Right so often, but wrong this time

I have always admired Thomas Sowell.  He’s an amazingly brilliant economist, a true scholar, and a believer in free markets.  He’s alway spoken his mind, and been astute to all the interventionist fallacies.  But sometimes even brilliant men get things wrong.

Interviewed by Reason about his new book “Housing Boom and Bust”, he has this to say about Fed policy:

reason: How much weight do you place on the notion that Federal Reserve expansionary money and credit policies primed the bubble, and bust, in housing?

Sowell: I find it hard to accept. I’m sure if the interest rates had been at 8 percent the boom would not have gone as far and the bust would not have been as big. I’m not saying monetary policy had no effect. But I am struck by the fact that Federal Reserve policy is nationwide, and in places like Dallas the increase in housing prices was in single digits and the decrease has been in single digits. So while Fed policy undoubtedly aggravated circumstances, it can’t be the fundamental cause because the defaults were so heavily concentrated. 60 percent of all defaults nationwide were in five states, and I suspect if you broke down the data even more you’d find specific regions in those five states very heavily implicated in defaults.

Oh, how I wish he would review a little ABCT.  Let us look back to this graph I posted a few days back:res_v_nonres

This graph so clearly shows that regardless the state concentration, the massive redirection of investment away from non-residential (i.e. productive) investment towards residential (i.e. non-productive) investment, was the housing bubble.  Surely Sowell is aware that capital is mobile, and that investment capital would be diverted to the highest rates of return.  

It matters not at all that the malinvestment was concentrated in several states nor does it matter that other markets saw little appreciation in housing prices.  The problem was that the vast increase in money created created market distortions and mistimed resource allocations.  This much is certain.

What this specifically means, in simpler terms, is that while money is, or at least it seemed to be, infinite, resources most certainly aren’t.  Thus, this means that resources were diverted away from less attractive markets (such as Dallas) and redirected to more attractive, for instance California.  More importantl, it means the resources were diverted away from productive to non-productive investments.  This is clear from the graph above.

Necessarily, as demand for resources grew, so too did their price, thus the opportunity cost of investment.  


Let’s look at this graph for a moment.  We see modest increases in the PPI for capital equipment, which is of course very technologically sensitive, but massive increases increases in intermediate materials, far less technologically sensitive.

This huge increase (and precipitous drop) coincides with the housing bubble.  It is precisely these goods that housing development needs, while the non-residential investment requires more capital goods.  

Yes Professor Sowell, it WAS the Fed.

But this is perfect.

Sowell: The presumption that Obama knows how all these industries ought to be operating better than people who have spent lives in those industries, and a general cockiness going back till before he was president, and the fact that he has no experience whatever in managing anything. Only someone who has never had the responsibility for managing anything could believe he could manage just about everything.

As is this:

Sowell: I would hope not, but I certainly do think very seriou s consequences are likely to follow from all this, and they aren’t really discussed much. The ease with which we are now throwing the word “trillion”—I remember when billion was a shock word. To talk about trillions as though they are nickels and dimes, it’s a classic example of doing something that sounds good at the moment whose repercussions are beyond the horizon. When bad effects of his policies come, will people connect the dots? Or will Obama be able to get away with it like FDR did, blaming it all on his predecessor?

I think we all know the answer to that one.

I know, you’re the Milton and Rose Friedman fellow at Hoover.  But please, refer to this:


I think it speaks for itself.


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