When the Feds policy spiked the punch to new levels of potency as the decade progressed and the Florida land bust played out, the frenzy was redirected to common stocks. The stock market itself along with its complicit financial infrasture, peaked in 1929 with mom and pops all over the nation and beyond locked in. It began its first gasps earlier in the year and then saw the famous exhale as initially a few insiders and then commoners as well headed for the exits.

The one insight that might have relevence here is that according to the long history of financial crises, liquidity, or time-deferred capital, having stretched beyond the limits of society’s risk tolerance, always snaps back, and often does so rather abruptly and with overshoot. If the forces that had led to the liquidity over-extension are of significant magnitude, which typically requires a pricey and broadly desired asset such as land, residential homes and commercial buildings, the contraction is characterized by an equal and opposite force of great magnitude. As a corollary, equal and opposite force is required to neutralize such a contraction. If one models the economy according to the concept of kinetic and potential energy, with expansion and contraction as manifestations of the kinetic based on market valuations, then a counter-contraction is not based on market valuation (price fixing, suspending losses, injecting ‘stimulus’) is simply a conversion of kinetic energy to potential. As the potential energy accumulates to a leve at which it can no longer be sustained, it is converted again to kinetic. This model applies equally well to both upside and downside trends in market valuation.

Today, allowing the forces of economic contraction to be expended as kinetic energy is simply not permissible by policymakers. Therefore no amount of additional lending, spending and other non-market based solutions is excessive. It’s all righteous, according to Bernanke and friends. Future historians will surely disagree.

The issue today – and the problem with Keynesian keystone coppery in general – is that Keynes’ theory, like Marxist theory, denegrates market forces and holds that central policy can coerce asset pricing and risk tolerance to idealized levels. However, economists have not yet arrived at an understanding that in order to be truly effective, counter-contraction monetary and fiscal measures must be derived from existing capital, not time-deferred capital. Otherwise, instability is compounded as the economy becomes more dependent on moral hazard, mark-to-whatever-sounds-good asset pricing, and other time-deferred remedies.

The counter-contraction forces applied in during 1930 and beyond were inadequate to stem the contraction, which played out in a manner that affected the lives of every member of society, until WWII put folks back to work. Today, the inevitable contraction is being held at bay by huge doses of time-deferred fiscal and monetary heroin. Worse, the rubber band of aggregate purchasing power has been stretched even greater. With the institutional ponzi schemes like Social Security, state-funded health care and public employee pensions, there is a huge and growing imbalance in potential vs kinetic energy. Just like in the 1930s, I suspect that having committed the same policy errors that led to the most recent mini-boom/busts (.COM, real estate and the like), only orders of magnitude greater, the “aftershock” promises to be of truly historic proportions.

There’s some smart yet cynical Keynesian out there who realizes the truth, but secretly hopes that if it takes place over enough time, maybe we won’t complain too much.

I couldn’t agree more.
Here’s 2 articles I wrote on the same subject.
http://www.jamesgoulding.com/predictions.htm#Currently
http://www.jamesgoulding.com/essays.htm#The_1920/21_Crash_and_The_2000/01_Crash;_A_Comparison

Keep up the great work Doc!
J Goulding
http://www.jamesgoulding.com

and readers, Let’s DIGG this Blog post so we can get more blog posts FAST!! Good stuff….

Free markets are only free to let greed overcome all else; they certainly don’t function efficiently and without trust, they cease to exist. Brilliant plan that.