Hyperinflation

[Jerome Scuggs]

Nycle, within the framework I provide, the decisions of the big banks to pursue their risky loans fits in nicely. I argue that the distortions of the Fed caused the banks to jump headfirst into the bubble, which turned out to be a bad idea. My "walls of text" explain exactly why the bankers did this. To call this financial crisis "isolated" is a terrible way to look at it, because you exclude potentially damning information which distorts your conclusions. I find it odd that you call this analysis "unrealistic", considering I have shown the historic and current statistics that correlate very nicely with what I have said - and contradict your own assertions.

Keep in mind - I'm not defending the market participants, I'm defending the market. I am the one who is advocating that these "bad" bankers should be allowed to fail accordingly - and you are the one supporting their continued existence in the financial industry. I'm not sure how this one is being blamed on the "failure" of the markets when the markets clearly have not been allowed to function.

Seeing as you no longer choose to participate in the discussion, though, I will also cease arguing over the past (even though as the creator of this topic, I see no reason as to why this has gone "off-topic"). Instead, I will take my conclusions - and use them to make some predictions about what is going to happen - I will even apply my analysis to the events of the past few days to show how it all fits.

I've finally come to understand the tenets of the "new" plan that was hastily put in place - the "historic" bailout that Congress approved is now a memory, not only was it useless (as I said it would be), but even the Treasury Secretary himself has openly abandoned the plan (however, the new wave of powers that the Fed/Treasury have received are very alive and very well).

The "new" plan is centered around the "nationalization" of the major banks. Instead of buying up the bad mortgages, the Treasury is merely going to flood their reserves with capital. This has a few implications and presents a few new conclusions.

First - the Fed is now monetizing all forms of debt. Not just bonds or securities - but even loans themselves. This literally means that the Fed can directly act as a bank in-of-itself. This allows the Fed to inject money into the banks without overtly "creating" money, though money is created and thus inflation will continue. This is because the Fed, in the short-term, will merely wire money electronically to banks - virtual money that will float around in cyberspace for some time, until a consumer withdraws money and the bank gives them cash - newly printed cash.

Paulson sat down with the major banks and told them he was purchasing stock in all of them. This allows, once again, the Treasury/Fed to inject money (via stock purchases) without overtly creating money. But the second implication is that these banks are now under close government control - an issue I will return to shortly. In the meantime, the way the Fed is doing this is by "purchasing" bonds from the Treasury, who then use the new money given to them by the Fed to make these purchases.

The most interesting conclusion that can be seen is that now, the taxpayer will have no easy way of telling whether or not his money was spent wisely - and if he will, in fact, be "paid back" with "good investments". Previously, a consumer could merely check the value of their mortgage against the amount realized after it was purchased by the government, and then calculate the difference. But by instead injecting money directly into the reserves of the major banks, the Fed is further encouraging more loans - in short, doubling down on a bad bet.

The new plan is needed because it is doing what the free market has refused to do - that is, send new capital to these failing banks. If there was truly a way to profit from the selling-off of these non-performing mortgages - then free market actors would find the way. But with an infinite line of credit open to them, what incentives do these banks now have to efficiently liquidate their non-performing loans? The plan sets the economy up for an even greater risk of "moral hazard". One can argue the merits of "moral hazard" up until now, but at this point it's hard to argue that a new, greater risk now exists for bad decisions to be made. In 1999, when Fannie/Freddie began pursuing "subprime" loans, the risk of such a venture was mentioned - but the risk was that they would eventually be "bailed out" - not left to go bankrupt, but instead saved. To what extent this affected the next few years in the subprime market noone will ever be able to calculate - but to deny that it had an influence at all would be fairly poor judgement.

This plan will, in the short-run, cause harm to smaller, local banks. As per my analysis, the market is shifting capital away from the failing institutions and into these smaller, safer banks. This has a twofold effect: one, consumers' assets are truly safe, and two, the smaller banks are increasing their reserve capital, allowing them to make larger loans - which attracts new customers away from the failing banks. The process is allowing new competitors to enter the larger finance markets.

