On Sennholz

So, Ron Paul's economic theory is of the Austrian school. Paul credits Hans Sennholz both for inspiring his enthusiasm and influencing his economic theory. Sennholz has passed, but his writings live on: was he legit? Let's see...

In July of 2000, Hans notes the potential danger of derivatives based on mortgages:

Rising debt is not the only threat to the economic boom. Derivatives are the single greatest danger, especially to financial institutions. These are options, futures, and options on futures which are highly leveraged speculation on virtually everything: interest rates, stocks, stock indexes, and foreign currencies. Even bonds and mortgages may yield derivatives as they are split into the interest-only portion and the principal-only portion. American commercial banks, brokerages, and insurance companies are the primary source and traders in derivatives now exceeding $35 trillion. What would happen to derivative players if the markets should suddenly begin to readjust, if interest rates should rise suddenly or price inflation should return in force?

Fair enough. He predicted the 2007 crisis right before the 2001 crisis. Right reason, wrong readjustment. What did Sennholz have to offer more recently? Well, in Feb of 2006, he gets is almost exactly right:

And where in the cycle are we today? Most symptoms seem to point to the third phase when goods prices begin to rise and the inflators become inflation fighters....Surely consumer goods prices have been rising at modest rates because massive imports from China and other Asian countries have diminished the price pressure. But these countries compete for raw materials and energy products, such as petroleum, which has raised those prices significantly. Moreover, American real estate prices have been soaring, which enabled many home owners to consume the rising equity and go deeper into debt....The fourth and final phase of the cycle is not yet in sight. Yet we must face and get ready for the ordeal that is bound to come at home and abroad.

So, we have a dog and a tail: monetary policy and the business cycle. But which is dog and which is tail? Does the Fed create the business cycle by over-inflating the economy until it breaks under the pressure and readjusts and the cycle continues? Or does the business direct the Fed to make what attempts it can to smooth out an exogenous boom-bust process?

Sennholz, Paul and their ilk think that the dog is chasing it's tail: using a sub-market lending rate to inflate the economy is the problem, not the solution. It's an argument that makes sense, but someone's being left out. Even if the Fed put the gun in our hands, it didn't pull the trigger. Someone had to be buying all those houses, brokering all those mortgages, and investing in all those derivatives. Sure all that money has to go somewhere, but sometimes a bad investment is just a bad investment.