Montreal, April 15, 2008 • No 255




Chris Leithner grew up in Canada. He is director of Leithner & Co. Pty. Ltd., a private investment company based in Brisbane, Australia.




by Chris Leithner

          Little more than a year ago, an article splashed across the front page of the business section of The Australian (27 February 2007) profiled the chairman of one of Australia's most prominent brokerage firms. He congratulated himself, his firm, the financial services industry – and above all the allegedly rude health of stock and credit markets. "I should be beyond being surprised," the chairman enthused, "but I cannot believe how much money people have available for special opportunities. The level of liquidity amongst private clients is so much larger now than it has ever been."


          The article reassured readers that this chairman "has seen his share of stock market booms and busts – including the 1987 Crash – [and] does not see the current share market boom ending in tears." To be sure, "some parts of the Australian market are fully valued, but some of the leading companies such as BHP Billiton and Rio Tinto are very good value by any historical and fundamental standards. While global markets might pull back, they are actually quite cheap." The chairman concluded that the Australian market's boom since 2003 "is much more sustainable" than its predecessors; and thanks to China's meteoric rise, it rests upon stronger fundamentals than the booms of the past. "This one looks to be a lot more sensibly based."

          What a difference twelve months make! By 18 March, a date on which The Australian alleged that "global markets plunge[d] into a complete state of panic," the All Ordinaries Index had fallen 25% from the all-time high it reached on 1 November (6,853) to an 18-month low of 5,163. The speed of this descent was unlike anything since 1987. Accordingly, during the last quarter of 2007 the moods of many became brittle and during the first quarter of 2008 they became black. The Wall Street Journal (17 March) editorialised that the events of the weekend of 15-16 March (when the Fed arranged the sale of Bear Stearns to JPMorgan Chase and opened its discount window to securities dealers), "mark the latest historic turns in what has become the most pervasive financial crisis in a generation." In "We Will Never Have a Perfect Model of Risk" (The Financial Times, 16 March), Alan Greenspan – whose ability to escape responsibility for the destructive consequences of his actions is Houdini-like – reckoned "the current financial crisis is likely to be judged in retrospect as the most wrenching since the end of the Second World War."

Of Physicians and Investors

          How should bona fide investors react to the ructions of the past nine months? They could do far worse than to emulate doctors (real ones, that is: medicos and not posers like economists). If people who bought and sold securities thought and acted like physicians, they'd strive to cumulate valid and reliable knowledge.

          A physician's diagnosis is partly an association of a patient's outward signs and symptoms with an underlying disease or condition. A more advanced diagnosis is the culmination of a process of logical elimination. Just as a particular crime typically has more than one suspect, a given symptom can often be the consequence of more than one underlying cause. Hence the physician, like the detective, conducts various tests. The purpose of the diagnosis is to remove, insofar as possible, all but one "suspect" from consideration – and to "collar" a particular physiological or biochemical cause of a disease or condition.

          The history of medicine is the increase over time in the number of diseases to which diagnosticians correlate symptoms. It is also a rise in the number of maladies to which they can reliably attribute causes, and of treatments to which they can adduce consequences. Progress has not, by and large, been steady: sudden leaps and extended stasis seem to alternate. But modern medicine does not go backwards; that is, each generation can legitimately claim to know more than its predecessor.

          In that sense, medicine is a much more advanced and scientific endeavour than are mainstream finance and economics. In these relatively primitive fields, knowledge does not, by and large, cumulate. For decades, the mainstream has repudiated rigorous logic and compelling evidence; instead, the dead body of orthodoxy has prevailed, and grotesque fashions have risen and fallen like hemlines around a putrid corpse. The most striking thing about contemporary economists, if we regard them as an anthropologist would, is that their status within the tribe of economists is tied to a bizarre ritual (called "REE-search") and obscure documents (that are partly melodrama and mostly comedy), known as publications, that invariably contain "models." The purpose of models is not to subsume and explain the real world, but to use implausible assumptions and arcane methods that impress other economists.

