Ȁȃǿ Partʺ: Economicsprices wrong but also shrank real cash balances and reshuffled their owner-
ship. Furthermore, previous money and price inflation had helped trigger
the oil shocks themselves (and this inflation in turn arguably traced to a
built-in bias of the Bretton Woods system).
Ludwig von Mises aptly entitles one of his chapter sections “Ļe Fal-
lacies of the Nonmonetary Explanations of the Trade Cycle” (ȀȈȃȈ/ȀȈȅȂ,
pp.Ȅȇǿ–Ȅȇȅ; cf. pp.ȄȄȃ–ȄȄȄ). He particularly criticizes “the two most pop-
ular varieties of these disproportionality doctrines”: the durable-goods (or
echo-effect) doctrine and the acceleration principle. He judges them hard
to square with thegeneral, economywide character of business expansions
and contractions (pp.ȄȇȂ,ȄȇȄ).
Ļe crisis and recession beginning inȁǿǿȆhad a conspicuous real
element—the collapse of a housing boom. In its background, however,
lurked a monetary policy of arguably excessive liquidity and too-low inter-
est rates, as well as ill-considered government housing and mortgage poli-
cies and private financial imprudence.
Ļis recession illustrates the contagion of distress through several
channels. Insolvency or illiquidity of some institutions weakens others
holding claims on them. Consider an example. Consumers buy houses,
putting up only a very small fraction of the purchase prices in money
of their own and obtaining mortgage loans for the rest. Now a financier
“packages” these mortgages into bonds. More specifically, he buys these
mortgage claims from the original lenders (unless he already owns them
by himself being the original lender). He gets the necessary funds only
fractionally from resources of his own and issues bonds for the differ-
ence. His bonds are in turn bought by further financiers, who also pay
only a fraction of the purchase price in cash and obtain the rest by issu-
ing still further bonds. Bonds bought serve as collateral for the loans
obtained (that is, further bonds issued) to pay for the bond purchases.
And so on. In short, loans are made with borrowed money obtained in
turn mostly by borrowing: bond sales finance bond purchases. At the end
of the chain are the saver-investors who pay in full, for example, individ-
uals who invest in bonds or bond mutual funds or participate in pension
funds.
At some stage in the chain, a financier may issue bonds divided into
two or more tranches, some appearing safer by having a primary claim
on earnings and ultimate repayment and lower tranches being riskier by
having only subordinate claims. Upper-tranche ultra-safe bonds are appar-
ently manufactured, then, out of low-quality mortgage loans.