Understanding the Economy

I read it!  The whole thing -- comments included!

I think Tom's explanation is reasonable.  What I gathered, is that our system is extremely precarious, and any tiny impact in one part of the economy can bring down giants.  The solution he suggests doesn't follow from the problem.  He links the initial problem back to Fannie and Freddie and government involvement with both institutions.  Then he goes on to say that the government should have regulated businesses that tried to profit from the governments involvement.  It turns into a circular argument! How is more government intervention going to fix what government intervention caused.!?

Here's the story: government creates an implicit guarantee of subprime loans.  The value of our dollar is linked to the populace's trust of the US government – hold this thought.  Since the government is perceived as trustworthy, inverters flock to the high returns and perceived low risk of subprime mortgage securities. This creates a bubble.  The bubble pops when investors realize that housing is severely overpriced.  The value of housing drops, and millions of Americans are left with debt that was drawn against a deception -- they now have nothing to back their huge debt.  Foreclosure ensue, and investors begin to fail.  Everyone turns to the US government for fulfillment of their implicit guarantee.

But it turns out the US government can only fulfill their implicit guarantee by borrowing and inflating (printing more money), which they do.  So they buy up all these bad loans at a price nobody is sure of.  But, the money to pay these debts doesn't come from an increase in the money supply due to a growth in the economy, it comes from excessive inflation and increased debt.  So it turns out that the US government wasn't deserving of trust, and if the US government isn't deserving of trust, then the dollar isn't sound, nor are loans to the US government.  So it's just a matter of time before folks make the connection and faith in the dollar fails.  When this happens, the world economy collapses due to the dollar's deep global ties. We have not hit the bottom as some may predict. (Watch these same guys predicting the bottom back in 2006.   Peter Schiff, an Austrian economist, rightly refutes them.)

I think some government officials are well aware of the dollars impending demise.  I'm watching for a new money standard to emerge, but I don't expect it to be better than what we have.  It will only be an attempt to bolster value by improving people's perception – and it will probably work on the short term.

There is one interesting thing that Austrian economists and Keynesian economists seem to agree on: nobody knows the proper price of these bad mortgage securities.  But, only the Austrian economists can explain why.  In fact, Ludwig von Mises showed why in his explanation of why a socialist economy is impossible: there is no way for central planners to know the correct prices of commodities; only a free-market economy can do this.  (Here's a great explanation from Joseph Solerno.  It's about 50 minutes, but well worth the time.) 

Since the US government has intervened in the subprime mortgage debacle, nobody really knows the true value of these securities. This is exactly the problem that started the whole thing in the first place.  The government's implicit guarantee to back subprime mortgages, and the creation of Fannie and Freddie, impeded the market's ability to correctly gauge prices.  This created the bubble; this created the burst; and doing more of the same will only hurt the economy in the long run.