Ludwig von Mises Institute - Tu Ne Cede Malis
Advancing the scholarship of liberty in the tradition of the Austrian School.
Housing prices have been propped up, banks and auto companies have been bailed out, regulations have been increased, debt covenants have been violated, unemployment insurance has been extended. FULL ARTICLE by - Ganesh Rathnam
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Comments (37)
Fephisto
The picture fits very well, and is thus incredibly hilarious.
Published: November 6, 2009 7:42 AM
flix
very clear, graphic and much needed explanation of why it will be inflation that wins out, despite deleveraging potential. Personally I'm betting on a T-bill dump being the trigger... with currency markets catching the most headlines.
Gold touched 1100$ today....
Published: November 6, 2009 9:11 AM
Patrick Barron
Excellent article, even if very disturbing. I cannot fault the author's logic. Nevertheless, I believe that the following quote from the article is misleading:
"Consider a system with $100 in loans due in a year at a 10 percent interest rate. The total amount of money in the system is only $100 but the amount due at the end of the year is $110. Where will the $10 come from? It has to be lent into existence at some point prior to when the $110 is due. Absent this increase in money supply, the loan will default."
Even in a fractional reserve banking system, loans are repaid out of profits, which are internally generated by business. Even consumer loans are repaid by business, because consumers repay loans from wages and wages are paid out of business revenues. A business stays in operation by making a profit. So profits are the key to any capitalist system.
If I am wrong about this point, I would appreciate anyone blogging on this article to point out the error. I can take the criticism.
Published: November 6, 2009 9:32 AM
Hal (GT)
Great article. The Nascar analogy is a perfect picture of what I see as occurring too. And the continue employment situation in our cities around the nation continue to way heavily in the debts category. It's just a matter of time before contact happens with that wall or the wheels come off altogether.
Published: November 6, 2009 9:48 AM
Mike
Spread this article around. The sooner the shit hits the fan, the better.
Published: November 6, 2009 9:52 AM
Bogart
I like the NASCAR tight (Lowering Prices) vs loose (Rising Prices). I do not like the terms inflation and deflation. The Austrians will say correctly that the inflation has already happend. The future results of this inflation are what is under debate.
My opinion is there will not be hyper-inflation or even a lot of inflation. The AG-BB formula of lots of inflation to combat price corrections with spending by the federal govenrment is exactly the playbook Japan used to enter into a multi-decade slow growth funk. And I predict that the USA will experience exactly the same thing.
This experience is not deflation. It is the result of theft of resources. What happend in Japan was that currency traders could take loans in Japan and buy bonds paying higher interest in foreign countries. Then the trader gets a small payoff 0.75% maybe for transaction costs.
Published: November 6, 2009 9:53 AM
bob
Patrick,
You are not wrong. Ganesh is invoking the compound interest paradox, which has been debunked thousands of times.
Without that additional $10, it is more difficult to repay a loan, but not impossible.
If the loan were required to be paid back in full with interest in a single payment, then it would be impossible. How many loans do you know of that want to be paid in this manner? How many DEMAND you do so?
If the bank only put money into the economy by issuing new loans, then it may have a point. But are the bank employees, suppliers, etc. working for free? Do they not earn paychecks, which get spent back into the general economy?
Loan repayments are generally small fractions of total debt. Banks have to pay employees from interest earned before deciding to retire the surplus or loan it back out. Finally, bank profits are unlikely to be hoarded by bank owners but instead spent or loaned back into the economy.
Rather than say "impossible," say "more difficult".
Published: November 6, 2009 9:54 AM
William P
"Yes, all hell will break loose, but only for the people who took imprudent risks like borrowing recklessly or depositing money in unsound banks."
Excuse me? I don't think we should be blaming the 99.999% of U.S. citizens who are ignorant of the fact that their local banks are unsound. I realize the theoretical implications and all that, but WIPING OUT millions of people's saving would cause riots. Clearly something should have be done to protect people's savings, if only illusory (and undoubtedly requiring some gov't machinations to redistribute wealth).
A collapse of the civil society, while it may come from what we've done already, is not something that I'd treat so flippantly.
Published: November 6, 2009 10:01 AM
bob
We are not Japan for several reasons. Japan did not and does not have the world's reserve currency. Japan has a much higher private savings rate than the US (although it is set to decline with an aging population). There are several reasons to expect rising prices and money supply here.
The banks will not loan without an inflationary situation helping to reduce the burden of their under-performing assets. They would also like to earn higher interest on loans. If left strictly to domestic policies, this would look like Japan. However, we have international issues. If the dollar is even slowly replaced as the world's reserve currency, this is highly inflationary to the US. The paper money from yesterday will come back here, and real goods will leave.
Once the banks start loaning, it's basically a race. Banks can either sit on their excess reserves as they lose real value, or they can lend against them as soon as possible.
I think the Nascar analogy is ok, but I think it's more like a kid trying to hold a beach ball underwater, only the beach ball is getting bigger and bigger.
Published: November 6, 2009 10:07 AM
Stranger
"Excuse me? I don't think we should be blaming the 99.999% of U.S. citizens who are ignorant of the fact that their local banks are unsound. I realize the theoretical implications and all that, but WIPING OUT millions of people's saving would cause riots. Clearly something should have be done to protect people's savings, if only illusory (and undoubtedly requiring some gov't machinations to redistribute wealth)."
