“Stocks Slammed as Dow Erases 2012 Gains”

That’s the title to a headline piece over at CNN.

The Dow Jones industrial average (INDU) plunged 275 points, or 2.2%, the biggest one-day drop since November. The blue-chip index gave up all its gains for the year, and is now 99 points below where it finished 2011. The S&P 500 (SPX) lost 32 points, or 2.5%, and the Nasdaq (COMP) dropped 80 points, or 2.8%.

Ouch. The cause of the plunge?

“The U.S. employment report was simply terrible,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

The May jobs report showed only 69,000 jobs were added to payrolls, less than half the 150,000 jobs forecast by economists surveyed by CNNMoney. The unemployment rate ticked higher for the first time in a year, rising to 8.2%.

I take three things away from this:

1) The election is still Mitt Romney’s to lose.

2) Keep in mind the role of central banks in all of this. So far their policies have failed to produce anything but more instability.

3) This crisis is The End of the economic system delivered to the world at the end of World War 2, and whichever polity navigates its way out of this thing first is going to be the new trendsetter. Check it out:

Bond yields have been in record low territory for the past couple of weeks, as fears of Europe’s escalating debt crisis have been building. A report on Friday showed the eurozone unemployment rate at a record high of 11%. […]

Concerns about slowing growth in emerging markets, including China and India, have also put investors on edge. Two reports out of China Friday morning showed that the manufacturing sector contracted more than expected in May, fueling investors’ concerns that the country may be headed for a hard landing.

As global economic growth has slowed in the last year, exports to Europe — China’s largest foreign market — have taken a hit as the debt-ridden region teeters on the brink of recession.

As I’ve stated earlier, there is no reason to fear China’s rise. Not only is the state much, much poorer upon inspection than is often imagined, but much of China’s growth over the past decade has been built upon a house of sand. With the exception of the “special economic zones” in the south of the country, the rest of the state still has a terrible record on protecting private property and other individual rights. Quick digression: it is not a coincidence that most of the agitation for more freedom is coming from the special economic zones (aka free trade zones). More commercial freedom leads to (and protects) other individual freedoms (like complaining about government corruption). You want democratic rights without the rigorous protection of commercial rights? Good luck.

In addition, most of the economic growth outside of the free trade zones has been through state-owned enterprises. Monopolies have never been known to be honest, and my last two dollars is betting that these state-owned enterprises haven’t been all that honest about their gains over the past decade or so. If China is going to really flourish, it has to do so the old-fashioned way: by protecting individual liberty and justice for all (including property rights) and opening its protected, inefficient domestic markets up to world trade.

Just because China’s foundation for prosperity looks like it has been built by a government-run company and the EuroZone is roiling does not mean that the US is going to come out on top of this crisis. Judging by the failures of the central banks (and by the international lending institutions to promote growth in the post-colonial world), our banking system needs major reform.

Co-editor Fred Foldvary wrote an article in the Freeman explaining how central banks cause economic instability and how to avoid such causes in the future:

Competition among banks, as well as the convertibility into gold, would result in price stability, since the banks would only be able to issue as many bank notes as the public was willing to hold. If there were more bank notes than the public was willing to hold, they would come back to the bank to be exchanged for gold.  But the money supply would also be flexible, since if there were a greater demand to hold money, the amount of bank notes or bank deposits would increase.

Free banking mitigates the boom-bust cycle.  There is a structure to capital goods similar to a stack of pancakes.  At the bottom of the stack are rapidly circulating capital goods such as inventory close to the consumer-goods level.  As we go up the stack, the capital goods turn over more slowly.  At the top are long-duration investments such as real-estate development.  The higher up the stack, the more sensitive are the capital goods to the interest rate.  Lower interest rates make the stack steeper, as there is more investment in long-term investments.

In a free market, the “natural rate” of interest depends on the “time preference” of people to obtain goods sooner rather than later.  Interest is the premium paid to shift purchases from the future, when one would have to save enough to pay cash, to the present day by borrowing.

The Fed lowers the rate of interest by creating fiat money out of nothing.  As a result, businesspeople borrow more for capital goods high on the stack, such as real estate.  Prices rise fastest and soonest where the money is being injected into the economy with loans.  Thus real-estate prices escalate, creating a bubble like those that occurred before 1973, 1980, 1990, and 2007; indeed a similar bubble occurred during the 1920s before the Great Depression.

Every boom preceding a bust has been fueled by artificially cheap credit.  With free banking the interest rate would not be manipulated down.  The natural rate of interest would raise the carrying cost of borrowed funds, reducing if not preventing the financial fever.

If the US is to recover sufficiently from this downturn, and if it wants to remain a bastion of liberty and peace throughout the world, Washington needs to begin reforming the banking system. Repealing legislation that has granted a monopoly privilege for the issuance of currency in the domestic economy would go a long way to helping the economy not only recover but stabilize as well. Alas, reports CNN:

Given the growing fears, and fragile market and economic environment, Saluzzi said central banks around the world — particularly the European Central Bank and the Federal Reserve — will likely come out with plans to help stimulate the global economy.

Nobel prize-winner Friedrich A. Hayek on a free-market monetary system.

Co-editor Fred Foldvary on monetary geo-economics.

Aaaand Rep. Ron Paul (R-TX) was able to get a very good economist into a House subcommittee hearing to stump for one of his bills Update: the bill was about “currency reform”; that is, opening up the Fed’s monopoly to marketplace competition.

Please keep it civil

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