­lit­i­cally pow­er­ful and reck­lessly run govern­ment-spon­sored en­ter­prises, Fan­nie Mae and Fred­die Mac, which were bulked up with sub­prime mort­gages, teetered dur­ing that sum­mer. Washington came to their res­cue. Then Washington let Lehman Broth­ers, a far larger and more im­por­tant in­sti­tu­tion than Bear Stearns, fail. “No more bailouts!” was the mes­sage. And then the first money mar­ket ever cre­ated, hav­ing be­come overly ag­gres­sive, was hit with losses. A run on money mar­ket funds, which had over $2 tril­lion in as­sets, en­sued. Si­mul­ta­ne­ously, AIG, the world’s largest com­mer­cial in­surance com­pany, needed a huge in­fu­sion of emer­gency cash.

Panic erupted as ev­ery­one clutched cash in des­per­a­tion. Washington re­versed course again, grant­ing fed­eral guar­an­tees for money mar­ket funds and bailouts for se­lected banks. AIG and Cit­i­group were, in ef­fect, na­tion­al­ized.

• An ac­count­ing rule be­came a weapon of mass de­struc­tion. In 2007 reg­u­la­tors res­ur­rected an ac­count­ing rule, dubbed “mark-to-mar­ket ac­count­ing,” that had been abol­ished dur­ing the Great De­pres­sion. Its ef­fect was to con­stantly and re­lent­lessly ar­ti­fi­cially de­press the value of bank cap­i­tal at a time when these in­sti­tu­tions were in pre­car­i­ous con­di­tion.

The Bush ad­min­is­tra­tion was ob­sti­nately obliv­i­ous to the per­ni­cious­ness of this de­cree. Fi­nally, in early March 2009, thanks to the ef­forts of a hand­ful of en­light­ened in­di­vid­u­als, the House of Rep­re­sen­ta­tives held a hear­ing that made it sharply clear that this edict had to go. Reg­u­la­tors got the mes-

sage and ef­fec­tively de­fanged the de­struc­tive rule that was threat­en­ing the very ex­is­tence of our bank­ing sys­tem. That put an abrupt end to the ter­ri­ble bear mar­ket that had bat­tered eq­uity av­er­ages by al­most 60%. The sub­se­quent bull mar­ket has gone on to this day.

This whole sorry episode un­der­scores an un­der­ap­pre­ci­ated tru­ism: Gov­ern­ments, not free mar­kets, cause eco­nomic calami­ties.

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