In a 100% reserve system, the government is responsible for ensuring that banks do not embezzle people's savings on bad loans, by strictly separating loans and credit from deposit banking. It therefore makes sense for the government to reimburse lost savings when fractional reserve banks collapse as well. It's the government's fault they were lost.
What the government shouldn't do is re-capitalize the bank, as a loan bank only has a social value so long as it can preserve the capital it loans out. If, like Lehman Brothers or many other wall street firms, it wipes out its capital, that means it is an anti-social institution, its entire corporate structure should be liquidated and its employees should be re-trained as burger flippers.
Published: November 6, 2009 10:19 AM
Patrick Barron
Stranger,
Although you are correct that the government bears the most responsibility for this debacle, it is not an entity separate from society. Since the only resources government obtains are those that it confiscates from the people, how can it "reimburse lost savings when fractional reserve banks collapse" except by confiscating even more of the people's resources? It is a common error of logic, in my opinion, to believe that government resources can be used to bail out anyone without committing a crime by confiscating those very resources from someone else.
Published: November 6, 2009 10:32 AM
George
So what can one do to protect one's savings and investments during this time?
What about the US dollar carry trade which is currently inflating all kinds of assets, including gold? Maybe even the yellow metal might not be all that safe of a haven should the rates be hiked and the carry trade come to an end.
The Austrians have talked a lot about our problems, but what can someone personally do to protect themselves in this year and the next? That would be interesting to hear.
Published: November 6, 2009 11:11 AM
Mike
George,
Get away from cities out to where food is being grown, and befriend some farmers in a big hurry?
Heh, I'm sort of joking, but I do think it's worth bringing up. What's going to happen to American civilization when hyperinflation does hit? This seems to be the elephant in the room when we all talk about this stuff.
Published: November 6, 2009 11:25 AM
Paul
I think Rathnam is forgetting one thing. There is no pricing power. You can pump the money (debt) all you want, but if consumers don't spend prices won't go up. Unless government puts a gun up your head and tells you to spend, I think deflation is what we'll see in the next few years.
What government has done is simply replace defaulted debt with new debt. It's like pumping air in a tire with a hole.
Published: November 6, 2009 11:41 AM
billwald
"Common sense tells us that if phenomenon A causes problem B, then B cannot be rectified unless A is first removed."
Common sense tells us that if a drought causes a water shortage, then the water shortage cannot be rectified unless the drought is first removed?
Published: November 6, 2009 11:54 AM
Fed Up
Thank you Mr. Rathnam for posting an up to date, Friday November 6th 2009 article that speaks about what's happening today to people living today.
Thank you very much. Very nice, informative and instructing article that respects those who suffer here and now.
Other Mises.org posters should take example on you.
Published: November 6, 2009 12:18 PM
Fed Up
"One then must decide whether it will be a deflationary recession or an inflationary recession. Intelligent people can disagree on this, but my take is inflationary."
There was a term invented during Jimmy Carter's Democrat and liberal destruction of America and America's economy:
STAGFLATION !
I think were headed towards stagflation. We will continue to lose jobs, the purchasing power of individuals and small companies will continue to fall all the while prices will increase nonstop.
Food, gas, heat, electricity, internet, housing all will go up while jobs and wages will go down.
Published: November 6, 2009 12:22 PM
sb101
@ Paul
"I think Rathnam is forgetting one thing. There is no pricing power. You can pump the money (debt) all you want, but if consumers don't spend prices won't go up. Unless government puts a gun up your head and tells you to spend, I think deflation is what we'll see in the next few years."
Bingo - could not agree with you more. You can print a trillion $$ but if it gets buried in the sand (or sits on bank balance sheets as reserves) you can not have domestic inflation. You can't have hyperinflation when wages, credit, and jobs are shrinking at this rapid rate, no matter how much money you print.
Published: November 6, 2009 12:26 PM
fundamentalist
George: “…what can someone personally do to protect themselves in this year and the next?”
It depends on how aggressive you want to be. To start, put what money you have into things that appreciate with price inflation. Commodities are best because they react the most quickly. Foreign exchange would be good if other countries weren’t inflating also, which they are. Gold is slow to react, but eventually catches up. Farmland is very good because food prices rising makes farming very profitable. The stock market tends to do well until interest rates rise.
Paul: “You can pump the money (debt) all you want, but if consumers don't spend prices won't go up.”
Exactly! That’s why we won’t see price inflation for a couple more years, at least not until businesses start hiring.
Fed Up: “I think were headed towards stagflation.”
That’s a likely scenario. But first we’ll have some asset inflation, probably in the stock market. Next will come cpi inflation as guv spending kicks in more and businesses start hiring. Then we’ll have high interest rates with high inflation and thus stagnation.
I’m not a financial advisor, but I slept in a Holiday Inn Express once.
Published: November 6, 2009 1:00 PM
Patrick Barron
I have been reading Rothbard's "The Mystery of Banking". He explains how a crisis starts as deflation and moves to inflation and finally to hyperinflation. In the Austrian method, of course, it is impossible to predict WHEN this will occur, but Rathnam is correct, in my view, in that if one accepts the principle of cause and effect then hyperinflation is in our future.
