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"WILL CAPITALISM SURVIVE?" was the question before the lunch table Wednesday. "It hasn't been tried," I replied, "at least not since the McKinley administration and certainly not since 1914," when the Federal Reserve started operations in earnest.

In doing my conservative curmudgeon act, I probably came across as supercilious. But my response also reflected my reaction to the smug contempt toward free-market philosophy in general and Ronald Reagan and his lesser successors in particular expressed elsewhere in the press of late.

The credit crisis and the ensuing global economic contraction have failed to make an impression on academe, where free-market orthodoxy still reigns supreme, the New York Times asserted in an article in arts section recently ("Ivory Tower Unswayed by Crashing Economy," March 4.)

The problem, the Times asserts, is the current generation of academics have been brought up primarily in free-market orthodoxy exemplified by the so-called Chicago School, named for the University of Chicago, from where Milton Friedman and his fellow adherents spread their ideas.

Ignored was the work of John Maynard Keynes, the Times contends, whose ideas have been revived with the massive expansion of government intervention in reaction to the current crisis. Also overlooked was Hyman Minsky, another 20th century economist who asserted that financial markets are inherently unstable and, in turn, can destabilize the real economy.

On the latter score, Minsky was indeed almost completely unknown by the current generation of economists. When I wrote of the economy having a "Minsky Moment" as the credit crisis first erupted in 2007, the name was met by a blank stare except from a few. Now, Minsky is widely cited as having discerned the link between market crashes and the economy.

But to say that anyone who is a serious student of economics is not thoroughly familiar with Keynes' ideas beggars credulity. The standard construct of the economy used by virtually all forecasters, from the Federal Reserve on down, is basically Keynesian, with varying opinions about how the model works. That none of them predicted the current crisis is telling, and indeed damning of the approach.

What definitely is ignored in academe is the Austrian school of economics, especially for baby boomers brought up on Samuelson's economics text, which was pure Keynesian orthodoxy. I did not learn the names von Mises and Hayek or their ideas until a decade or more after graduation (with a degree in economics, by the way.)

The Austrian view is a mirror image on the right to Minsky's from the left. The economy, if left alone, is self-correcting, say the Austrians. But central banks' inflationary expansion of credit produces booms and malinvestments, which inevitably lead to a crashes and depressions.

The only prevention for boom and busts are sound money, which is impossible with government-controlled central banks. Once the bust comes, the only cure is to let it run its course; allow the malinvestments go bankrupt and let the market reallocate the capital to productive uses.

The most famous expression of that philosophy was the prescription of Treasury Secretary Andrew Mellon: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system." The result, according to the man of whom it was said three presidents served under him, the last being Herbert Hoover: "Values will be adjusted, and enterprising people will pick up from less competent people."

The Austrian prescription, of course, was rejected first by the New Deal of Franklin D. Roosevelt, and now by massive response by both the purportedly conservative Bush administration and now the Obama administration. First came the $700 billion TARP last year to stabilize the financial system, followed by the $787 billion fiscal stimulus enacted last month. Across party lines, it's accepted that government's role is to prevent the economic pain that would come of "liquidate, liquidate, liquidate."

But the Austrians were the ones who could see the seeds of collapse in the successive credit booms, aided and abetted by Fed policies, especially under former chairman Alan Greenspan. While he disavows (again) the responsibility for the boom and bust, most recently on Wednesday's Wall Street Journal Op-Ed page ("Fed Policy Didn't Cause the Housing Bubble," March 11), monetary policy played a key role in creating successive bubbles and busts during his tenure from 1987 to 2006.

Greenspan always contended that monetary policymakers can neither predict nor prevent bubbles in asset markets. They can, however, clean up the after-effects of the bust -- which meant reflating a new bubble, he argued.

That had a profound effect on risk-taking. Knowing that the Greenspan Fed would bail out the markets after any bust, they went from one excess to another. So, the Long-Term Capital Management collapse in 1998 begat the easy credit that led to the dot-com bubble and bust, which in turn led to the extreme ease and the housing bubble.

Austrian economists assert the current crisis is the inevitable result of the Fed's successive efforts to counter each previous bust. As the credit expansion pumped up asset values to unsustainable levels, the eventual collapse would result in a contraction of credit as losses decimate banks' balance sheets and render them unable to lend. That sounds like an accurate diagnosis of the current problems.

In the meantime, both Western democracies and autocratic governments such as China are actively utilizing the ideas of both Keynes and Friedman alike in enacting massively expansionary fiscal and monetary policies to counter the crisis resulting from the severe contraction in credit.

If these policies are successful, perhaps governments will adhere to Austrian principles to prevent a new boom and bust. That is for the next cycle, however. To paraphrase St. Augustine, governments may be saying, "Make us non-interventionist, but not yet."

Comments: randall.forsyth@barrons.com