A Refresher Course on Fractional Reserve Banking

          What on earth has this to do with contemporary economic and financial conditions? In order to comprehend what has happened, is now occurring and may eventually transpire in Wall Street and Main Street, it is imperative to remove distorting Keynesian spectacles and diagnose the world as our forefathers did – that is, through unimpaired (i.e., Austrian School) eyes. "To understand the nature of the worldwide Great Depression and the severity and greater length of the American contraction," said Gene Smiley in Rethinking the Great Depression: A New View of Its Causes and Consequences (Ivan Dee, 2002), "one must understand something of the nature and characteristics of money. Three essential features are banks and the creation and destruction of money; the role of the Federal Reserve System in creating and destroying money; and the gold standard and fixed exchange rates." Moving forward 75 years or so, sub-prime lending in the U.S. is not a cause of the ructions in credit and stock markets: it is a symptom (and hence a consequence) of bad policies, namely Keynesianism and fractional reserve banking. These policies misconceive the nature of money, ignore the supply of money and weaken banks. To diagnose our ills we must, like a good medical diagnostician, identify and carefully distinguish causes and consequences. Our forebears did just that. Alas, Keynes and his followers have spoiled our intellectual inheritance.

          The essence of modern banking is the arbitrage of risk: banks borrow from a group of people who are prepared to supply funds (depositors) and lend to another but not completely disjoint group (borrowers) who demand funds. In order to compensate depositors for the use of their funds, banks pay them interest; and to compensate for the risk that inheres in lending, banks charge borrowers interest. If they arbitrage successfully (i.e., receive more interest from borrowers than they pay to depositors, and recoup principal from borrowers and return it to depositors), banking is profitable. But banks cannot avoid the uncomfortable fact that they lend depositors' funds. Banks cannot repossess these funds instantly, yet depositors can demand their funds any time they wish. Such a bank cannot meet its obligations if they fall due. Accordingly, the bank that lends deposits is, always and unavoidably, technically bankrupt.(1) Fortunately for bankers, common law since the 19th century and contemporary legislation exempts banks from the normal requirements of solvency.

          A critical ingredient of banks' success or failure is the creation and destruction of demand deposits. A bank lends what would otherwise be idle depositors' balances by creating (or adding to) borrowers' demand deposits. Borrowers then write cheques in order to spend the borrowed funds. Demand deposits facilitate commercial transactions and are an integral part of the money supply. A depositor's signature on a cheque authorises his bank to pay a portion of his demand deposit to the cheque's bearer. Yet as Hazlitt, Rothbard, Smiley and a host of others have noted, a crucial difference distinguishes demand deposits from other types of money. By the late nineteenth century, banks in America, Australia, Britain and other countries had generally become "fractional reserve" banks. When a bank clears a cheque it debits a demand deposit; and when a bank's customer deposits funds into an account, the bank credits his demand deposit. Most of the time, the amount of currency paid when cheques are cleared approximates (and thus offsets) the amount received in the form of new deposits. Given that it is safer and more convenient to hold one's liquid funds in the form of a demand deposit in a bank rather than notes and coins stuffed under the mattress or buried in the back garden, and that it is usually more convenient to write cheques than to hold large amounts of currency, under normal conditions it is very unlikely that all or even many of a bank's depositors will simultaneously seek to convert their demand deposits into currency.

          Hence banks' incentive, which has been aided and abetted by two centuries of favourable decisions by courts, as well as protective legislation, is to undertake "fractional reserve" banking. Fractional reserve banks retain only a designated fraction of their deposit liabilities in their vaults (i.e., in the form of currency reserves); instead, they convert them into assets by lending most of them to borrowers. Banks lend in order to generate income to remunerate staff and meet other expenses, and to pay interest to their depositors and dividends to their shareholders. Other things equal (and assuming that the bank arbitrages successfully between depositors and borrowers, and that many depositors will not simultaneously seek to convert their demand deposits into currency), the lower the fraction of deposits held in reserve the more profitable the bank. At the same time, banks' perennial risk is that they lend imprudently or too aggressively (see in particular James Grant, Money of the Mind: Borrowing and Lending in America from the Civil War to Michael Milken, Noonday Press, 1994). Over the decades and centuries, a rough pattern emerges: the more profitable the bank, the more prone it becomes in a crisis to collapse.