Published: November 6, 2009 1:03 PM
Paul
Fed Up: “I think were headed towards stagflation.”
I don't buy this. Everything was going up during the 70s including personal income. Property price were skyrocketing. In California, houses in many areas were up 10x in 10 years. There was no bubble in asset prices that the stagflation era initiated off of. In the beginning energy prices, housing prices, and debt levels were low.
Today is an entirely different story. We're coming off the biggest asset bubble the world has ever seen. It isn't even close to being fully deflated. The trend shows that people are curbing their spending and saving more money. The fed is pumping money into a deflating balloon.
While the people of Mises have been wailing about hyperinflation for years (maybe even decades), they have completely missed the boat on deflation. They said it couldn't happen, yet we have seen it for the first time since the Great Depression. They were adamant that high levels of inflation were the only outcome of bailouts and trillion dollar budgets. Yet, a full year after the financial crisis, there is still little pricing power. Long and short term treasury rates remain at half-century lows with foreigners continuing to finance record amounts. Folks, this does not look like inflation.
Published: November 6, 2009 5:22 PM
Ribald
I have to agree with Paul here.
Historically, the hyperinflation scenario has never happened as hypothesized (in the US at least). Those making the predictions seem to have simply kept repeating the prediction in the hopes that it will eventually come true and vindicate them. They often subtly hedge the prediction so that it's entirely meaningless (i.e. "eventually, x will happen").
It's often said that we shouldn't ignore the monetary source of inflation (as opposed to the price effect). I agree, but the hyperinflation scenario is never presented as a purely monetary event. Price inflation is the negative consequence that motivates the dire warnings, after all.
It's true that the economy's in shambles, but the hyperinflation scenario, as stated, is as unlikely as it is unfalsifiable.
Published: November 6, 2009 6:26 PM
Sukrit
Hyperinflation is not going to happen because even the political authorities aren't that dumb. I don't understand why Austrians have been making this prediction for 30 years. Am I missing something?
Published: November 6, 2009 8:51 PM
HM
Inflation.
Hyper-inflation.
No, wait, deflation.
Depression.
No, wait, stagflation !
A day or two there was a good article debunking global warming, oops, climate change. The basic premise was there are 25 different models used to predict climate change, none of which actually agree with the facts.
If, after pumping trillions of dollars into the economy, the various economic geniuses can't decide whether the economy is going up or down, well, I guess economic science leaves a little to be desired. Might as well read chicken entrails.
Published: November 6, 2009 11:58 PM
Joe
"Meanwhile, for reasons detailed below, the money supply will constantly increase. We then have the textbook case of more money chasing fewer goods, leading to rampant price escalation."
This quote says it all with respect to the author's understanding of the most fundamental law of economic science, the law of marginal uitility, he is completely ignorant of it! Mises definitely would have labelled him a monetary crank. Of course he is not alone in this neo pop austrian movement of the last few years.
Unfortunately for the author, and his whole case for "runaway" inflation, that "textbook" example only exists in the "economics" of Milton Friedman. A quantity of money, even an increasing quantity, does not necessarily lead to its price falling. Similarly, an increasing quantity of beer does not necessarily lead to a fall in the price of beer. This is what makes the author and his ilk monetary cranks, they have one theory for the determination of the price of money, and another for the price of other goods.
Just in case anyone thinks that I am being too strict in my crtiticism, or that in general it's alright to say that increasing money supply leads to increasing prices, needs to appreciate two things: 1) The "runaway/hyper inflationists' " entire case is built on this foundational assumption that when actually scrutinized turns out to be in error. This utterly betrays the fact that they are NOT austrians, they have rejected the truth that it is subjective marginal utility that determines prices! 2) People need to realize, as well, that these inflationist cranks were completely blind sided by 2008. Remember, the prominent members of this new, so called austrian, movement are generally in the financial services/investment advisory fields. As a result, they allegedly had investment strategies to protect their clients from this scenario. They failed to predict this collapse because their theories are fundamentally flawed. Similarly they cannot explain why gold fell from $850 to $250 between1980 and 2001. This fact alone refutes their mass inflation/buy gold, because the Fed is loose, conclusion.
People need to wake up. These prominent so called austrians all work in the financial industry, in one way or another they are looking to make money (apparently soon to be worthless fiat money) by selling fear. This pop austrianism, whose leading proponents do not even understand/accept the law of marginal utility, are an embarrassment to the Mises Institute.
I
Published: November 7, 2009 4:24 PM
A. Viirlaid
Ganesh -- you made me laugh -- thank you:
That's some doctor all right --- our Dr. Ben Bernanke!
He reminds me of the almost giddy-gleeful Dr. Riviera on the Simpsons:
http://en.wikipedia.org/wiki/Nick_Riviera
I am optimistic by nature.
But when it comes to the Money System, I am with Ganesh Rathnam. There may be a few inconsistencies or even errors in Mr. Rathnam's article, but he knows more than does our famous Dr. Ben about what really ails us.
That is, this Crash-Fest is only just starting. Mind you, very few of us will be cheering like we might at the Indy 500.
