So far, in reading chapter 2 of Meltdown, we already identified four responsible sources for the 2008 housing bubble: government-sponsored enterprises, the law, speculation, and rating agencies. In this article, we will add two more: tax code, the Federal Reserve and its monetary policy.
In explaining the role of tax code, Tom Woods identifies it as just one example of government's numerous programs to motivate people to borrow and buy houses that artificially increased the demand for housing. Other programs include favors that developers enjoyed such as "free land" and "new roads". The US government did this "at the federal, state, and local level" (p. 24).
Tom Woods is in favor of "tax breaks". However, for him, this should be indiscriminately applied, unlike the one used that popped up the housing market. Two examples of arbitrary implementation of tax code include "a $5,000 credit" for "first-time homebuyers" and exemption from capital gains tax if someone "bought a house for $5000,000 and sold it for $1 million" (p. 25). But if you invested similar amount in the stock market or in a business, capital gains taxes applied to you.
The Federal Reserve and Its Monetary Policy
A complete understanding of the business cycle is impossible without seeing the role of the Federal Reserve. This is the common blindspot among mainstream intellectuals. In explaining business booms and busts, they left out governments and central banks. They failed to see that increase in the money supply pushes down interest rates that creates business boom. The construction and real estate bubble can be traced back to this root.
The increase in money supply, popularly known as credit expansion, quantitative easing and stimulus package does not come from saving or capital accumulated through time, but creates demands not based on genuine consumer demand, and that is why it is described as artificial. It is therefore not accurate to call this system free market for it originates from government interference. This act diverts resources from one sector of the economy into another sector.
In times of boom, it is difficult to distinguish sound projects from unsound ones. The money created from 2000 to 2007 found way into the housing market and made it grow. "Get-rich-quick scheme," excessive optimism, and taking risky decisions became popular. When the housing bubble burst out, the speculators were singly blamed, but the Fed escaped public attention.
This disastrous event had parallel in the past. Woods mentioned the 1819 Panic and the "credit-induced boom from 1914 through 1920". Quoting Fred Garlock, Woods describes the 1914 to 1920 period as characterized by extravagance, speculation, unusual profits, business boom, and "borrowing for the purpose of relending" (p. 28).
I am not familiar with the US story of credit expansion from 1914 to 1920. I thought Woods was referring to Germany's experience during WW1 that ended in 1921 to 1923 hyperinflation. But he was referring to American history.
Reading this section of the book, it remains fresh in mind what the Federal Reserve did after the housing bubble. It issued a series of QEs. After 7 years, the European Central Bank joined the QE party by purchasing 50 billion euros per month until September 2016. Switzerland anticipated this action that caused it to disconnect itself from the European monetary union.
The impact of the 2008 housing bubble was not only confined on US shores. It rippled throughout the global economy. How about the effect of ECB's QE? Will it not find its way into the Asian market? If it does, what will be the extent of its impact on different sectors in Asian economy?
One news article states that the impact of ECB's QE will be felt in Philippine stock market this March 2015. Is this a development that investors and traders to celebrate? Or is this leading to the path of illusory growth?
How I wish that the US "Audit the Fed movement" be realized in our time. I also want to see it shutdown.
1. Briefly describe the role of tax code in the growth of housing market?
2. Why is this growth a bubble?
3. Why is it important to understand the role of the Fed in explaining business boom?
4. How would you characterize the business boom period?
5. Do you think that the monetary policy used by both the Fed and the ECB beneficial to nations' economies? Why?
Source: Wood, T. E. Jr. (2009). Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Washington, DC: Regnery Publishing, Inc.