Fractional Reserve Banking Ignites a Business Cycle: A Stylised Example

          A fictitious but still very realistic example shows how fractional reserve banking creates (and occasionally destroys) money, and thereby creates the boom that causes the bust. Let's assume that a gold miner extracts nuggets that are worth $5,000, and that a local mint transforms them into $5,000 of gold coins. Also assume that the miner deposits the coins (i.e., converts the coins into a demand deposit with a balance of $5,000) at his local bank. For convenience, let's refer to this bank as Bank A. Further, assume that the law requires that banks hold a certain minimum percentage of their deposits as cash reserves composed of either gold coins or currency (bank notes). More specifically, banks are required to hold 12.5% of their deposits as reserves; as a matter of practice banks retain some additional margin of reserves above the required minimum as a precaution against unexpected deposit withdrawals; and therefore banks normally hold 15% of their deposits in gold and currency. This amount sits either in the bank's vault or (much more likely) is a demand deposit at another (usually larger) bank. Accordingly, Bank A would retain $750 of the miner's $5,000 deposit in reserves and would seek to lend the remainder ($4,250) to creditworthy borrowers.

          If a borrower obtained a loan, then the bank would lend the money by creating a new demand deposit in the borrower's name (or by adding to the borrower's current demand deposit) in an amount equal to the loan. Once the bank had lent its new excess reserves of $4,250, it could make no new additional loans until it obtained additional excess reserves. But the story does not end there. Quite the contrary: it's barely begun. For simplicity, let us assume that a single firm borrowed the entire $4,250 and that it used this amount to construct additional space at its factory. Assume as well that this firm received the cheque for $4,250 and deposited it in its bank (which we will call Bank B). Bank B then sends the cheque to Bank A, where $4,250 is deducted from the borrowing firm's demand deposit and $4,250 (either in the form of currency or more likely a bank cheque) is forwarded to Bank B. Accordingly, Bank A no longer has excess reserves from the miner's deposit of $5,000.

          But Bank B has. More precisely, on its balance sheet it now has a new liability (namely a demand deposit) of $4,250 and a new asset (additional cash reserves) of $4,250; but given that it holds 15% of deposits as reserves it will retain only $637.50 in reserves against this new deposit. Bank B can lend its new excess reserves of $3,612.50 by creating (or adding to) a demand deposit for a borrower. When a second borrower spends the $3,612.50 and his cheque clears Bank B, this bank (like Bank A) would have no excess reserves available for loans. But Bank C has. Let us say that the $3,612.50 cheque is deposited in a demand deposit in another bank, and that this bank is called Bank C. It now has excess reserves of $3,070.63 and can lend this amount by creating (or adding to) a borrower's demand deposit.

"The essence of modern banking is the arbitrage of risk: banks borrow from a group of people who are prepared to supply funds (depositors) and lend to another but not completely disjoint group (borrowers) who demand funds."

          Consider the process thus far. A miner has mined $5,000 worth of gold and, after having it struck into coins, deposits it in Bank A. The new $5,000 of gold has been converted into a new demand deposit of $5,000 and the money supply has increased by $5,000. Because banks keep only a fraction of their deposits in reserves, Bank A lent the excess reserves and those became a new demand deposit of $4,250 at Bank B. Bank B then had excess reserves, which became a new demand deposit of $3,612.50 at Bank C. In a fractional-reserve banking system, the "hard money" of $5,000 (i.e., the gold the miner found) has set in train a process that has thus far increased demand deposit money by $5,000 + $4,250 + $3,612.50 = $12,862.50.

          But the process is not finished because Bank C now has excess reserves. This process of expanding the money supply through the creation of demand deposits can continue until all of the $5,000 in gold is transformed into required and precautionary reserves. Given a reserve ratio of 15%, the miner's production of $5,000 of money would eventually increase the money supply by $33,333.33 (i.e., $5,000 ÷ 0.15). Fractional-reserve banking always changes – and virtually always increases – the supply of money; in other words, it almost inevitably manufactures inflation. Further, the smaller the reserve fraction the greater the resultant change of the money supply (which equals the rate of inflation) Given this leverage, relatively small changes in reserves typically create much larger changes in the supply of money. Keynesians discount or ignore the supply of money; in sharp contrast, Austrians diagnose these changes of reserves and of money supply as the ultimate causes of the business cycle.