What a witches' mixture of causes to make for a real Devil's Brew:
Fiat 'paper-money' Currencies and
Fractional Reserve Banking and
Mixed-Up Central Banking and
Political meddling in many things, just one example being the setting of market Interest Rates = Price of Money.
We cannot save ourselves on the 'back of China'. That is "Wishful Non-Thinking".
China has made the same mistakes that everyone else has.
In a world where all governments and their agencies meddle with currencies, the Money Systems will take years to return to normal. This will cause any return to normality for our economies and financial systems to be likewise delayed.
We cannot expect a Fractional Reserve Banking System that is required to hold less than 10% in reserves to restrain itself from creating massive amounts of Debt. It is in the nature of any private business sector to maximise profits within the mandated Rules of Market Engagement.
Currently, one person's deferred consumption (savings deposited into the retail banking system) gets multiplied into Debt by a staggering 10-fold as banks create money "from thin air".
IMO Fractional Reserve Banking can work, but only when reserves are at a level of at least 50% or deposits. Not because of any worry about runs on the retail banks --- after all we are so 'sophisticated' that our Central Banks can always backstop those runs and depletions of money by just 'printing' more paper money --- but BECAUSE with much higher reserves, the banking system will be constrained from creating so much new Debt in the future!
Our current policies are insane, and that is one reason our Money Systems are in an Insane State.
This will take years to unfold. It is because it will take years to liquidate the Debt.
The years of Ever Expanding Debt were 'miraculous'. Likewise the years of seemingly Ever Contracting Debt will seem tragic.
It's a fine mess we have created.
And it is not just the amount of Debt in absolute terms that is an issue. It is what that Debt has wrought. It is what that Debt was used for or more likely misused for.
When our Money Systems interact with countries having so-called Dirty Floats for their home currencies, we end up having our Political Systems indirectly direct where our consumption and use of our resources go.
That can be very harmful socio-economically because it is not the TRUE COST of money that is helping entrepreneurs and investors decide where to focus their efforts. In fact as the Austrian School of Economics teaches these investments very often end up as so-called malinvestments. When True Lies lead to misallocation we all suffer. No one knows how to estimate likely returns from given expenditures. And now The FED is blowing up another Asset Bubble. Some recovery. Some elixir. Some drug this OPM, as Patrick Barron reminds us in his contribution.
Ask "Why is our Central Bank even setting our prevailing interest rates?".
As "Why should we not let the market set the interest rates without artificial intervention?"
Ask "Do we let the market decide the price of bananas or do we have a Central Banana Board that does that for us?"
And where such Central Marketing Boards exist, ask "Is our Central Marketing Board’s management of the supply and price of (for eg.) Automobile Tires or Eggs and Milk a good thing?"
Maybe it would be during a World War, but I would submit it is not at all other times.
Another whole area of problems is created by the inefficient functioning of our Public Sectors.
No government operation needs to be accountable to a simple test each year like the private sector has to meet. No government agency will ever go bankrupt because Expenses exceed Revenue year after year.
We are part of this problem. We simply expect our governments to do TOO MUCH for us.
Is there any logical reason why a school or hospital cannot be operated as a profit-making operation.
Sure, if you need to give access to those right-to-life-and-health resources for people of limited means, do so as a matter of public policy with vouchers or with subsidies --- even though your government is using ‘progressive’ taxation to reap the required funding resources from the private sector. OPM = opium = Other People’s Money --- it is so easy. Just reap the rewards of others’ work. But how long will they keep working for your benefit?
Why are there so many activities in the public realm that could be better done in the private? And better done because of the discipline of the market.
Those future days are far off (if ever) simply because thanks to prior government intervention we are likely to go through some really desperate times. These coming times will have us all clamouring for even more government ‘safety nets’ than ever before.
Socialism Here We Come!
Roosevelt "wasted his opportunity".
This time I am afraid that the Democrats have resolved not to waste their opportunity. Or even if they have not done so consciously, they may very well unwittingly slip-slide us into a Statist Socialist 'paradise'. It is just the nature of the times, the nature of this particular disaster.
"We have met the enemy, and it is us."
America implode like the U.S.S.R.? Who would have ever given that idea any credence until now. It is a remote possibility though today IMO.
But whether it comes from more 'crashes' or just a slow slide into a lower standard of living, the real danger is that we will never restore the wealth-creating engine that America once was.
One day we might well see that we have been living off of our capital for a long time, and we never knew until all of our seed corn was gone.
Published: November 7, 2009 4:38 PM
A. Viirlaid
Another take on Government "providing us with jobs" can be found at:
http://www.prudentbear.com/index.php/guestcommentaryview?art_id=10299
Published: November 7, 2009 6:37 PM
Terri K
Certainly assets such as housing are experiencing deflation, as they should, and many predicted this as a result of the housing bubble bursting. But when I see or hear someone speak of "price inflation", and correct me if I'm wrong, they usually seem to be referring to things we consume in every-day life such as groceries, energy or toilet paper. I mean, have any of you taken a trip to the grocery store lately??
That's what is causing and is going to cause the most harm to the majority of people.
