Introduction

Aside from biology and physics, economics is the science that is probably the most relevant to your daily life. But unlike those two sciences, which don’t require a conscious knowledge of their principles in order to make effective use of them, an inability to understand basic economic principles is quite likely to have a negative effect on various aspects of your life, especially in the present economic environment. In referring to these principles, I do not mean to indicate the colossal clashes of aggregate macroeconomic forces that occupy the headlines; while their interactions will have an effect on your employment, your bank account, and perhaps even your mood, there is no one who truly understands those great forces. In fact, the complexity of their abstract interactions is such that it may not even be possible for anyone to fully comprehend them. I am referring instead to the fact that whether you recognize it or not, you are an economic actor and most of your decisions, conscious and unconscious, have an economic aspect to them. Furthermore, even the smallest of your decisions will inevitably make an impact on the world around you.

At its core, economics is the study of value. The major differences between very different economic theories such as socialism and monetarism can be ultimately traced back to their competing definitions of what value is. This is admittedly not the usual definition of economics, but upon sufficient reflection, it will soon become apparent that every conventional definition of the science can eventually be factored down to a consideration of value. It does not matter if you consider economics to be the study of “the production, distribution, and consumption of goods and services”, “an agglomeration of ill-coordinated and overlapping fields of research” involving history, statistics, theory, sociology, and political economy, or even, as Xenophon defined it, “a branch of knowledge whereby men are enabled to increase the value of their estates.” All economics ultimately rests on the basis of a single question. What is value?

The great challenge of economics, and the ultimate source of its tremendous complexity, stems from the fact that value is a variable. Even worse, it is an extraordinarily complex variable that can be assigned a different valuation by every single potential actor that has the capability of interacting with a particular economic object or action. Even a series of actions as simple as getting out of bed, taking a shower, and eating breakfast necessarily involves thousands of intertwined economic decisions made by a literally incalculable number of economic actors, each of whom are affected, in turn, by the economic decisions you made in the 15 minutes it took you to shave, shower, and drink your coffee. The seemingly insignificant decision to hit the snooze alarm and sleep for an additional five minutes is an action of distinct economic impact with the potential to affect everything from the net consumption of domestic agricultural products to the amount of crude oil imports from Saudi Arabia.

In 1958, Leonard Read of the Foundation for Economic Education wrote “I, Pencil”, a story subsequently made even more famous by Milton Friedman in Free to Choose, in order to explain the power of the free market. He told of the amazing way the division of labor and international free trade combined graphite from South America with rubber from Malaysia and wood from Oregon in order to produce something as mundane as a yellow No. 2 pencil. The incredible thing, of course, is that all these diverse elements are produced by the cooperation of people without any central direction. And yet, this classic tale only told half the story, the half related to the supply side. The story on the demand side is arguably even more amazing, as the myriad assignments of personal value for a pencil made by the millions of people who buy pencils and by the tens of millions who elect not to buy them are all factored into an incredibly massive, but ever-changing computation that always manages to produce a definite price for every single transaction that takes place at millions of different points in the space-time continuum.

Of course, it is impossible to consider the potential economic aspect of all your daily actions; that way lies madness. And yet, there are many decisions that are well worth contemplating from an economic perspective even though they not usually considered to have much to do with economics. Decisions about attending college, renting, dating, marrying, home-buying, selecting a career, and propagating the species are all life-defining decisions. Each of these decisions has an economic aspect to them, and these economic aspects will often have a significant impact on the shape your life will subsequently take as well as the sort of economic decisions that you will face in the future. Unfortunately, few individuals ever take these economic aspects into account because they are seldom aware that they exist. This means they are also unaware of the probable ramifications of those decisions, to their probable detriment.

This lack of awareness is especially true of politicians, who the economist Adam Smith described as “assuming, arrogant, and presumptuous” and “great admirers of themselves”, a perceptive description that is as relevant in the age of Obama as it was in the age of Pitt the Younger more than two centuries ago. It is doubtful that Jimmy Carter and the 95th Congress ever had any idea that the Housing and Community Development Act of 1977 could eventually play a role in the great tremors that shook the American banking system in 2008, while 25 years later, George W. Bush similarly failed to grasp the likely consequences of his White House Conference on Minority Homeownership. And yet, despite the complex nature of most economic interactions, they are seldom as mysterious or as unpredictable as the financial media might otherwise lead one to believe with their frequent references to black swans and unforeseeable events. As evidence in support of this assertion, consider the words of one armchair economist written less than a month before President Bush announced his goal of increasing the number of minority homeowners by 5.5 million before 2010.

“There can be little doubt that the implosion of the equity markets will soon be followed by the pricking of the credit and real estate bubbles. As great financial houses such as Citigroup and JP Morgan Chase teeter on the edge of bankruptcy, it is well within the realm of possibility that the triple whammy of the equity, credit and real estate implosions will lead to the collapse of the entire global financial system.”

- Vox Day, “My Hero, Alan Greenspan”, September 23, 2002

In retrospect, it is obvious that the bipartisan push for increased homeownership through low interest rates and relaxed lending standards did not add the $256 billion to the American economy that was predicted by the Bush administration, but instead became an important factor in destroying four times that amount of wealth in 2008. What is less well known is that long before the subprime lending market erupted in 2004, it was already apparent to a few clear-eyed and contrarian economists that the housing market was possessed of the same irrational exuberance that had propelled the 1999 technology stock bubble to such gravity-defying extremes. Even before economic prophets of doom such as Marc Faber, Nouriel Roubini, and Peter Schiff became famous for their correct warnings of imminent crisis, Edward Gramlich, a governor at the Federal Reserve, told Fed Chairman Alan Greenspan that making home mortgages available to low-income borrowers would lead to widespread loan defaults having extremely negative effects on the national economy. This extraordinarily specific warning was given in 2000, amidst the wreckage of the dot com bomb and before the housing bubble even began! Needless to say, Greenspan rejected Gramlich’s recommendation to audit consumer finance companies on the basis of his fear that it might undermine the availability of subprime credit.