Fractional Reserve Banking and Monetary Disturbances in 1907

          Let's revisit an historical example that illustrates the problems – namely outbursts of volatility and instability – that necessarily accompany fractional reserve banking. Almost exactly a century ago, on 14 October 1907, an unusually large number of the depositors of five banks in New York City began to convert their demand deposits into currency. Their preference for currency over deposits exceeded the banks' ability to convert deposits into currency: trouble therefore brewed. On 21 October, the Knickerbocker Trust Co. experienced a severe "run" on its deposits and failed; and on the 24th, depositors at the second largest trust company in the City began a run on their deposits. Worried depositors at other banks began to convert their deposits into currency; in a chain reaction, concerned banks outside New York that held deposits with banks in the City now began to convert those deposits into currency and gold; and depositors at banks in other Eastern cities, observing the unfolding panic in New York, also began to convert their deposits into currency. By late October, a nation-wide banking panic (subsequently dubbed the "Panic of 1907") had developed.

          JPMorgan & Co.'s huge balance sheet, and the confidence it (and he) inspired, saved the day and eventually halted the panic. Thanks to Morgan's reserves, reputation and encouragements ("There's the deal," J.P. reputedly told the heads of other banks. "I'll let you out of my library when you've signed"), banks were able to stem the redemption of deposits into currency and gold. They continued to clear cheques and borrowers continued to repay their loans. Just as they had ended previous banking panics, these actions ended the Panic of 1907. But in its immediate aftermath, and as a safety precaution, banks increased the percentage of their deposits they kept as cash reserves. And depositors, for a while, held more of their capital in currency and less in demand deposits.

          Notice that, in order to rebuild their reserves – for example, to increase the percentage of deposits held as reserves from 15% to 20% – banks must reduce their supply of net loans outstanding. In other words, they must reduce the money supply and thus implement a policy of deflation. If borrowers repaid $100,000 of their outstanding loans, for example, then banks might create only $85,000 of new loans. Having reduced the supply of loans, they could also reduce the demand for loans by increasing interest rates or the terms and conditions of collateral and repayment, or by "calling" (i.e., demanding immediate repayment of) loans. Under these conditions the demand deposits destroyed by the repayment of old loans would be larger than the deposits created by new loans. Increasing the fractional reserve ratio thus tends to decelerate, halt and eventually reverse the growth of the money supply. The miner's new $5,000 in gold would result in "only" $25,000 of new demand deposits at a 20% reserve ratio versus $33,333.33 at a 15% ratio. At a 20% ratio, each dollar that a depositor converted into currency rather than held as a demand deposit would require that the banking system destroy $5 of demand deposits. At a 15% reserve ratio, each dollar of demand deposits converted into cash necessitates the destruction of $6.67 of demand deposits.

          Under a régime of fractional reserve banking – which, remember, is not a creature of the free market but is a government-imposed phenomenon underwritten by banks' exemption from the normal laws of bankruptcy – small changes in reserves beget large changes in the supply of credit. Sudden changes in the supply of credit, in turn, create instability in Wall Street and (eventually) booms and busts in Main Street. Fractional reserve banking not only fuels inflation and booms; the logical consequence of inflation and boom is deflation (a reduction of the money supply) and bust.

          In 1907, banks responded to October's runs by accumulating (i.e., not lending) excess reserves. The money supply subsequently stagnated and eventually shrank, the pace of economic activity (which had hitherto depended upon debt finance) decelerated sharply and prices (including the price of labour) fell precipitously. The rapid decrease of many prices, which was unrelated to the preferences and demands of consumers, drastically but temporarily weakened the ability of the price mechanism smoothly, accurately and efficiently to co-ordinate the actions of capitalists, producers and consumers. Only when the structure of production adjusted to these new and chastened conditions could prices transmit accurate signals, growth resume and prosperity return.

