Comments (19)

• Paul Marks

  A great dispute in ecomomics is between those who think that the cutting off of more credit causes the depression (for example Milton Friedman with his belief that the "fall in the money supply" i.e. the collapse of the credit money bubble in 1929 and after should have been avoided by yet more Federal Reserve System support) and Austrians who believe that such further credit expanision (to prevent a bust) just makes for an even worse bust later on.

  I am not a supporter of "empirical" notions of "testing" economic theories (the real test of such theories is to test their logicial reasoning by thought and debate).

  However, the theory of putting off the bust by ever more credit expansion is being "tested to destruction" here in Britian.

  There has been the longest period without a bust in the history of the boom-bust credit money cycle and the money supply (however measured) is still growing strongly.

  Either (as Chancellor Brown claims) Britain has abolished the boom-bust cycle or there is an all mighty bust comming.

  Asset prices (both the stock market and real estates) have shown great inflation (a nice sign for a comming bust).

  We shall see.

  Even forgetting a bust, the capital stucture is incredibly distorted. With vast malinvestment.

  Looking at the British economy is like looking at a human face in a fun house mirror.

  How twisted can the economy get before it starts to impact on real incomes?

  Britain could be following the path that Argentina took after Peron took over in the 1940's

  True there has been no hyperinflation (as there was by the 1970's in Argentina) but there is the same sense of advanced country (and Argentina was an advanced country) in a state of twisted decay. Living standards did not seem to fall - but when the drop eventually came it was sharp.

  Sadly after some periods of reform. Argentina is back to its old ways - with price controls and the rest of it.

  The economy looks fine plenty of "G.D.P. growth" -but the country is rotting again, and so is Britain.

  Published: April 28, 2006 5:21 PM

• averros

  Paul --

  There has been the longest period without a bust in the history of the boom-bust credit money cycle and the money supply (however measured) is still growing strongly.

  The effects of monetary expansion can be compensated by increasing productivity due to improvements in technology. That does not make it any less damaging or evil. Just less obvious.

  Published: April 28, 2006 11:32 PM

• adi

  Still Mr Callahan didnt give very persuasive argument why entrepeneurs make systematic mistakes year after year even if there is huge benefit in forecasting precisely actions of the FED and Govt ( avoiding financial disaster is a huge benefit ).

  New Classicals ( Lucas, Barro, Sargent etc ) can explain business fluctuations arising from the fact that many economic variables are subject to measument error(s) even if they are measurable at all. Then economic agents must somehow "extract signal from the noise".

  Sargent thinks that Friedman type of rules ( "let money grow something like 2% per year" ) may be efficient in a sense that they are easily understood.

  My training has been in econometrics, mathematics and statistics so i understand these concepts what New Classical school advances even if i dont believe in them. Still we must have good answers when somebody asks that are we making too simple theories about very complicated things.

  Asko Olavi Kauppinen, Student of economics in University of Joensuu, Finland

  Published: April 29, 2006 1:44 AM

• Urbanitect

  "Still Mr Callahan didnt give very persuasive argument why entrepeneurs make systematic mistakes year after year even if there is huge benefit in forecasting precisely actions of the FED and Govt ( avoiding financial disaster is a huge benefit )."

  The Fed is also forecasting, and it can forecast how people will react to its policies. Then it becomes a contest between different forecasters, and since the Fed controls the deck it tends to win out. Once arbitrageurs have been neutralized, the only thing keeping in line credit expansion is inflation and eventual collapse of the currency.

  Published: April 29, 2006 2:33 AM

• Fred Mann

  adi writes:

  "Still Mr Callahan didnt give very persuasive argument why entrepeneurs make systematic mistakes year after year even if there is huge benefit in forecasting precisely actions of the FED and Govt ( avoiding financial disaster is a huge benefit )."

