22 Oct 2008

Scott Horton Interviews Murphy on Credit Default Swaps, etc.

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This interview is another long one–you people are probably wondering how I get anything done. What’s good about these ones is that Scott and I are close enough that if he sets up a premise, I’m not afraid to disagree with him.

Incidentally, in our original interview Scott asked me whether things would have been different had the Fed tried to do a “soft landing” after the Greenspan stimulus. (I’m not sure if this portion was retained in the edited version linked above. And my computer is messed up and I can’t just listen to that portion of the interview to check.) I explained that that is exactly what they tried to do. As the graph below indicates, they raised the rates back up very gradually, and they made sure the markets knew exactly what was coming.

This episode really underscores the importance of capital theory. If macroeconomics were really just about aggregate spending and “the price level” and so on, then the Fed did a great job handling the dot-com crash and then 9/11. In fact, that’s why they hailed Greenspan, and why so many supply-siders were so bullish for so long. (After all, Bush cut taxes, and the markets were fairly deregulated.)

But subscribers to Austrian business cycle theory knew that the housing boom had sown the seeds for a recession. The entire world’s capital structure was altered into an unsustainable condition by the injections of central bank funny money. If the Fed had kept rates at 5.25 percent back in September 2007, the US would have entered a sharp recession. (On the bright side, we would probably be through the worst of it by now.) But instead the Fed started cutting rates and–more important–giving lifelines of artificial credit to all of the needy bankers. The economy has been limping along in a state of denial ever since.

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