Published: November 7, 2009 6:50 PM
Carl
Even in a fiat based monetary system, credit is not money. Credit is a claim on money. 96% of the U.S. money supply is credit. Credit is created by debt. Even Bernake cannot expand credit without a corrisponding debt being created. Inflating debt does not increase the money supply, it only increases the demand for money, until the credit issuing system collapses. A collapsing credit system can not cause monetary inflation as the credit that was being used as money simply dissapears, POOF!. Leaving in its wake massive amounts of debt representing claims unfulfilled. Under these circumstances, prices become irrelevant as no one has any money/credit to produce or buy anything with.
Published: November 8, 2009 8:44 AM
Bennet Cecil
The endless paper money printing transfers purchasing power from holders of dollar denominated wealth to the US government. It is simply a fair tax since everyone pays it except the government.
Hopefully, it will cause the dollar to slide against Euros, gold, oil etc. Savers will dump dollar denominated assets and refuse to purchase US government debt. Interest rates will rise greatly and the stagnation will transition to stagflation. Remember the Johnson-Nixon-Ford-Carter era?
The American voter will eventually wake up and elect politicians who will limit government spending, stabilize the dollar and bring back free market capitalism.
If the dollar suddenly collapses, all bets are off. There could be a revolution.
Published: November 8, 2009 4:53 PM
Patrick Barron
I just did some quick math to determine the possible growth of M2, based upon the level of reserves at the Fed. These numbers are taken from the Fed's own website. All numbers are in billions of dollars
Total Reserves: $1,122
Required Reserves: $62
Excess Reserves: $1,059
(There must be some technical issues for why required and excess reserves do not equal total reserves.)
M2: $8,333
Therefore, the level of current total reserves means that M2 can increase by a factor of 18 times its current size to $149,784. This tells me that hyperinflation is possible. If the Fed does not want M2 to increase to 18 times its current size, why did it pump so many excess reserves into the system in the first place? This seems to me to be the height of irresponsibility, perhaps even constituting malfeasance of office with criminal intent.
Published: November 8, 2009 7:12 PM
A. Viirlaid
I don't know about "malfeasance of office with criminal intent". I suppose it might be remotely possible. From every appearance, to an intelligent observer like Patrick Barron, it might even seem like the only logical explanation. Maybe Bernanke is a member of some foreign sleeper cell intent on doing U.S. some serious harm.
After all, Bernanke is a learned, intelligent person. So how else can an intelligent person who frequents this website understand how someone like Dr. Ben Bernanke seems to be so intent on wreaking such havoc on America and the world?
IMO it is more likely that the explanation lies in "malfeasance of office with criminal stupidity".
Bernanke, and the prevailing economic school of thought which agrees with him and his policies (like Krugman et al), generally believe that economic growth comes from promoting more debt within society.
And the experience of the past 7 decades would seem to support this school of 'thought'. This approach has "always" worked.
By the way, the reason for all my qualifying-quotes is that I question ALL of this seemingly mindless devotion to solutions that have worked in the past --- that they have NOT worked is something we cannot easily discern, that is true. It is just that IMO within the short spans of human lives we cannot see this. We are unaware that the huge imbalances and disorder we have created are not accidental, but indeed are the VERY result of the Money System we have constructed. There are many people who can see this --- Dr. Ron Paul, Doug Noland, Peter Schiff, Bill Bonner and Addison Wiggin of The Daily Reckoning, and many more --- but none are in any position of power to convey this thinking to the mainstream or to the media in a manner that would change public policy.
Each time we have supposedly 'solved' one crisis we have only added to the burden that makes solving the next crisis that much harder. The 'solutions' we are applying are little drops of a cumulative poison that get the patient back on his legs temporarily for another decade or so.
So the prevailing 'intellectual' take on today's crisis is not unexpected. It's just wrong. (And stupid as I said.)
What is laughable is that The FED and the other authorities 'in charge' think that they can promote economic growth in the short run, make it 'self-sustaining' and then magically quickly remove all the 'stimulus' that is supposed to make this short term economic growth happen.
Again, this approach has virtually always 'worked' in the past BUT with ever-diminishing efficaciousness each time that it has been applied. We just have not paid attention.
IMO it will not work this time AT ALL. If I am wrong, then it will be next time that it does not work. At this last point, naturally the mainstream will laugh --- they want the Austrians to prove it won't work and tell them EXACTLY WHEN it won’t work. The Austrians don't have an answer because the economic, financial, and money systems are complex, chaotic, non-linear, and not prone to having their behavior easily modeled or predicted. But that will never satisfy the mainstream. When the system does finally fail, the mainstream will refuse to acknowledge that their system was flimsy, and built to fail. The Austrians will get little intellectual credit for their efforts to point out the problems inherent in the system. Don't expect Ben Bernanke to bite the hand of the system that feeds him and his career.
That is why we have a 'debate' between aficionados of this website and mainstream economic 'non-thinking'. Here the quotes around the word 'debate' are meant to signify that it is only the Austrian side that is 'debating'. The other side is wholly convinced (based on a misreading of their take on Economic History) that their approach will work --- it HAS to work. Experience has 'proven' that to them.
It has proven no such thing to the Austrian thinker.
So whether future price inflation happens or not is, in my mind, not the relevant question.
Perhaps the 'stimulus' can be removed in time --- I actually doubt it because as a classic inflationist, this FED’s Chairman will leave the 'stimulus' in place for far too long, waiting for the recovery that never quite becomes self-sustaining.