  Entrepeneurs consistently make these mistakes because they are NOT always rational!!! As Mr. Callahan mentioned (too biefly), "mania theory" considers the impact of mass-psychology on the behavior of the individual (including entrepeneurs).
  As a stock, currencies, and interest-rate trader, I have put a great deal of time into studying mass-psychology as it manifests itself in the stock market. Although most people believe that the stock market is random, I can assure you that it is most certainly NOT random. The stock market is not random, because people still posess a herding instinct (at least, this appears to be the best explanation). If you doubt this, ask yourself if your decision to buy or sell stocks might be colored by a sudden 2000-point drop in the Dow. If the answer is "yes", then you can already see the potential for the development of price patterns.
  Anyway, because entrepeneurs are humans too, they still make decisions based on a deadly coctail of logic, emotions, AND cues from the herd. See the "merger mania" of the late 90's, for example. It is no accident that this merger mania peaked along with the stock market.
  As manias develop (as represented by "large" moves in the market in question), the rational/logical components of entrepeneurial decisions shrink relative to the emotional/herding components.
  I realize that this may sound like nonsense if you have never considered this angle before. Unfortunately, I can not present a convincing case for this theory in a relatively short blog post. But I can recommend a website for those who might be interested. I think the folks at www.socionomics.org have an interesting and mostly-accurate take on this whole subject.

  As an interesting side-note, the Fed does NOT lead the interest-rate market, as is almost universally believed. Rather, it follows the market. This can be easily illustrated by plotting the Fed Funds Rate on top of any interest-rate futures contract (inverted to reflect yield as opposed to price). If you do this, you will see that EVERY major trend change in Fed rate policy is preceded by a major trend change in the interest-rate market.
  Hopefully people will look into this. I don't think the Austrian School can claim to have a complete understanding of the business cycle (or Human Action, for that matter) without considering mass-psychology.

  Published: April 29, 2006 2:51 AM

• adi

  Mr Mann didnt consider problem in his view that besides economics we must have also good knowledge of social psychology if we are to study economic phenomena ( like business cycles ); These psychological theories have changed also quite a lot and then we have build our foundations in quicksand. As economists we rarely have opportunity to critically review these theories which may be quite separate from economics ( I dont know exactly but there are very many different schools in psychology as in economics )

  I would like to know how we can combine together the "cluster of errors" which are made by entrepeneurs and sametime know that people can actually learn without supposing they have super human computing capabilities. Of course this seems very difficult problem and I would propably get Nobel Memorial award in economics if i could accomplish that...

  Published: April 29, 2006 7:46 AM

• F L. Light

  Exhilarated expectations come
  With cheaper credit past a middling sum.
  

  Published: April 29, 2006 10:24 AM

• Som

  I was wondering, does the Business cycle according to the ABCT finish it's course in a shorter amount of time with a high time preference population vs finishing in a longer amount of time? or is the time preference of the people irrelevant after the credit expansion begins?

  Published: April 29, 2006 3:10 PM

• Fred Mann

  In this high-time-preference population, each individual would presumably be more inclined to take on debt. Therefore, the money supply would be able to spike upward quicker, and each individual would reach his debt threshold more quickly. At this point the business cycle would begin its decline. So, I think the answer would be "yes". BUT ... new money can be introduced into the system by the government in the form of multiple multi-billion dollar domestic infrastructure programs. In this case, the time preference of the individuals is irrelevant. No contractor would turn down a large government-sponsored project (regardless of his time preference).
  The key factor in ABCT is new money. The cycle occurs because the new money, once it filters through the population, is erroneously perceived by entrepeneurs as a sign of increased savings and/or capital within the population. In fact, there is no increase in the pool of real funding (as Frank Shostack calls it). Therefore the result will always be the same -- massive debt defaults and an extended period of conservation which results in zero or negative economic growth.

  Bottom line ... if new money can be introduced into the population by "force" (which it can be --- as in the make-work projects outlined above), then time preference is irrelevant.
  

  Published: April 29, 2006 5:07 PM

• Urbanitect

  RE: "Still Mr Callahan didnt give very persuasive argument why entrepeneurs make systematic mistakes year after year even if there is huge benefit in forecasting precisely actions of the FED and Govt ( avoiding financial disaster is a huge benefit )."

  I've thought some more about the reason why entrepreneurs make mistakes year after year, and the reason it turns out to be is that they aren't making mistakes at all. As long as the central bank is continuing to inflate and lower the rate of credit those entrepreneurs are acting perfectly rationally. Their investments are good and profitable. It's only when the central bank ends its policy of inflation that their investments become errors, and the point when the central bank changes its policy is unforecastable.

  Published: April 30, 2006 1:57 PM

• Ohhh Henry

  There has been the longest period without a bust in the history of the boom-bust credit money cycle ...

