Von Mises On Government Intervention In Credit Markets

Yesterday I wrote this politically-oriented post on my companion blog, musing whether or not the Federal Reserve System violates the Constitution. The post was sparked by reading a Wall Street Journal editorial this past weekend by Mark Spitznagel. Spitznagel runs Universa, a California-based hedge fund group which now counts Nassim Taleb as one of its close advisers/employees.


Sometimes it takes a single article focusing on a single phenomenon to make me see that phenomenon in a new, and usually more appropriate light.


In this case, it was Spitznagel's citing Von Mises as having predicted the Great Depression simply by reasoning through how government-forced monetary base creation and rate manipulation inevitably lead to damaging distortions in the capital markets.


It was Spitznagel's description of how government intervention in capital markets, via excessive money and credit creation, which I quoted in that other post, that really illuminated the problem for me.


How is it that yesterday, Monday, November 9, 2009, we witnessed a 2%+ rise in the major US equity indices simply because the G20 finance ministers announced over the weekend that they will continue to hold rates at absurdly, unsustainably low levels, while continuing to spend borrowed or printed money on stimulus programs?


Did we not struggle through immense financial and, now, non-financial economic pain, beginning in mid-late 2007, precisely because Alan Greenspan cut and held rates at unsustainably low levels beginning post-9/11, 2001? And Ben Bernanke responded to the 2007 softness in mortgage-backed bonds by cutting rates again?


Viewed more clinically, as Spitznagel does, from the distance, through time, of Von Mises' work of the early 1900s, it's easy to see that any significant government intervention in capital/credit markets only distorts investors' and savers' intentions, causing havoc.

In this post, from last October, I discussed Anna Kagan Schwartz' interview in the Wall Street Journal. She, too, decried the Fed's creation of excess liquidity, arguing that the only issue was which banks were solvent, which was easily solved by closing the insolvent ones! Simple, and non-capital market distorting.

Alan Reynolds wrote a brilliant analytical piece in the Journal back in September, on which I commented in this post. In part, I observed, in answer to the question Reynolds posed in his piece as to why recessions became longer and more severe with increased government intervention,

"Why do you suppose this is true? What is it about large-scale government intervention that causes recessions to be longer and deeper?

I would guess it is two factors.

The first is the distorting effect of government, which is to say, political meddling with price, demand and supply signals in an otherwise-free market for goods and services. Reading Amity Schlaes' excellent history of FDR's economic failure, "The Forgotten Man," brings home how destabilizing and distorting massive government economic intervention is. Investors hold back, worried about the shifting rules governing the context of their investments. Which industries will government punish or radically regulate next?

The second is the nature of recession-based government legislation. Typically, it involves two things- printing or borrowing large amounts of money on the citizens' behalf, and creating or enriching transfer payment schemes.

The first action leads to higher taxes, crowding-out of private investment, and higher interest rates down the road. None of which are necessarily healthy for the private sector, or a country, as a whole.

The second action slowly, inexorably overlays a drag on economic activity, as new claims on behalf of non-producers are made and collected by big government. This saps savings in order to transfer wealth to those who consume without creating value in the economy. This additional marginal tax, in the form of items like FICA, predictably depress marginal economic activity across many income levels.

These transfer payment schemes are rarely reduced or eliminated, so, over time, you probably have an accretion of this economic drag on productive private sector activity."

Without knowing it, my first point was echoing Von Mises' own theory and observations.

Since my primary research inspiration and influence for over a decade has been Joseph Schumpeter, another, perhaps more well-known member of the Austrian group of distinguished, turn-of-the-century economists, I'm very open to learning more about Von Mises. I ordered the book to which Spitznagel refers for my business partner and myself just after reading his editorial.

As I noted at the beginning of this piece, reading Spitznagel's laser-like citation and description of Von Mises' explanation of the dangers and bad outcomes that result from significant government intervention in credit and capital markets caused me to stop and view the past decade of US monetary policy in horror.

Right now we are seeing more distortion in capital markets from wrongheaded Fed policy. After having induced, with the collaboration of bad federal Congressional and administration policies since 1996, bad mortgage lending with low rates since 2001, the Fed has returned to the same economy- and credit-wrecking interest rate policies which caused our problems in the first place.

As I noted in that political blog post yesterday, both William McChesney Martin and Paul Volcker, the only Fed chairman who are truly revered, earned that reverence by persevering in raising rates in the face of intense criticism. Both put the US economy on track for a long period of prosperity, until it was undone by lesser chairmen.

Who believes that today's zero Fed funds rate and excessive US deficit spending can possibly be healthy for the US economy? Spitznagel reminds us that Von Mises warned of such irresponsible forcing of savers' and investors' hands. Holding rates so low and creating so much credit necessarily leads to bubbles and lending to unworthy business projects. The only outcome is loss and more economic pain.

How can Bernanke be so blind as to fail to understand that he is now repeating what his predecessor did, with likely the same result in the not too distant future?