Rather than let this process happen, the government is throwing a wrench into the gears, by allowing the banks who made massive mistakes to continue... with an unlimited supply of credit. This means that the smaller banks - who could be gaining potential customers and increased reserves - are being prevented from growing. Aside from that, there is another potential threat - that, in order to remain competitive, these smaller banks might engage in the same type of poor loan-making activities that generate short-term profit at the expense of long-term risk. The sight of these larger banks being bailed out for their mistakes certainly does not reward the smaller banks for their patience and sound business decisions - and if their sound decisions do not reward them in the long-run with bigger market shares and thus profit, what incentive would they have to continue their less-profitable, but less risky activities?

In conclusion - the current plan will set up even small banks for a potential failure. In a free market, these banks would rise to the top because of their smart decisions, but that is not what's happening in the status quo.

Now, this is the short-term. In the long-term, I still see a massive failure of the major banks - in the form of "capital flight".

In the short-term, the big banks will gain alot of revenue - from the government, in the form of the bailouts and future programs - such as promises to guarantee future low-income home loans and other such risky ventures. Of course, the market has now learned of the true risk of such risky practices - and so capital will not return to these banks.

Instead, the capital will flow into banks that are much safer, much more well-capitalized, and not under the control of government. In conclusion - the taxpayer's "investment" will be one of the biggest wastes of money history will remember.

If you think it sounds "unrealistic", it's happened before. When Sweden underwent a nearly identical bailout of its banks in 1992, the only one to survive intact was the Wallenberg SEB - one of the few banks that actively resisted any government interference.

You do make a point about the flood of money coming from China and Russia's central banks - asserting that this is what made the economy fragile. But they are continuing to buy up U.S. debt - meaning there is no unique implication as to why this was the cause of the collapse. Of course, Bernanke tightening the money supply after a few years of Greenspan's ultraloose policies would go very far in explaining it - which is in line with my analysis.

[Zerzera]

In this thread Jerome finds out that the American tax payers don't really make any money, and still get to be the consumers of the world.

You have to generate money somewhere, and since you are too busy burning fossile fuels in your oversized trucks on the way to the mall to fill your oversized fridges, the government will have to create it for you.
You don't really generate wealth by spending your time pooring coffee and philosophizing kiddo, be glad that you are on the good side of the system. In some parts of the world they are actually working a month full of hard labour for the money you get for your pseudo-work.

On behalf of these people I would like to say; shut up and keep spending that money, or they will lose their jobs in those neat factories!

[MetalHeadz]

Because it's not the nominal money supply that causes monetary inflation, it's the available supply of money that causes it. It is absolutely necessary that you understand the difference between these two or you won't understand how monetary inflation works. The available money supply is part of the nominal money supply, but not all of the nominal supply is available.

Before the credit crunch started, the supply of money on the capital market was provided for by private (non-government) entities like banks, who in turn have money entrusted to them by other private entities (consumers, corporations). A bank uses all of this money to fulfill its main task: to bring supply and demand together on the capital market. This is all done on the basis of confidence, the confidence that the money you lend plus interest will be paid back for by the receiving party.

But what if this confidence disappears, which is what the credit crunch has done? Banks are scared to death to lend other banks any money because no one knows for sure whether they will get their money back. Because how do you know that the bank you lend your money to is not on the brink of collapse and won't be able to repay you? The inevitable result is that interbank money flows and credit lines are severed; banks hold on to their money, the capital market dries out, the available money supply to fill demand shrinks. This has the added effect of less insolvable banks not being able to refinance their debts, which is the cause of many, but not all recent bank failures.

So this is where the governments and central banks come in to replace the private available money supply by injecting money into the system and thus keeping the capital market flowing. Since this money is there to replace the private money that no banks want to lend out to each other anymore, on a net basis there is effectively no change in the amount of the available money supply. This money is literally being created out of thin air, or being pulled out of their asses, so to speak, and there is no gold or dollar bills to back it up (only a fraction of the total money supply is cash, the rest is virtual). This is the very essence of capitalism. People have confidence that the money that is being "created" is worth anything, and that everyone will attach the same nominal value to something that does not exist.

