Though the mills of God grind slowly; Yet they grind exceeding small;
Though with patience He stands waiting, With exactness grinds He all.
- – Henry Wadsworth Longfellow, “Retribution”
The 2008 disaster was a long time in the making. Every time we have a crash, it is because we stubbornly entertained the wrong ideas for many years beforehand.
The seeds of destruction in 2008 were primarily ideological; they grew out of widely accepted but flawed ways of thinking about capital, economic growth, and financial regulation. Instead of basing economic growth on an honest free market model that privileges concepts such as equity, transparency, production, and prudent and limited regulation, those in positions of influence chose the path of debt, opacity, speculation, and wholesale deregulation.
There were two problems with this approach. First, the United States does not have a genuine free market; government regulation and crony capitalism play an enormous role in distorting incentives and interfering with market processes. Second, this regime is based on the radical error of pretending that markets are efficient and investors are rational when precisely the opposite is true.
A capitalist system inherently prone to booms and busts became even more susceptible to disequilibrium. In order to understand what happened and in order to rebuild a more resilient system, we must dig deeply into basic economic principles and reevaluate them.
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