The relevant question is will all of this hectic activity achieve anything?
The answer is no --- it will do far more harm than the 'illness' it is meant to alleviate.
Whether it is deflation or inflation that is observed, it may be seen by those in the mainstream to be the devil to be fought --- when in fact it is the destruction of the economy and the dollar that is the 'sideshow' those in authority should have been paying attention to.
Published: November 9, 2009 11:37 AM
Lysander
Ganesh Rathnam writes:
"If the market were allowed to work, loan defaults would cause bank failures en masse. Bank failures would also wipe out the savings of depositors.. but only for the people who took imprudent risks like .. depositing money in unsound banks."
All banks are illiquid and depend on the Fed to supply liquidity in a crisis. That is the reality of the current banking system. If the Fed did nothing in the crisis, then EVERYONE with money in a bank would lose their shirts. No exceptions. Is that really what we want? What I want is the system to be fixed so that crises are no longer regular occurrences. One such fix was proposed by Rothbard.
Ganesh Rathnam writes:
"This cycle cannot continue endlessly. One fine day it will blow sky-high."
Why such assurance? Yes, if credit expansion is not halted, then it will lead to the crack-up boom and hyperinflation. But a recurring business cycle is probably more likely. As Mises himself said:
"public opinion .. no longer denies that the cause of the depression is the preceding boom and that this boom is engendered by credit expansion. The awareness of these facts alarms the financial press as soon as the first signs of the boom appear. Then even the authorities begin to talk about the necessity of preventing a further rise in prices and profits, and they really begin to restrict credit. The boom comes to an early end; a recession starts."
Hardly an apocalyptic vision.
Bernanke did what was necessary. He extended credit to stop a banking collapse, and he plans to shrink the Fed's balance sheet once confidence has been restored.
Yes, the Fed should be eliminated, but first banks must rebuild enough liquidity to survive bank-runs irrespective of the fluctuating "confidence" people have in them.
Published: November 10, 2009 7:20 AM
Autolykos
To Lysander:
You do understand that banks are illiquid because they have only fractional reserves, right?
As far as I can see, there are only two general options: allow the economic illusions to continue, or not. The Fed has no incentive whatsoever to dramatically increase the reserve requirement for member banks, let alone raise it to 100%. So the illusions go on.
Hyperinflation is not caused by governments or central banks per se. It occurs when the general public by-and-large rejects the fiat currency. Prices denominated in the fiat currency increase even further because hardly anyone (if that) considers the currency to be worth as much as the government claims it to be worth -- if they consider it to be worth anything at all.
Now what would cause people to reject the fiat currency? If the government, through the central bank, keeps inflating the money supply in earnest, people's confidence in the fiat currency will eventually shatter. Of course, for better or for worse, there's no way to predict exactly how long that would take.
What I find amusing is how you can believe that Bernanke will be able to "shrink the Fed's balance sheet once confidence has been restored". How will he be able to get rid of the massive amount of excess reserves? The Fed doesn't own those -- the member banks do. Eliminating those reserves by fiat will only undermine the very structure of the Fed by angering those banks who hold them.
And the toxic assets that the Fed has taken on? Who wants to buy them? Since they're considered "toxic", the answer must be "no one". Therefore the liquidity the Fed added in exchange for the toxic assets will also not go away.
The whole point of the Fed's actions in this situation has been to prevent the disillusionment from spreading, by propping up the banks' balance sheets. As it's able to create new money ("liquidity") out of thin air, the Fed is in a unique position to maintain economic illusions.
Right now, the US government and the Fed are between a rock and a hard place. It's extremely likely, for political reasons, that the government will continue on its path of ever-increasing debt. So on one side, the government could become unable to make its interest payments, due to the Fed refusing to buy more debt. On the other side lies hyperinflation from mass inflation, if the Fed is willing to buy government debt ad infinitum.
Basically, the question is not whether there will be pain, but what form the pain will take.
Published: November 10, 2009 11:21 AM
Ned Netterville
HM: "If, after pumping trillions of dollars into the economy, the various economic geniuses can't decide whether the economy is going up or down, well, I guess economic science leaves a little to be desired. Might as well read chicken entrails."
Yep, or as Ludwig von Mises put it, "If it were possible to calculate the future state of the market, the future would not be uncertain. There would be neither entrepreneurial loss nor profit. What people expect from the economists is beyond the power of any mortal man. The very idea that the future is predictable, that some formulas could be substituted for the specific understanding which is the essence of entrepreneurial activity, and that familiarity with these formulas could make it possible for anybody to take over the conduct of business is, of course, an outgrowth of the whole complex of fallacies and misconceptions which are at the bottom of present-day anticapitalistic policies. There is in the whole body of what is called the Marxian philosophy not the slightest reference to the fact that the main task of action is to provide for the events of an uncertain future. The fact that the term speculator is today used only with an opprobrious connotation clearly shows that our contemporaries do not even suspect in what the fundamental problem of action consists."
Mises' words should serve as a warning to those who come here to discover the direction in which the DJII is heading. Austrian-economic laws and theories include the disclaimer "all other thing remaining the same." In the real world, all other things never remain the same. But the fact that economics cannot tell you what gold or google shares will be worth tomorrow or next month does not diminish the value of Austrian economics, which is the only brand of economics I recognize as economics.