Aside from that, as you can see, the available money supply has not really increased as the central banks pour in dollars to keep the capital market flowing and to restore confidence. As confidence is gradually restored, the private money supply that became immobilised due to the distrust will slowly become mobile again, and this is where the governments and central banks will withdraw money from the market (by selling securities on the open market, but that's a different topic) and thus making sure the available money supply doesn't increase as the previously immobile capital starts flowing again. The result: No increase, no decrease, no inflation. The money that is being poured in right now shouldn't be viewed as unlimited, but more like "as much as is necessary to keep the available money supply on the capital market on healthy levels".

Spot on.

[Jerome Scuggs]

http://www.metro.co.uk/news/article....4&in_a_source=

gl;hf

[Galleleo]

So you would rather not read articles that might prove you wrong jerome?

[Zerzera]

So you would rather not read articles that might prove you wrong jerome?

Yes, he selectively ignores arguments.

[Zeebu]

there is nothing wrong with reading/ignoring what you feel like

just like there is nothing wrong with throwing a stereotype over an entire country.



both practices are fine

[Jerome Scuggs]

So you would rather not read articles that might prove you wrong jerome?

I'll extend every courtesy that is extended my way

Unlike most people, who say they read but don't - I'm usually too busy reading to really care about whether or not people know. I'll get back to your post when I've read everything. Would you rather me instead critique the literature before I read it? Seems to be what everyone else is doing, so, might as well hop on the train.

But hey - if "not reading" is the only argument you can put up as to why I might be incorrect, it's alright, 'cause it still means you have no real counterpoints to present, which brings me to

Zerzera, selectively ignoring is better than outright ignoring, though while I do not do the former you certainly do the latter

edit: which also reminds me, I read an interesting piece today that pretty much sums up why what Zerz says is not worth the effort to even try to defend. Specifically this gem: "What we really see in Weisberg’s approach toward economic collapse and 9/11, both of which he blames on not enough government, is that he, like all who see the world in this way, is no less ideological than we are."

[Galleleo]

I have tried to argue your literature before and I have read a whole bunch of the links you gave us, but it doesnt really seem to work with you at all. You either ignore complete or parts of a post and just focus on 1 point and throw 20 articles at that 1 point.

[Zerzera]

just like there is nothing wrong with throwing a stereotype over an entire country.

No stereotype, just a generalization of the current status of the country.
I will aknowledge the same about me and my country. But that's because I am not a hypocrite asking for the destruction of a system that practically keeps me alive. A system which I enforce by my decisions every single day.

Zerzera, selectively ignoring is better than outright ignoring, though while I do not do the former you certainly do the latter

I answered you many times. It's impossible for me to counter you because you are an ideologist. Just like I can't argue against the existance of God.
You criticise reality and propogate a system that can't exist. Then instead of proving to me how it can exist, you ask me to prove that it can't exist. You make the claim, you prove it.
My claim is that the current system exists, I have proof; it's called reality. What do you have?

And what's worse is that you still support the system we have. You support it every single day. So you don't even practice what you preach. Want me to point that out? (You will ignore it anyway.)

You probably do your own groceries right? I do. When I go to a supermarket I could distinguish products in two categories;
Free trade products and regular products. The first are sort of honest products, the farmers get a fair price (not that I could really tell from the package) for their product and thus the product is a bit costlier.
That's why I don't buy them! I don't give a shit that our system abuses poor people in third world countries, I want the cheap product. And if no decent government is in place I will probably buy all my goods from companies that have their labour done by slaves or childs. Because that's free market. They can do it cheaper. They hardly have a living standard so they can work for a loaf of bread.
It's their own fault for being born in a country without a real government, it's their fault that they ended up in a factory instead of school. So they could have been working in a coffeeshop, abusing drugs and pretend they are world changing philosophers. If only we allowed their parents to be able to feed an extra mouth.

