The day that the $700 billion bailout bill went down to a shocking defeat in the House of Representatives, the Dow Jones Industrial Average suffered a record 777 point one-day crash. “Something must be done!” bellowed the bureaucrats and billionaires. But following the passage of the bailout, the Dow and the broader S&P 500 index each lost 22.1% in just a little over a week. Yes, the markets roared back the following Monday, with the Dow gaining a record 936 points. But those 936 points aren’t worth as much as they were a week ago.

What Really Caused the Great Depression?

Fed Chairman Ben Bernanke is considered by many to be one of the foremost experts on America’s (first) Great Depression. In fact, it’s his analysis of the Depression that has led to his nickname “Helicopter Ben.” Bernanke believes that the Depression was caused or prolonged by deflation—falling consumer prices—and that it could have been easily avoided if the Federal Reserve just created more and more money. Flooding the economy with new money—as if it were dropped from a helicopter—would reduce the dollar’s purchasing power and keep prices rising: the key, in Bernanke’s view, to avoiding economic calamity.

But the Austrian school of economics offers a much different analysis of the causes of the Great Depression. Ludwig von Mises, Murray Rothbard and other notable Austrians argued that it was the Federal Reserve’s expansion of the money supply during the “Roaring Twenties” that caused the stock-market bubble that finally burst in 1929 and that it was increased government intervention into the economy that intensified and prolonged America’s misery.

Bernanke and most mainstream, non-Austrian economists are obsessed with the idea that falling prices must be prevented at all costs. But in fact, falling prices are the natural result of progress in a free-market economy. From the end of the Civil War to the birth of the Fed in 1913, prices actually went down, not up. But in the 95 years since the Federal Reserve Act, the dollar has lost 95% of its purchasing power—and that’s according to the government’s own numbers, which are questionable at best.

Inflation: The Fed’s Real Mandate

Financial pundits are fond of spreading the lie that the Federal Reserve System was created to combat inflation. The obvious fact of the matter is that it was created for the explicit purpose of inflating. Inflation—that is, the expansion of the money supply—is the only real tool at the Fed’s disposal, and when you have a hammer, all problems look like nails. Bernanke believes he can keep prices from falling by creating new money, and in the long run, he’s undoubtedly right. But at what cost?

On September 29, the day the bailout was temporarily blocked, the Federal Reserve thwarted the public will and issued a $630 billion “bailout” of its own by expanding the money supply. The next day, Bernanke and Co. lowered their target for the fed funds rate from 2% to 1.5%. But the fed funds rate is not an interest rate that the Fed can set by decree. As the rate banks charge one another on overnight loans, it is set on the open market and only “targeted” by the Fed. When the target rate was 2%, the real rate was 7%. How does the Fed try to get the real rate to match its target? By doing the only thing it can do: creating money out of thin air and funneling it into circulation.

There is a rate that the Fed does set by decree: the discount rate. This is the rate at which troubled banks can borrow directly from the Fed. The week before the bailout, banks borrowed a record $262 billion from the Fed, but that record was shattered just one week later as banks tapped Bernanke and Co. for a cool $409.5 billion more. And then last week, the Fed offered to put up as much as $1 trillion to purchase the short-term “commercial paper” debt of private corporations. This all in addition to the $85 billion the Fed used to “rescue” bankrupt insurance giant AIG.

And where does all of this money come from? The Fed has the legal authority to create it by fiat!

The Redistributive Effects of Monetary Expansion

Not to be outdone, the Treasury used its newfound powers to extend the bailout by taking a $250 billion step towards the complete nationalization of the banking system. Where will this $250 billion, or the $700 billion for the bailout, come from? Obviously, the federal government doesn’t have a hoard of money lying around—it’s broke. In fact, the national debt clock in New York City has run out of digits! The only way for the government to pay its bills is to issue new debt, most of which will be “monetized” by—you guessed it—the Federal Reserve. This is a fancy way of saying that the government will use its intermediary, the Fed, to simply print the money needed to fund its socialization schemes.

With all this new money in circulation, the purchasing power of the money in your pocket is going to go down. It will take more dollars to buy a gallon of milk, and, yes, it will require more dollars to buy a share of stock. But the “gains” in the market have been and will be illusory and, contrary to the Ben Bernanke/Milton Friedman “helicopter” theory, the government doesn’t drop new money from the sky. Unless you’re an old buddy of the Treasury Secretary Hank Paulson, chances are you won’t be one of the first beneficiaries of the funny money, but that gallon of milk will still cost more at the store.

This, in a nutshell, is the Fed chairman’s strategy to prevent a second Great Depression. Does it sound like a good plan to you?