Since you are reading this book it has probably not escaped your attention that many of the same individuals who did not see the crisis coming are now loudly assuring the public that the worst is already past, whereas those who correctly anticipated it tend to be somewhat less optimistic about the future. Wall Street televangelist Jim Cramer boldly announced the end of what would be in historical terms a remarkably short depression on April 2, 2009. This was less than a year after he was recommending aggressive purchases of stocks with the Dow industrial index priced at 14,280. In early 2008, the current Federal Reserve chairman, Ben Bernanke, told the U.S. Senate Committee on Banking, Housing, and Urban Affairs to expect “a somewhat stronger pace of growth starting later this year”. It is perhaps worth noting, then, that the Bureau of Economic Analysis reported a year later that the American economy contracted at a rate of 6.3 percent in the fourth quarter of 2008, a strong pace of negative growth equivalent to the evaporation of $908 billion on an annual basis. That was hardly the Fed chairman’s first errant forecast; in October 2005 he told Congress there was no housing boom, and that a 25 percent price increase in 24 months simply reflected strong economic fundamentals.[1]

Of course, the credibility of these and many other famous mainstream figures is more than a little uncertain these days. The present crisis was not supposed to be possible in a world without a gold monetary standard. To paraphrase Franklin Allen, professor of finance and economics at The Wharton School, the problem is not so much that the experts missed the crisis as that they absolutely denied it would happen.

“We believe that the failure to even envisage the current problems of the worldwide financial system and the inability of standard macro and finance models to provide any insight into ongoing events make a strong case for a major reorientation in these areas and a reconsideration of their basic premises.”

− The Dahlem Report, February 2009 [2]

However, this book is not intended as a literary victory lap for a single obscure prediction made by a minor political columnist seven years ago. It is not a get-rich book, a survive-the-post-apocalypse book, or a thinly disguised marketing tool for a financial services company. Its purpose is merely to consider how, after more than 200 years of refining the science of political economy, we arrived in the present situation, and to reflect upon where we are likely to go next. My hope is that it will provide you, the reader, with a rational context that will help you make more informed decisions as you face the difficult challenges that lie ahead. It will also help you put the economic news reported by the financial media in a more historical perspective. Neither markets nor economies go straight up or straight down; adding to the degree of difficulty in understanding where they are headed is that the mainstream media from which we receive most of our information has an institutional memory that is measured in days, if not hours. Due to the large bear market rally that began in March 2009, many, if not most, economic observers are presently convinced that the global economic difficulties of last autumn are largely behind us now, courtesy of the aggressive, expansionary actions of the monetary and political authorities.

They are wrong. It is not over. It has only begun.

I believe that what we have witnessed to date is merely the first act in what will eventually be recognized as another Great Depression. The primary questions at this point do not concern if it will occur, but rather, the full extent of the economic contraction and how long it will take for the economy to return to its pre-contraction levels of wealth and employment once it is recognized to be taking place. In the historical case of America’s Great Depression, it was 1941 before the economy again reached its nominal 1929 GDP; it was not until 1954 that the stock market returned to its previous levels. It does not require a doctorate in advanced mathematics to realize that if the present contraction is of similar scale to the one that began 80 years ago on Black Tuesday, it may well be 2032 before this second Great Depression comes to a similarly comprehensive end.

For all that it is an important science, it must be kept in mind that economics is a relatively young one. The chaotic nature of its inherent complexity means that economics is almost as much art and intuition as scientific method and reason. While one can use economics to identify trends that enable one to predict the general course of events, one can seldom hope to correctly anticipate either their timing or their scope with any degree of accuracy. Throughout this book, I have made a number of projections about the future based on historical patterns, government-reported data[3] and economic models that I believe to be the best that economic theorists have made available to us. Because both the data and the models are known to be imperfect, and in some cases even intrinsically flawed, the specific details of these projections will almost certainly turn out to be wrong, although I hope they will hit reasonably near the target. Nevertheless, I have elected not to present these calculated conclusions in the usual Delphic manner favored by economists so as to cover all possible eventualities. To do so would be to destroy the clarity and usefulness of this book. Ergo, the ancient rule applies: Caveat emptor!

I have attempted to keep the use of technical terms to a minimum in the text, but because a certain amount of jargon is inescapable, a glossary of important concepts and oft-used abbreviations is available for reference in the appendices. While it is full of numbers, percentages, graphs, and tables, in the interest of clarity I have entirely omitted the algebraic equations so beloved of economic theorists as well as the calculus favored by econometricians. I have also presented the statistical references in the simplest possible terms, so there are no references to logarithms, regressions, or any other statistical methods that the untrained reader would be unlikely to understand. This is a book for economic actors, not the economists who study them.

I should also note that historical events have been largely described according to the conventional terms and measures utilized by mainstream macroeconomists. It is my intention that the reader first understand the present economic circumstances in the same manner with which they are presented to him in the media before he is confronted with any unorthodox perspectives. In other words, the fact that I often refer to the size of a national economy in terms of Gross Domestic Product should not be interpreted as contradicting any subsequent doubts expressed about the accuracy or the utility of the statistic reported on a quarterly basis by the U.S. Department of Labor’s Bureau of Economic Analysis.

Given its stark message, I do not expect that many readers will find this book to make for enjoyable reading, but I do hope that it will nevertheless prove to be worth the investment of time and money involved. And perhaps it will help to keep in mind that the old maxim about the value of keeping one’s head when everyone else is losing theirs applies as well to economics as it does to the field of battle.