You are still stuck with the idea that the market will limit the power of a company. But it doesn't. A company that enslaves people have a product superiour to that of others, if only because of the price. And in a free world they will have the means to do so. They will grow bigger than any government we have ever seen because the peoples vote will be in the store, where only the price will matter.

[Epinephrine]

Jerome, I have to say you write good stuff. I have noticed more and more that the stuff you write is more quality than before. A lot of things that you have written, I have personally read from other sources and I do agree with you in many respects.

1) Creating money out of thin air faster than population growth, or economic growth (via many new things to buy) can absorb the 'new' money = inflation

2) Housing bubble was partially created because of excess capital which needed to go 'somewhere', especially after the dotcom bubble blew up

3) Having companies which aren't 'allowed to fail' creates over time an imbalance in the system where some companies, even ones that deserved to die don't, which means that they will be increasingly arrogant in exploiting the system and doing increasingly risky things.


But I disagree with some of your analysis.

1) You bash 'fractional reserve banking' over and over, but never show any proof that such an idea would not exist in a system without a central bank. I don't see any reason why banks wouldn't lend most of their money out to maximize profits from interest payments. While it is true that regulations say that banks need to keep at least 10% capital for all loans (they can only loan up to 90%), if there were NO regulations, I do necessarily see why banks wouldn't do the same thing they are doing now, or go even further.

2) You state that the central bank system is directly responsible for the bubble. Yet, there are endless examples of central banks lowering interest rates and injecting money into the system around the entire world which have not resulted in bubbles (i.e. Japan in the last 15 years, America in the 1950s). There are also examples of bubbles that have occurred before the invention of centralized banking (i.e. the Dutch Tulip bubble in the 1600s). Therefore, while you may be partially correct that this bubble was in part caused by a fault lowering of interest rates too far, your inference that this was the ONLY cause is faulty at best. I believe there are definitely links to it, but it is nowhere near the only cause of things, nor is it a direct result of such a thing.

By ignoring why bubbles occur in the first place regardless of money supply (the psychology of people in general which is to be greedy and get more than they deserve), your analysis becomes faulty, because everything else in your analysis relies on this fact.

3) You blindly assert that there's more than enough money out there in smaller banks to make up the difference in the current 'credit crisis'. Yet you provide absolutely no evidence other than stock prices. You have not shown that the necessary billions of dollars exist anywhere else to run the businesses who depend on short term loans to pay off their workers and so on.

While I agree that doing so was the thing that bit them in the end, this is something which EVERY company is doing. If companies were in trouble and there was actually a lot of money out there to be used, then we'd have no problem, companies would find those 'good' banks and everything would be good.

The problem is, the major banks actually do control so much of the actual market thanks to their massive reserves (which are significantly more than the various small banks) and clout and more sophisticated loan systems (since they weren't really in that business in the first place, small banks would take a long time to get up to par with what the majors were doing in short term credit), that since no one trusts these big banks now, the entire system is actually threatened quite a bit.

While I have no doubt that over a very long amount of time (maybe at best a few years), smaller banks would be able to fill the vacumn led by the badly managed majors, the point is, many of the major banks, even ones which are relatively well run might fail for no good reason other than panic, and many business will go under as they fight for credit that just isn't there yet, and many, many, many people will lose their jobs, which along with already stretched budgets from mortgages and so on, many people will go homeless which would create an economic disaster of epic proportions which would take a very long time to sort out.

4) Isn't the bailout financed by the treasury, which is using future tax dollars to finance (i.e. not by creating money out of thin air)? Isn't that somewhat unrelated to the fed lowering interest rates? You so casually tie them together in your statements as to link the two together which is highly misleading.

5) You always have a bit of the hint of the idea of the gold standard in the back of any post you make. Yet even with the gold standard, the amount of actual gold the government held versus the amount of money that existed was always constantly increasing. I think it went from 20:1 pre World War 2, to 35:1 by the time Nixon was in power. So even though it was 'backed' by something, the money supply was increasing regardless. That is why the entire system could so easily be dumped, because at that point, the system was worthless anyway because there simply isn't enough gold in the world to cover the amount of money there is.