Think of it this way: Austrian economics can tell you with absolute certainty that the various economic-stimulus policies proposed by Presidents Bush and Obama and enacted into law by Democrats and Republicans in Congress cannot produce the results for which they were (purportedly) intended. They cannot "stimulate" economic growth. However, Austrian economics does not pretend to know, for example, that on the immediate horizon there is an invention currently only in the mind of a human being somewhere, which will rather quickly evolve into a product or process that increases the productivity of all people to such a great extent that economic recovery and growth will occur regardless of the growth-inhibiting policies of government. And Austrian economics can tell you for sure that the advantages to mankind derived from the great invention will be diminished by each and every intervention in the free market undertaken by government.
Published: November 10, 2009 1:08 PM
A. Viirlaid
One good thing for me from all the posts I read on these Mises blogs is that I always end up thinking more than I did before I read them. Thank you to all of you and to Autolykos and Ned Netterville toward the end above.
Lysander makes a good point --- no one wants a total collapse. Problem is that The FED is in a vicious circle (and not a virtuous one) of its own making and of the making of the system it exists within and that it nurtures.
There are many possible proposals for improving our current financial systems. Some are alluded to in the postings here.
Not all proposals will make sense in the final design package, so to speak.
But clearly we need some improvements --- even non-Austrians would agree with that.
As our legislators (or their assignees) go through the badly-needed Re-Design Development Process, they will consider many proposals and use many perspectives and yardsticks with which to evaluate these proposals.
The best ways IMO to improve the current system would be to employ those proposals that leverage the Free Market to provide the most choice to consumers.
Using the buzzwords of the day, the best proposals would be the ones that provide the most transparency and accountability.
There may be constraints that our Money Authorities set as boundaries with which (in their minds) to limit risk to some reasonable level for the overall system.
That, for example, is what the discussion --- about no longer having any "too big to fail" institutions that can threaten the entire system --- is all about.
Another consideration is the amount of the resources required to backstop those institutions that our Money Authorities do decide to 'guarantee' with their socialized insurance schemes and institutions like the FDIC.
None of us can completely eliminate Moral Hazard, nor should we even try, because that is impossible given what Moral Hazard is. That is, there are good things that come from speculation, as alluded to by Ned Netterville in his quote from Ludwig Von Mises:
MORAL HAZARD exists hand-in-hand with speculative activities. If you want your system to allow for speculation, which I agree seems to offer valid benefits, then you will always have, nay always need Moral Hazard.
One idea that implicitly seems to arise from our current discussions on this specific blog is a proposal for having different banks that have varying capital reserve requirements.
Why should all retail banks have the SAME reserve requirements? That limits market choice. Why not have different classes of banks with different risk profiles? In reality we already have those differences but we don't group or effectively differentiate (in marketing terms) such banks currently.
There are many factors affecting risk. In the good old days of George Bailey and Mr. Potter, banks or credit unions that lent mortgage money were thought to be relatively safe. Mortgage loans were actually 'conservative'. How times have changed. Or perhaps, more accurately, how have our institutions and rules changed the times?
So types of assets held by banks and financial institutions have an effect on their respective risk profiles both for investors and depositors.
Another difference in the riskiness of any financial institution is what its capital reserves are. With mandated common minimum reserves, most banks have seemingly gone nuts (or in risk-terms have so done in the recent past) trying to maximize their profits (on behalf of their stockowners).
They have tried to attract more and more deposits with a view to recycling those as loans as fast as possible.
They have gone even more nuts in the past few decades by using their depositors' money (OPM) to make riskier and riskier loans that they did not plan to hold in their own portfolios to maturity (like in the days of George Bailey).
This is what eliminating Moral Hazard leads to. If the banker knows that The FED or Treasury will bail them out (The Greenspan Put was not only for the Stock Market) then that banker will gamble all the more --- hey, the depositors won't get hurt if worse comes to worse --- and there is a good chance I, Mr. Banker, will make even more money for my stockowners. We live in a Gambling World.
Instead of George Bailey's simple world, the banks in the past decades have packaged mortgage loans (among others) into securitized 'assets' --- 'bonds' in one sense if you prefer --- that these banks have been flogging in the marketplace for fees.
In other words, they "pass the buck" or more properly "pass the loan" --- Moral Hazard is no longer attention-worthy.
In my opinion we can have a better system
We could have Banks that wish to offer their services as Full Reserve Banks. Of course such banks could only lend in the traditional sense from their own profits, not from the resources of deposit-making clients. But I submit that there would be a market for such banks.
(I know there already are Money Market Funds and other similar vehicles with which to realize such lower risk classes for your deposits --- but I think there could be a place for Retail Banks IN THEIR ENTIRE MAKEUP to sell such services to very risk-averse clients. And of course such banks could not deviate from what they marketed as their product and as themselves. The FACE of such banks would be "in your face" --- there would be fewer illusions.
Naturally, such banks' deposit-making clients won't be earning any interest from their deposits. Instead those clients will be paying fees to those banks to 'warehouse' their wealth.
Sort of like Safety-Deposit Box Banks.
We could refer to this Class of Bank as "Bank-100-Class" to indicate that the deposits taken in are never lent out. The reserves are 100% of deposits.