  That's an interesting comment, but I'm not sure if it's true. It seems that the strategy has been to keep on igniting new bubbles, in order to distract the population away from the previous burst bubbles. For example, telecoms and dot coms are still in the doldrums, I would even say "recession", since their bubble burst in 2000. And I read a very eye-opening essay a year or two ago, which made a convincing (although anecdotal) case that certain regions of the USA are in a rather deep and gloomy economic depression. The author was pointing out that many Upstate New York cities such as Buffalo, Schenectady, etc. have had massive job losses, while at the same time their city governments are going broke with all of the various health, education and welfare spending programs.

  Even within regions and industries that are not obviously in economic trouble, it seems that there are more and more individuals and families slipping off the liferaft and into bankruptcy - I gather this is true from the large number of credit-counselling companies advertising on American radio stations.

  And last of all there is the research of John Williams, part of which is summarized here. I think it speaks for itself:

  Williams believes GDP is contracting now. The government reported only a 1.1% increase in the fourth quarter. Even in an election year, and despite the government’s best efforts to paint a pretty face, all it could muster was a measly 1.1%. More likely, the economy actually contracted 2% in the fourth quarter. This means we are in a recession NOW.

  This is not conspiracy-theory stuff. As Williams points out, it’s all disclosed in the footnotes in the government’s reports. All he is doing is backing out many of the changes to more realistically compare these numbers with the numbers of the past.

  
  

  Published: April 30, 2006 5:43 PM

• Fred Mann

  "I've thought some more about the reason why entrepreneurs make mistakes year after year, and the reason it turns out to be is that they aren't making mistakes at all."

  This is a good point, but I'm not sure if it's entirely true. For the last few years, banks have been making increasingly risky loans to home buyers with suspect creditworthiness. They have done so en masse (in concert with a rising stock market -- not a coincidence -- see www.socionomics.org or www.elliottwave.com), and I believe they will regret their decisions. The risk of a housing bubble hasn't exactly been a secret, yet the risky loans continue.

  Published: May 1, 2006 2:54 AM

• jim_bradley

  the game is to make all adjustments inflationary, that way the rich can push new cash into a basket of assets and trust they will gain proportionally over time against that cash at the expense of those earning cash later. strategy works only if we don't have significant deflation.

  note that the same argument specifying why new loan money must be used for competitive reasons applies equally to central banks when one central bank is expanding money. japan has been a big source of liquidity and when they loosen, it lowers worldwide interest rates. fixing the u.s. fed is not going to give us monetary nirvana. it wouldn't hurt of course, but is doesn't cover all the bases.

  Published: May 1, 2006 11:44 AM

• Paul Marks

  I am wary of the argument that the reason we have not seen a formal bust is because of new technology. It is possible (perhaps) that we just have a ever more twisted capital stucture (in practical terms - some people richer than they would otherwise be and a lot of people poorer than they would otherwise be)rather than a formal bust - but (again) I have my doubts.

  Technology has been advancing for centuries - and that has not prevented a lot of busts. "Ah but now technology is advancing faster than before, we have entered a new age.......".

  I am old enough to have heard that song too many times.

  Perhaps we really will not have a bust (that we just have a twisted economic structure), but I still think that the credit money business cycle is not dead.

  How long can all this new money stay in asset prices?

  How long before it flows (even a treacle like flow as Hayek would have said) into general prices?

  Certainly cheap goods from China (and the rest of Asia) have kept prices down (without the monetary expansion they would have been falling) - but there is a different "smell" on the high streets of Britian.

  It may not have hit London yet, but I keep seeing "closing down sales" or shut shops.

  Perhaps the vast load of debt (both property debt and nonpropety debt) is indicating to people that they are not as wealthy as they thought they were. There has been a massive miscalculation - a lot of people have treated the credit bubble (and the related bubbles) as if they were real wealth.

  Consumers are overextended.

  So is the government (especially if we take P.F.I.s and other book keeping tricks, such as the Network Rail debt, into account).

  If I were writing about the United States I would now talk about industry - however in Britian (in spite of recent hype about industrial recovery) industry is finished.

  "But you have the great City of London" - a lot of branch offices for various international financial sector enterprises. They could be shut tomorrow. Which would be difficult for the government - as it is more dependent on taxing financial services now than it has ever been in British history.

  Financial industry regulations are still less that the United States - but that is not saying very much, the various government laws and agencies make Britain not a wonderful place to base a financial services enterprise.

  The City (whether in London or the provincial centers) is trading off past glories - I think it is going to hit trouble.

  And (as stated above) the rest of the economy hardly exists at all.