          In 1907, then, fractional reserve banking (the ultimate cause) and a monetary disturbance (the consequence of banking arrangements and the immediate cause of the crisis) transformed what might otherwise have been a brief and relatively minor contraction into a rapid and severe decline of economic activity that persisted until June 1908. During the late 1920s and early 1930s, much more severe, complex and extended monetary disturbances occurred. This turmoil, together with politicians' and policymakers' utter unwillingness to let the price mechanism operate freely, transformed what might have been a short and sharp contraction of the type that occurred in 1907 (and again in 1920-21) into a depression of unprecedented severity that lasted throughout the decade.(2)

The Panic of 1907 and the Credit Crisis of 2007-08: Plus Ça Change …

          Is the cause of a particular malady, the business cycle, known or unknown? Keynesians simultaneously claim two things. First, an "excess of aggregate demand" causes the upward leg and a "deficiency of aggregate demand" causes the downward leg. Businesses and consumers who seek to consume more than the government desires allegedly cause the boom, and businesses and consumers who obstinately decline to consume as much as their rulers demand cause the bust. The cure, they say, is interventionist monetary and fiscal policy, which allegedly lessens the severity of upswings and downswings.

          Second, say the Keynesians, no rational cause but rather the "animal spirits" of businessmen, underlies the business cycle. Because these animal spirits are ineradicable, palliative treatments (such as imprisoning businessmen in regulatory cages) are the most that can be expected. During the 1930s and 1940s Lord Keynes expressly denied, and today his heirs emphatically disavow, that monetary and institutional factors – particularly fractional reserve banking – cause financial and economic perturbations (see in particular Paul Krugman, The Great Unravelling, Penguin, 2005 and the excellent "Oh Keynesian, Where Are Thou?" by Mateusz Machaj).(3)

          Since the late 19th century, Austrian School economists have emphasised that in a fractional reserve system banks cannot quickly return cash to large numbers of depositors because the bulk of the deposits reside in an illiquid form, i.e., loans and income-earning securities rather than currency and gold. In an emergency, banks must turn to the strongest and most solvent among their ranks, if such a beast exists, in order to obtain cash quickly. In 1907 they turned to JPMorgan & Co., and in 2007-2008 they have turned to the Federal Reserve. If banks sell loans and securities in order to obtain cash for their panicky depositors, as they did a century ago and are doing again now, they depress the prices of the loans and securities. Under these circumstances the banks have even fewer assets to cover their liabilities, and risks to their liquidity (i.e., ability to convert assets into cash) and ultimately solvency (i.e., the ability to repay debt and other liabilities) rise.

          Hence the Fed's actions since August 2007: it has lent reserves to banks in exchange for collateral. The Fed is lending more reserves for longer periods of time, and is prepared to lend at lower rates of interest and in exchange for ever less pristine collateral. These actions give the banks time to purge and repair their balance sheets, i.e., to recognise bad loans and raise new capital, and thus to rebuild depleted shareholders' equity. The Fed, in effect, is underwriting the banks' day-to-day and least-risky transactions. As it did in the early 1980s and again in the early 1990s (and later reversed), it is undertaking a nationalisation-by-stealth of parts of the U.S. banking and mortgage industries.

          Critically, however, the Fed cannot increase assets relative to liabilities: it cannot, in other words, create shareholders' equity. Only savings can do that. Keynesians have always rejoiced that central banks routinely conjure money out of nothing; but they have never grasped that nobody can contrive savings from a vacuum. These days, where do savings reside? Not, by and large, in the U.S., U.K. or Australasia. To some extent they dwell in Canada and the Eurozone; but they mostly congregate in Asia and the Middle East. Americans flatter themselves that they are the world's most powerful nation. But aircraft carriers and military bases around the world may avail Americans little when Arabs and Asians finance them – as well as American banks and mortgages.

