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An Economy in Crisis

 September 16, 2008 10:10 AM
 


Ok, Ok, so I haven't published in a long time. Between the kids, and a surgical Sub-internship, I've been a little bit preoccupied. However, I think that it's time for another post. This will lean a little more towards economics than healthcare, but I think that it's crucial at the current juncture to understand what is happening in the economy.

Yesterday, the Dow Jones Industrial Average (DJIA) crashed down over 500 points, the worst loss since trading resumed after 9/11. Financial giants Lehman Bros. and Merril1-Lynch essentially fell apart, with one going into bankruptcy and the other being bought out. AIG and Wachovia are still looking a little shaky. The government has actually seized control of Fannie Mae and Freddie Mac, the largest government takeover of companies ever. Gas spiked again in the face of plummeting commodity prices, especially oil. What's the deal?

The History

I think that many people fail to grasp the significance of what has just happened. If you put all of the above problems in with the current real estate crisis, you've got a recipe for financial disaster not seen since the late 1920s. I'm not saying that I think that we're in for another great depression, though I don't think that anyone thought we were in for a great depression until the great depression occurred either. It is clear that something is terribly wrong. That something is a little bit complex, but I will do my best to elaborate on the problem.

In the early part of the 1990s, as Bill Clinton was taking office, and the DJIA lived below the 3000 mark, a couple of interesting things were happening. It was the beginning of a revolution in the way everyone did everything. Computers were becoming integrated into the fabric of day to day business. The internet was becoming available to private individuals, and communications were becoming cheaper than ever thought possible. We were also in a small recession. The Fed reacted to this small recession by pumping liquidity into the financial markets (fancy jargon for lowering the rate at which banks can borrow money or allowing banks to keep a smaller percentage of their total portfolios on hand so that more money can be lent out). This coincided with a progressive explosion communications and then the rise of the dot-com boom (anyone remember Silicone Valley?).

It was the beginning of a recipe for an economic boom. There was cheap money, new technology hitting the business world, and after the failure of the democratic party to keep congress after the first two years of Clinton's leadership, government gridlock with minimal regulation on the booming economy. Oil went down to close to $10/barrel. The DJIA soared over the decade, jumping from less than 3000 to well into the five-digit range. Small booms rippled through many industries. There were small spikes in real estate. Some of the biggest transformations however, occurring outside of the technology sector, occurred in the financial sector. Banks, which had been de-regulated in the 1980s, were now able to fuel the growing demand for start-up capital. They were aided by cheap money from the Federal Reserve, which allowed them to operate outside of the normal boundaries that contain risky practices in a true free market economy. That being said, a great part of the boom was the result of natural market forces reacting to unprecedented changes in efficiency afforded by changes in technology.

Around the turn of the century, this boom hit its peak, and a small recession took place afterwards. This was nothing catastrophic. Central bank liquidity always fuels a boom-bust cycle in business, as markets have to adjust from the distortions on the market imposed by newly printed money interjected into a market with no economic foundation to support it. Then it happened, 9/11.

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