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On March 30, 2009, Harvard and Princeton professors Coval, Jurek, and Stafford released a paper concluding what I, as a proponent of the Austrian School of economics, have been saying for quite some time.  The Austrian School of economics bears its name because its genesis goes back to its intellectual fathers, who came from Austria.  While the analysis of this paper isn't entirely Austrian, the conclusions are 100% in agreement with the Austrian School.  It is encouraging to see academia echoing what would have been the prevailing sense of paleo-academics not even a century ago.

I have written extensively about the pathological origin of the economic crisis and the way out.  Because the format of my writing has been in brief and easy-to-understand language, much of my analysis is fragmented into a plurality of different commentaries.  When my commentaries are juxtaposed with one another, I believe they serve as a fairly good primer on economics.  Over the next several days, weeks, and months, I will be posting links to my commentaries.

Without belaboring the details, as I have in my commentaries, I will provide a condensed version of the problem as I have seen it:

1) A policy of inflation - i.e., an expansionary monetary policy - is unsustainable over the long-run.  Inflation engenders malinvestent and malconsumption, creating pseudo rates-of-return.  Either we abandon inflation as a policy, or the currency itself goes bankrupt.  Inflation can only work in the short-run, and only for a narrow group of beneficiaries, at the expense of producers and savers.

2) Over the course of years, the smallest amount of inflation will lead to an outflow of capital, draining bank reserves, and leading to national insolvency.  Whether the inflation is 2% or 10% is inconsequential.  It is a matter of whether or not we blow through our savings by the 5th of the month or the 15th of the month.

3) The problem is not illiquidity, i.e., a dollar shortage.  The "liquidity" is out there, i.e., in foreign reserves.  Inflationary regimes have inherent dollar leakages, which is why inflation bankrupts a nation.

4) As the result of inflationary-induced, artificially-low interest rates, the loan market became insolvent.  The problem is not a "credit crunch," but a savings crunch.

5) There is a confusion about cause and effect.  The way to fix the problem is not to inflate and spend more in an effort to fix prices.  What people perceived as good, i.e., cheap credit, was what precipitated the crisis.  Bailouts of any kind only hold prices artificially high, engendering even greater misallocations of resources.  The solution is what the perceived problem is: deflation.  Let prices fall, so that the market can discover real prices.  Only then will assets begin to clear the market again.  The best way to protect bank reserves is not to re-create vanishing savings on a printing press, but to raise interest rates.

6) As long as we continue down the present policy path of trying to substitute a printing press and government spending for income-generating investment, there will be no economic recovery.  Lost jobs will not be replaced.  Interest rates will go even higher than where they would be absent central bank manipulation, as the market accounts for the inflation risk.

See:

Geithner Wrong, Crap Assets Correctly Priced, Say Harvard And Princeton Profs

Uncle Sam’s suspect diagnosis