  For a nation of some sixty million people we have a wildy distorted economy. It basically rests on the financial sector, which in tern rests on a credit bubble.

  I would advise anybody who can to get out of Britian.

  Published: May 1, 2006 12:14 PM

• M E Hoffer

  Paul,
  "Certainly cheap goods from China (and the rest of Asia) have kept prices down" + "If I were writing about the United States I would now talk about industry"

  I think the point missed, here in America, where we are projectiling our manufacturing base, and our Fiat, overseas, is that the "cheap goods" being imported from China, et al., actually become expensive in the fullness of time. The short explanation is that the promises, to the future, and undergirding the majority of our Middle Class(pensions, SocSec, MediCare, MediCaid, and on and on) were made, long ago, within the construct of a high-value added manufacturing economy with a large, v. population, employment base: Our Economy, growing ever more like the England you describe, is facing a massive breakage of those long-banked on expectations. That growing Abyss between what was promised and what can be delivered will prove to be at least one of the unseen effects riding along with the Goods being Imported.

  What thinks Ye ?

  Published: May 1, 2006 12:56 PM

• Fred Mann

  Also Paul, there is the question of the accuracy of the government's numbers. As Bob Prechter from elliottwave.com pointed out, the last recession in the US officially ended BEFORE the stock market turned up. This has NEVER happened before. So, the question is ... did the recession ever actually end? It probably did, considering the rise in the stock market of the last few years (if we assume the stock market is a leading indicator). But the duration of the last recession may have been much longer. Remember that the economic numbers that the government releases are usually inflation adjusted. If inflation is underestimated (which it is), then growth is OVERestimated. Of course, the term "recession" is arbitrary anyway.
  Also, I think you are correct in saying that the business cycle is not dead. I think we will see a resumption of the downtrend in the stock market (and therefore the economy) very soon. I also believe that this next downward thrust will exceed the move of 2000-2002. There is a possibility (30%?) of a BRIEF spike to new highs in the DJIA, but this will NOT be confirmed by new highs in the S&P. But, with or without this spike, a depression will very likely begin before the end of Bush's term, and probably much sooner. That's my prediction.
  

  Published: May 1, 2006 1:22 PM

• heterodox

  "mania theory"... animal spirits? This isn't a satisfactory explanation.
  

  Published: May 1, 2006 11:01 PM

• Fred Mann

  ""mania theory"... animal spirits? This isn't a satisfactory explanation."

  And I might say, "that isn't a satisfactory question!"

  But seriously, if you are referring to my posts ... as I said above:
  "Unfortunately, I can not present a convincing case for this theory in a relatively short blog post. But I can recommend a website for those who might be interested. I think the folks at www.socionomics.org have an interesting and mostly-accurate take on this whole subject."

  I would also add www.elliottwave.com.
  Ultimately, a theory is judged by its fruits. Rothbard predicted a crash in the early eighties. What followed was the largest bull market in history. One of the things that attracted me to Bob Prechter's work (as can be seen in the sites above) was his prediction of a multi-year bull market beginning in the early eighties and his subsequent record-breaking returns in the World Trading Championship. As a trader, all I can say is that prices in the financial markets ARE patterned. This observation is not included in ABCT, so ABCT is incomplete. As far as I can tell, ABCT seems to assume that prices in the stock market or currencies markets are derived in the same way as prices for toothpaste, labor, and automobiles. But this simply isn't the case.
  I realize that these ideas are radical AND that I have not presented the case scientifically. That's why I presented the websites for further research.
  I'm not sure if I've even begun to answer to your objection. If possible, please be more specific with your question(s).

  Published: May 2, 2006 12:13 AM

• adi

  Biggest problem with these "investors irrational behavior" or "lack of confidence" is causing cycles is that many proponents also advocate heavy government planning and regulations since its though that govt is so wise and all-knowing that it can make these things go away. I didnt see that though in pages which Mr Mann suggested.

  I have read professors Galbraiths ( "Great Crash" ) and Kindlebergers ( "Manias, Panics and Financial Disasters" ) books about these things and it seems that they also believe that economy based on credit ( through fractional reserve banking ) is very vulnerable to financial panics. These professors are also very interventionist since they were keynesians.

  Very funny thing actually was that some french investment banker in 18th century was supposed to say that "when whole world is going crazy we must emulate this behaviour to some extent". This banker was of course buying shares in South Sea Company....

  Published: May 3, 2006 3:56 AM