          The juxtaposition of the Panic of 1907 and the "Credit Crisis" of 2007-08 shows that the "American sub-prime crisis" is not a cause of the recent and current ructions in credit and stock markets. It is a symptom (and hence a consequence) of bad policies, namely Keynesian economics and fractional reserve banking. The sub-prime bust, the credit crisis and stock market ructions, in other words, are not "free market" phenomena: they are the consequences of meddling government. The correct prescription for these ills is not more government, legislation and regulation. Quit the contrary: it is drastically less of these harmful things.

          Alas, politicians, bureaucrats and market participants are so strongly addicted to interventionist medications that they simply do not recognise the harm these elixirs have done, are doing and (unless reversed) will continue to do. The mindset of one of Australia's most prominent financial journalists is typical. Noting on 4 April that "the collapse of the long-running bull market is revealing a series of errors of judgement that leave a nasty taste for all concerned," he concluded "we obviously will need extra regulations." Just as inanely, a former head of the Australian Stock Exchange and of a forerunner of the Australian Securities and Investments Commission was quoted in The Australian (also 4 April, which was clearly a great day for socialists in Oz), "the regulator needs to do more to prevent market manipulation by cowboys who believe they can drive a market down for their own benefit." Left unsaid, but implied, is that market manipulation by the Coalition for Inflation (which includes governments, central and commercial banks, regulators, borrowers and speculators), which believes it can drive a market up for their own benefit, is quite OK. Because they were clueless about the weakness of the Gilded Era from the mid-1990s, and are now oblivious to the causes of the crisis and ructions, the herd is demanding medicine that will exacerbate rather than ameliorate the problem. The trouble is that bad policy caused this mess. So how can more of the same resolve it?

          The most idiotic comments of all were uttered by folks who sought to ban one or another or all types of short-selling. During February and March, short-sellers played the same role in Australian (and to a lesser extent British) financial markets as witches did in colonial Salem: that is, they were scapegoats and innocent pawns. Fortunately, sane articles about short-selling appeared amidst the dross (see in particular "Tighter Shorts May Put the Squeeze on Those They Are Supposed to Protect" and "The March Against Shorting"). A letter to the editor of The Australian (2 April) about short-selling was unintentionally very wise. "There should be an immediate Government declaration that, pending enquiries, all parties are on notice that for every dollar lost a dollar will be demanded from those who have benefited. And that there will be no legal loopholes, that there will be severe penalties for those who do not return their undeserved gains." Why not apply this admirable rule to the government and its henchmen, and to politicians and their mascots, as just desserts for their lying, stealing, cheating and killing?


From the foregoing analysis emerge seven major points for investors:

1) Many journalists, market commentators and the like are manic-depressives. Their sudden and diametric changes of mood, together with their sheer contempt for logic and evidence, should be taken no more seriously than Commies' and fellow-travellers' demented twists and turns during the late 1930s and early 1940s. Like politicians, Redshirts and Brownshirts, so too mainstream economists and commentators: regard them alternately as evil and as objects worthy of nothing but ridicule.

2) In order to comprehend what has happened, is now occurring and may eventually transpire in Wall Street and Main Street, it is imperative to remove distorting Keynesian spectacles and diagnose the world as our forefathers did – that is, through unimpaired (i.e., Austrian School) eyes. This allows us to see something that the manic-depressive herd cannot or will not see: namely that sub-prime mortgage lending in the U.S. has not caused the ructions in credit and stock markets. The sub-prime fallout is a symptom (and hence a consequence) of destructive policies, namely Keynesianism and fractional reserve banking.

3) Modern banks, i.e., fractional reserve banks, lend depositors' funds. They cannot repossess these funds instantly, yet depositors can demand their funds any time they wish. Such banks cannot meet its obligations if they fall due. Accordingly, they are always technically bankrupt.

4) Fractional reserve banking links Wall Street to Main Street. It not only ignites the boom that causes the bust: it spreads the virus from financial to the real world. It did so in 1907, and also in every subsequent exclamation of the business cycle including 2007-2008. During today's bust, the Fed can buy commercial banks some of the time they need in order to repair their wounded balance sheets. But it cannot increase banks' assets relative to liabilities: it cannot, in other words, create shareholders' equity. Only savings can do that.

