At a glance: Global downturn

This has been a very good year for charts and tables. I am just trying to update some of my favourites.

Governments have been blowing asset bubbles for a long time. The bubbles eventually burst, inflicting untold damage on those who aren't fast afoot. Just consider John Law (1671-1729) and the fate of his Mississippi Company (see Chart 1).

John Law's link to today's economic and financial turmoil is via a Law-Keynes linkage. Like John Maynard Keynes (1883-1946), Law thought the economy could be stimulated and that growth rates could be permanently elevated through active monetary, fiscal and exchange-rate policies. In short, both economists supported the idea of an active, interventionist government. Today, this fashion is back in style.

When the bubbles burst and panic set in, the demand for money soared and the money multiplier collapsed in mid-September 2008 (see Chart 2). To stabilise the delicately balanced credit triangle, which depicts the modern fractional-reserve banking system (see Chart 3), the Federal Reserve more than doubled the size of its balance sheet in three short months.

The Fed's balance sheet expansion, among other things, has produced a monetary time bomb. If not defused, the bomb will go off in a burst of inflation.

Participants in the commodity markets sensed this danger almost immediately. Indeed, the volatile Baltic Dry Index — which is a freight-rate benchmark for shipping dry bulk commodities, like building materials, grains, coal and iron ore — bottomed out in December 2008 (see Chart 4), just as the Fed's balance sheet was setting new records for size.

Gold soars

Not surprisingly, commodity prices have marched higher since December 2008 (see Chart 5), with the all-important price of gold making new highs as this column goes to press.

The central bankers and finance ministers around the world call for more intervention. Some pundits go a step further and claim that the crisis in the United States was caused by free-market reforms introduced during the Reagan years (1981-1988). This is truly a bizarre idea.

The misery index signals that economic improvement (lower inflation, unemployment and interest rates, coupled with above-trend GDP growth) was more pronounced during the Reagan years than in any other administration since Truman's.

The misery index tells an important story.

We need less interventionism, not more.

Global economic meltdown begins

September 15, 2008, was the day that would be recognised as the start of the global economic meltdown. That was the day Lehman Brothers, the US investment bank with an estimated worth of $639 billion (Dh2.3 trillion), declared bankruptcy after a run on its assets.

Lehman was heavily invested in the subprime mortgage market and its derivatives, which were the cause of the international financial crisis and had damaged investor and consumer confidence.

Later that same month, American investment banks Goldman Sachs and Morgan Stanley had to apply for banking licences — subjecting them to tighter government control, but ultimately rescuing them from Lehman's fate by giving them access to billions of dollars of government aid.

For many oil and other commodity producers, it was a year of two halves. In the first half, speculation drove the price of oil up to a record $147 per barrel, boosting revenue and foreign reserves for many Gulf countries. But as the global economic crisis took hold and demand eased, commodity prices plunged and their stock markets felt the effects of the growing economic storm.

Steve H. Hanke is a professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C.