Market myths

The current financial crisis is causing the conspiracy theorists and self-taught economists to emerge from all the dark corners and crawly undersides of the political landscape. I am not going to pick on any one blog post, because the errors are too common. But I think it's worth explaining why some of the more lunatic theories are wrong.

Item One: The Iraq War did not cause this problem

Iraq is probably contributing somewhat to headline inflation. But it is contributing by making oil somewhat more scarce, thanks to production shortfalls and hoarding by speculators. Real factor scarcity does not create the kind of inflation that touches off asset price bubbles. Only inflation of the money and credit supplies, by giving speculators money to borrow and spend on their favorite asset, has the (arguable) power to create these financial manias.

Nor does the government's borrowing create these bubbles. If anything, it mitigates them by soaking up excess capital from the markets and thus raising interest rates higher than they would otherwise be. Essentially, the government took money out of the housing market and used it to blow things up in Iraq. Bad for Iraq, but probably good for the financial markets.

Item Two: The Bush tax cuts also did not cause this

As noted above, government budget deficits do not create financial manias. What the tax cuts gave to the economy in terms of stimulus, they took back in the form of higher interest rates.

Moreover, there's a strong argument to be made that the Bush tax cuts actually exerted some downward pressure on house prices. That's because when the tax rates fell, the value of the mortgage interest tax deduction also fell. Some of the money that people got back in the form of lower taxes probably went to the housing market, but you have to net out the amount of money leaving the housing market as the tax deduction became less valuable.

Item Three: Being on the gold standard would also not have prevented this mess

There are a lot of hucksters out there writing books and newsletters telling people that a gold standard (or some other commodity currency) is the cure for all their worries. The way they tell it, "hard" currency is a sort of broad-spectrum economic snake-oil, the ginseng of the financial markets. Only adopt their plan, they beseech, and America will no longer be plagued by exchange rate fluctuations, government profligacy, trade deficits, inflation, speculative mania, financial panics, or indigestion. This is triple-distilled balderdash.

There is nothing wondrously transformative about pegging your currency to the atomic weight of 196.97, or any other magical metal. America managed to have a regular supply of speculative booms and spectacular busts throughout the nineteenth century despite the soothing presence of gold in our money supply. The international gold standard in the 1920s and 1930s was marked by speculative mania, catastrophic deflation, competitive devaluations, massive exchange rate and trade imbalances, and of course the worst economic contraction in living memory. The depth and duration of which, I must point out, many economists attribute to America's fierce determination to defend her currency.

Presented by

Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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