For example while Ganesh Rathnam mentions Full Reserve Banking and I mention 50% reserve banking, why can we not allow the free banking system to provide Banking with Different Reserve Requirements?
There might still be a minimum reserve (say 50%) for societal reasons and for reasons Austrians know too well. (Those have to do with the Multiplier Effect of Fractional Reserve Banking and the fact that runaway Credit Growth is very damaging over time -- we are in that end-time now.)
Clients would know which banks are more risky by the amount of their reserves. In other words, not all retail banks need be in the same Risk Class, whether by their asset-mix or by their reserves held.
For example, Ganesh Rathnam might prefer to keep his wealth in a 100% Reserve Bank. He would not earn any interest and he would pay a fee for every transaction he did with his bank, but that might be what he wants for himself.
Then he could truly say that "those people who took a chance with a more risky bank only have themselves to blame". Because I agree with William P --- today such a statement is not true and acting on its premise can lead to societal meltdown.
Stranger makes a good point also. If governments do allow different classes of banks --- that is that some are in the Fractional Reserve Banking Class (perhaps limited to no less than the Bank-50-Reserve-Class that I alluded to in an earlier post) and others are in the Full Reserve Banking Class --- then people would be more aware of what banking with a non-Full Reserve Bank actually meant.
Such depositors (in a non-full-R.B.) would KNOW that it was their OWN MONEY that was being loaned out, and that THIS LOANED MONEY would be paying for their free checks, their interest paid into their account, their toasters and whatever else they got as freebies from their banks (a nice warm bank building, free transaction slips, bank books, nice tellers, handy ABM-s and so on).
Sure, such depositors could earn interest since it was their own wealth that was being loaned out, but they would ALSO know that the interest they earned on their deposits would come with some measure of risk. After all, if you get something for loaning your money out (through the intermediation of your local bank or say even through your local loan shark) is it not presumptuous to ASSUME that you are guaranteed to get all of your deposit back, always, with no risk of default on the part of the person borrowing YOUR DEPOSITED MONEY?
So in TODAY's world I tend to agree with Willam P. who says that for societal considerations we do not want all innocent depositors to lose their deposits like they would have in the 1930-s. At the same time IMO Stranger's point is right on --- the institution, if it fails, must be allowed to fail, subject to any other stronger institution buying it, and employing its workers. Otherwise how do 'good' risk management systems propagate from strong well-managed banks to the rotten ones? Easy --- they never would, unless you think governments can retrain those bad bankers to be good bankers.
Patrick Barron’s point is also valid --- one evil does not correct another. But the government has to come clean --- if it sets up an evil system that does people harm, it should acknowledge that, fix it, and move ahead. Yes, resources are always being taken from Other People --- whether as taxes or Printed Money --- so either we cleanse the rottenness out of the system or we wait until the rottenness destroys the whole system.
Waiting for technology to save us may be a forlorn hope this time --- it has happened many times and that is why The FED has gotten away for so long with debasing our currency, but this time technology and the advancement of science and society just might fail The FED. The curtain may finally be lifted to expose the fraud behind it.
As Ned Netterville astutely writes:
We could add "or regardless of the money-debasement policies of The FED".
So, getting back to the bank-differentiation proposal, if the depositor knew "going in" what the risk was that he or she was taking, maybe that would be OK? --- Buyer Beware! After all, we are all adults, right?
Published: November 10, 2009 7:18 PM
A. Viirlaid
No, I am clearly wrong here --- I don't exactly know why I wrote this phrase (in my last post) this way, but it is completely wrong.
I was a little tired at the end of the day after work, and I am sorry about this. I tripped over my words. I think I may have known what I wanted to say, but I did not write it that way.
We ought indeed to seek to eliminate Moral Hazard, because it motivates inappropriate behavior.
http://en.wikipedia.org/wiki/Moral_hazard
I may have been thinking RISK when I wrote "Moral Hazard".
In any case once I had posted and then reviewed my wording, I thought to myself, what was I thinking?
"... eliminate Moral Hazard, nor should we even try" --- wrong, because yes, we should TRY to build systems that minimize Moral Hazard because of the evil effects that it has. It is one reason that wayward risk-taking banks went "way" overboard in some of their most risky activities, as I wrote with regard to the "Greenspan Put".
Wrong again --- it is the opposite.
That is, I should have written "This is what having far too much Moral Hazard in a system leads to."
The thing I noticed in the popular media, when all the bailouts were being proposed, was how much people were wringing their hands about Moral Hazard.
Well that is far too late in the process to be worrying about Moral Hazard.
Once we are discussing bailouts, Moral Hazard be damned --- it is only during the time that the original egregious behaviors occurred that Moral Hazard should not have been present, so that those egregious behaviors might have been minimized.
Not later, when all the damage had already basically occurred.
Sure, bailouts are part of that egregious behavior.
But as Lysander points out, at that point your only option is to TRY and prevent the imminent collapse --- even if it comes anyway.
I know some of you won't agree with this last point, but hey, a drowning man will clutch at straws, or even at other people who are swimming towards him and who are trying to save him.
Yes, indeed, the drowning man will even cause the death of those who are intent on saving him, because of his own panic.
Published: November 10, 2009 11:41 PM