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Five Things: The Debt Crisis Is Not a Conspiracy


Why is everyone shocked to find the Federal Reserve doing exactly what it has always said it would do?


1. The Debt Crisis is Simple

Awash as we are in a sea of Federal Reserve- and Treasury Department-sponsored financial acronyms, it would be easy to assume the complexity of the debt crisis is beyond the comprehension of the average person. After all, who, apart from a wonkish cadre of financial engineering geeks, can be bothered with trying to sift through the details of things like the Primary Dealer Credit Facility or an array of seemingly sketchy repurchase agreements? Yes, it would be easy to assume the complexity is beyond comprehension; easy, but wrong.

Recently, I ran across a long-winded, chart-filled screed haranguing the Federal Reserve for single-handedly taking over the entire capital market. The claim actually made a certain kind of hysterical sense, perhaps because it appeared in bold typeface, even if it missed the point; outrage over the Fed intervening in equity markets is akin to expressing outrage over what color sack the robbers are using to haul away their loot. At what point did we all become armchair central bankers?

The reality is that the Federal Reserve is simply following the Irving Fisher debt-deflation game plan and doing exactly what the vast majority of US central bankers have always insisted they would be doing if trying to prevent a full collapse into a deflationary depression; that is, try and reflate.

2. When Did We All Become Armchair Central Bankers?

The various mechanics of this reflation attempt are only worth arguing about among armchair central bankers and the various banking system participants concerned with how big of a slice they're getting of the great reflation pie. For everyone else, things are far less complicated and, sorry to spoil a good conspiracy theory, far more bureaucratic and mundane. In order to understand it, let's go to the source.

Toward the end of the Great Depression, economist Irving Fisher outlined a nine-step sequence of events that followed a debt bubble, which became known as his Debt-Deflation Theory of Great Depressions. Believe it or not, the St. Louis Federal Reserve actually has available for download a very easy-to-read 21-page paper by Fisher outlining this theory here.

The paper consists of what Fisher called his "creed," consisting of 49 "articles." Among the most important for our purposes is number 20, covering "over-indebtedness":

Over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money. That is, over-indebtedness may lend importance to over-investment or to over-speculation. The same is true as to over-confidence. I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.

3. The Debt Bubble Sequence

In that brief article, Fisher handily summarizes why this is no ordinary recession. This debt bubble, over-indebtedness, was fueled by borrowed money, which was made too cheap for too long, and which resulted in massive over-investment, over-speculation, and over-confidence.

But everyone knows that. After all, it's how Alan Greenspan became a household name, appeared on the cover of Time magazine, and became known as The Maestro in the first place, and it's why all those accolades will ultimately be for nought as we continue to try and transfer the excessive corporate and public debt incurred during Greenspan's tenure, and which accelerated under Ben Bernanke, to government debt. More on that in a moment.

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