5) In order to restore their finances to order, banks must raise billions of dollars of capital. Their demand for savings will raise its price, and their caution will increase the price and stiffen the terms of loans. These actions will put downward pressure upon corporate earnings (including banks' profits), and therefore upon the prices of securities and financial assets.

6) The next decade will resemble the 1970s rather than the 1930s. It may well include recession and falling asset prices, together with rising consumer prices and interest rates ("stagflation"). The poor policies of the past decade are once again coming home to roost, and the growing clamour for more intervention will simply add to the downdraught.

7) Fractional reserve banking is not a creature of the free market: it is a government-imposed phenomenon. Hence the sub-prime bust, credit crisis and stock market ructions are not free market phenomena: they are the consequences of interventionist government. The correct prescription for these consequences of bad policy, therefore, is not more of the same bad policies. Quite the contrary: it is drastically less government expenditure, financial legislation and regulation. The abolition of corporate regulators and central banks would provide a good start.

          Where are stock market indices heading? I don't know, but the analogy of Daniel Turov ("Mixed Message," Barron's 21 May 2001) makes much more sense than the relentless cacophony emitted by most journalists, "market strategists" and other babblers. "Bear markets don't act like a medicine ball rolling down a smooth hill," said Turov. "Instead, they behave like a basketball bouncing down a rock-strewn mountainside; there's lots of movement up and sideways before the bottom is reached. During the Great Bear Market from 1929 to 1942, the Dow Industrials had rallies of 48% (from November 13, 1929, to April 17, 1930), 94% (July 8, 1932, to September 7 of that year), 121% (February 27, 1933, to February 5, 1934), 127% (July 26, 1934, to March 10, 1937), 60% (March 31, 1938, to November 12 of that year) and 28% (April 8, 1939, to September 12 of that year). Yet, on April 28, 1942, the DJIA was still at only 92.92, 76% below its September 3, 1929, high of 381.17."

          Turov adds "when the bulls stop asking 'is this the bottom?' and instead are explaining to their friends why 'this time it's different, and the market really is a bottomless pit,' then it will be time for me to pen 'Buy Signal, Part 2.' But we're a long way from that." His conclusion applies just as much to Australia as to the U.S. As such, it should – but probably won't – give the Australian herd pause: "the Dow first reached the 100 level in January 1906. It traded above and below that level for more than 36 years; it wasn't until May 1942 that the market left 100 behind for the last time. The Industrial Average first reached 1,000 in February 1966. It traded above and below that level for the next 17 years, leaving that figure behind for the last time in February 1983. The Dow first reached the 10,000 level in March 1999. Considering the unprecedented gains of the past several years, would it be that unusual for this benchmark to take a decade or even two before leaving 10,000 in the dust for the last time?"


1. For readable overviews, see in particular Murray Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II (Ludwig von Mises Institute, 2002); Vera C. Smith, The Rationale of Central Banking and the Free Banking Alternative (The Liberty Fund, 1936); and Lawrence White, Free Banking in Britain: Theory, Experience and Debate, 1800-1845 (Institute of Economic Affairs, 1995).
2. In addition to Gene Siley’s book, rigorous, readable and Austrian (or Austro-friendly) analyses of the Great Depression include Chaps. 9-10 of Thomas DiLorenzo, How Capitalism Saved America (Crown Forum, 2004) and Jim Powell, FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression (Crown Forum, 2003). The best analysis remains Murray Rothbard, America’s Great Depression (Richardson & Sndyer, 1963). For solid analyses of Franklin Roosevelt’s malevolence and the catastrophes, foreign and domestic, he wrought, see Thomas Fleming, The New Dealers’ War (Basic Books, 2001) and John T. Flynn, "The Roosevelt Myth," Fox & Wilkes, 1948).
3. Lest you think I am describing a straw man, consider this gem – written by a senior fellow at a think tank, not a letter-to-the-editor – from The Australian (8 April): “Private investment is the critical driver of business cycle phenomena in market economies. When the private sector is optimistic about the future, high investment takes place. To the extent that investment is controlled by a socialist government, it tends to be more stable, but as countries step out of the shadow of socialism, there is a bigger role for the private sector in decision making about investment. This leads to business cycles.”