Paul Krugman wanted a housing bubble in 2002

Victor Joecks

And, as Nevadans know, we got it.

The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

So let’s review. In 2000/2001, the tech bubble burst and 9/11 happened. Both had negative impacts on the economy.

In a free-market system, recession (or at least a slowing of the rate of economic growth) would have occurred. Now, no one likes recessions. They cause individuals and families stress, anxiety and worry. But recessions are also necessary to avoid the kinds of deep economy problems we are having now.

During recessions, in a free-market system, the economy moves money and jobs from low-performing areas to higher-performing ones. And when I say “the economy,” I mean millions of individuals acting in their own self-interest. The economy isn’t a giant organism that has a mind of its own.

This reset is necessary and healthy, because resources (natural resources, products and people) are scarce. Keeping limited resources in low-value sectors of the economy and not allowing them to move to high-value sectors limits economic growth.

To use an analogy, it’s like pruning a tree. In the short term, the tree is smaller, because you’ve cut back in some areas. But those cut backs are necessary to stimulate growth in the long term. Without those cuts, the tree won’t grow as large and may even die.

Let’s also use automobiles as a historical example. Before cars, people still needed transportation. They just used horses and buggies. As cars replaced the horse and buggy, the horse and buggy manufactures were hurt. Consumers no longer needed their product (at least not on such a large scale). Employees lost jobs. Large businesses closed or were forced to retool. This is the kind of economic reordering that happens everyday in the free market. And for consumers, it’s good that this happens.

Unfortunately, the government often prevents the necessary corrections from happening.

While it’s good for consumers in the long run for recessions and corrections to happen, economic downturns can be painful in the present. And politicians, citing misguided economic theories, are eager to look like they’re doing something to help. Politicians offer bailouts and stimulus packages that they claim will jumpstart the economy and decrease unemployment.

While stimulus packages, bailouts and creating bubble markets may work in the short term, they do not create sustainable economic growth. This is because scarce resources are not transferred from low-value products to high-value ones, as explained above.

Politicians or the Federal Reserve guided by Keynesian economics, pay little attention to the idea of long-term consequences. Unfortunately, for politicians this often makes sense for selfish reasons. Politicians want to get re-elected. By the time long-term consequences hit, it is likely a different politician will have to take the unpopular steps to deal with the mess they have created. Ironically, the politicians who actually created the mess may be remembered fondly for the good times they oversaw. The Federal Reserve faces political pressure to make sure the economy keeps going strong.

Because politicians and the Federal Reserve bowed to the political pressure in 2002 to improve things in the short run, we are now suffering the long-run economic consequences.

The stimulus bill and bailouts are simply a doubling down on our past mistakes. We must let individuals in the market shift scarce resources from low-value products to high-value ones, or our long-term economic growth will continue to be stunted.