George Copper writes in “The Origin of Financial Crisis” that our economic thinking is regimented for failure in a world that is more influenced by the bubbles in financial assets.
The efficient market hypothesis contends that prices find their natural levels from the normal forces of supply and demand. This is true, Cooper contends, for market items and services such as cars, bread and auto repair, but it is largely untrue for financial assets. We have seen that rising prices for houses incites a boom that attracts more buyers. Once could argue that perverse government incentives also drove the housing bubble, but this is also true of other financial assets. During the gold boom in the 1970’s unit sales peaked at the market top, the opposite of a true supply and demand curve.
He notes that the central banks in Europe worry more about fighting inflation because of the impact it had in the road that led to World War II. Our Central Bank worries more about a Depression since that segment of our history haunts us more.
Cooper contends that the bank would be wiser to control credit creation than the money supply for it is the excessive amount of credit that creates our bubbles. Our system demands that the bank maintain credit levels to sustain business peaks. We would be wiser to deflate credit induced bubbles more frequently and earlier to avoid bigger more destabilizing bubbles later. It is our inability to accept the smaller pains that led us to the larger pain we face today.
Our regulation is targeted toward the last crisis and does not address the next one. The tighter accounting standards in reaction to the dot.com bubble did nothing to stop the housing bubble.
Cooper suggests that instability is not necessarily bad; we would probably prefer a volatile growing economy to a stable stagnant economy.
William McChesney Martin, the longest serving head of the U.S. Federal Reserve , famously suggested, “The job of the Federal Reserve is take away the punch bowl just when the party gets going.”