The story will be instantly familiar to anyone who has read The Hitchhiker's Guide to the Galaxy: some of the world's most intelligent beings decide they want to know the answer to the Ultimate Question; they spend years creating an impossibly powerful computerized system to find it; eventually, the computer is switched on, whirrs into action and spews out its answer, which is… well, you probably know the rest. This time, though, the Ultimate Question isn't Life, the Universe and Everything, but rather How to Prevent Financial Crises. This time around, the supercomputer isn't called Deep Thought, but Early Warning System. Here in Istanbul, at its annual meeting this weekend, the International Monetary Fund will unveil a blueprint which, it is hoped, will enable policymakers to avoid the repeat of a crisis as nightmarish as that of the past two years. It is eagerly awaited – particularly by those, including Gordon Brown, who demanded an answer to the Question two years ago. But I gather they will be just as disappointed and perplexed as those who pinned their hopes on Deep Thought. – Telegraph
Dominant Social Theme: Wise men can see the future?
Free-Market Analysis: Boy, this is an exciting idea. The IMF, which until recently anyway, never met a country that it couldn't squeeze, is going to unveil a system that will predict financial crises. Since the IMF uses Keynesian (statist) analysis, we can't quite figure out how this will work. But we are interested to hear the details. Here's some more from the article:
At first glance, there is some merit to the idea of an early warning system for the world's financial system and economy. After all, markets failed to anticipate the crisis. Had you looked at the credit default swap markets, which were supposed to set out, in monetary terms, the risks facing the banking system, you would have been left with the impression that there were few better bets than the big banks. As we now know, they were catastrophically wrong.
Nor did the regulators do any better. But, tantalizingly, there were some who got close to predicting the chaos into which we have descended. Some British economists, newspaper pundits and even politicians warned about the fact that the housing market was looking dangerously precarious in the years leading up to 2007. Some (the Bank of England included) even said that banks stood to lose a hell of a lot of money because of their propensity to lend out sums they didn't have in their vaults. Plenty – apart, it seems, from the Treasury – were worried about the record levels of debt racked up by British households. Many warned of a virulent recession.
Yet no one managed to put all of this together and identify the precise chain of events that triggered it all. No one anticipated the collapse of Lehman Brothers – or, for that matter, that of the entire global financial system. Which is where the conception of an early warning system comes in: when the crisis erupted two years ago, Mr Brown and others argued that the International Monetary Fund should devise a way to amass all these warnings, sound the alarm at the appropriate moment, and work out precisely how governments should tackle the danger.
The problem is that the task has proved impossible. The system the IMF will introduce to the public on Sunday (actually they are calling it an Early Warning Exercise) is a far cry from the all-seeing eye envisaged by Mr Brown. It will not make predictions about forthcoming crises, but will merely – and privately – pinpoint certain "tail risks" to governments – potential ticking time bombs in their financial systems.
Readers of the Daily Bell will have figured out by now that we disagree with the above analysis. First of all, it wasn't a few "British economists, newspaper pundits and even politicians" who called the financial crisis. All you had to do was go on the Internet and read anyone of about 1,000 free-market sites, and you could have learned all you wanted to about what was bound to happen IN ADVANCE of the current crisis. The only people who were surprised were those who didn't read these sites – read by millions – or those who read the information but dismissed it as non-mainstream.
Second, the market acted as it should act. Fattened by a surfeit of easy money, the market went up. More money, more equity investment. That's an efficient market at work for you. Those who decry the efficient market theory are not taking into account the amount of money that markets are perennially stuffed with courtesy of central banks. Crashes occur when markets revalue not the amount of money in securities but the prospects of success for what has been done with all that money.
At the top of an equity boom, you've probably got 25-50 percent of fiat money invested in stuff that is not going to fly. Markets don't crash sooner because the investments have to be made first. But once they are made, and once the prospects become obviously difficult, as they inevitably will in a boom-bust central banking run world, markets subside. Again, there is nothing inefficient about this.
Finally, it is NOT impossible to figure out a way to warn about excessive risk. Anyone who uses free-market business cycle analysis can figure it out easily. Excessive risk takes place once central banks have re-ignited markets with excessive money printing — and that money is finding its way into the real economy. It will happen this time around as well. (There, we've made a prediction.) The trick of course is to get the TIMING right, and that is much more difficult because markets will call tops and bottoms not individuals.
The IMF doesn't need any fancy diagnostic tools to figure out if and when world's economy is suffering from a surfeit of risk. Its economists simply need to read Hayek and von Mises on the business cycle. These Austrian free-market economists, among others, explained quite clearly how central banks inflated the money supply, causing modern bubbles that in turn lead to risk taking and then disastrous busts. Books about this sort of analysis, and articles summarizing it are all over the ‘Net. All the IMF sages and political leaders have to do to educate themselves is to look. We fervently hope they will someday. If they do educate themselves, they may decide that a market-based gold and silver money standard will rectify much of what is wrong with today's economic environment. Then they won't need such diagnostic tools at all. They won't work anyway.