Note that this is in a way to protect against deflation. If there were always a finite supply of money in the world, and with the world population going up by 9x in in the past 100-150 years, and the amount of goods you can buy steadily increasing, we would have faced MASSIVE deflation. Deflation generally makes people save more than spend, and this would have had the effect of much lower economic growth rates from not spending. Remember, the more people spend, and the less they save, the more money moves around and the more economic activity that can occur.

6) There was a reason why the Federal Reserve was created in the first place. This was because the entire system fell apart in 1908 and had to be saved by a private citizen, JP Morgan himself. The reserve was created because they knew one day JP would die (and he died the following year I believe), and besides they knew relying on one person to save a country was a risky proposition in any time.

Personally I am not too familiar with the history of how things worked, and why central banks were created in the first place, but since it seems neither are you (as you never seem to address history rather than just draw weak inferences on what's happening right now) I think this is an important point that needs to be addressed.

Before anyone can be convinced that the current system is not worth saving, they need to be convinced that the contrary is better. As having scientific randomized control trials in an economy is very difficult, you need to have not just analysis from this current crisis, but previous ones, and also show historically how things would be different and also compare and contrast various countries and how their central banks have also failed them.

But not even recognizing any other systems except for America today, all you have shown is that the American system today is broken, but for that we all agree on already.

[MetalHeadz]

I thought your critique was generally sound Epi. However, I was wondering why you were so quick to defend the central bank? Here's my rebuttal.

2) You state that the central bank system is directly responsible for the bubble. Yet, there are endless examples of central banks lowering interest rates and injecting money into the system around the entire world which have not resulted in bubbles (i.e. Japan in the last 15 years, America in the 1950s). There are also examples of bubbles that have occurred before the invention of centralized banking (i.e. the Dutch Tulip bubble in the 1600s). Therefore, while you may be partially correct that this bubble was in part caused by a fault lowering of interest rates too far, your inference that this was the ONLY cause is faulty at best. I believe there are definitely links to it, but it is nowhere near the only cause of things, nor is it a direct result of such a thing.

With all due respect, nobody is disputing whether or not the American central bank lowered interest rates successfully in the 1950s. Using historical evidence as the basis of a fiscal 'law', in a non-absolute field such as Political Economics, is risky. I have not read every post made by Jerome in it's entirity, but I would hope he had not claimed that this was the ONLY causal factor in the ensuing crisis. Yet he would not have been far off had he. Low interest rates, adjusted and promoted by the central bank, would have been one of the preliminary and primary reasons why there was such confident speculation. The rates being so low, banks and financial institutions were able to borrow more and above their means and did so with the short term, capital driven mentality that unregulated markets have. The impact on the economy? Savings went down, loans and spending went up as with inflation. This unsustainable and self-perpetuating cycle, initialised by low interests rates, has meant these heavily indebted, highly inflated banks have become bankrupt. The banks did exploit and abuse the rudimentary conditions implemented by the central bank: but the central bank still set them.

By ignoring why bubbles occur in the first place regardless of money supply (the psychology of people in general which is to be greedy and get more than they deserve), your analysis becomes faulty, because everything else in your analysis relies on this fact.

Greed is a factor, not a cause. People aren't greedy if they can't afford to be. How greedy is an Ethiopian?

[Epinephrine]

With all due respect, nobody is disputing whether or not the American central bank lowered interest rates successfully in the 1950s. Using historical evidence as the basis of a fiscal 'law', in a non-absolute field such as Political Economics, is risky. I have not read every post made by Jerome in it's entirity, but I would hope he had not claimed that this was the ONLY causal factor in the ensuing crisis. Yet he would not have been far off had he. Low interest rates, adjusted and promoted by the central bank, would have been one of the preliminary and primary reasons why there was such confident speculation. The rates being so low, banks and financial institutions were able to borrow more and above their means and did so with the short term, capital driven mentality that unregulated markets have. The impact on the economy? Savings went down, loans and spending went up as with inflation. This unsustainable and self-perpetuating cycle, initialised by low interests rates, has meant these heavily indebted, highly inflated banks have become bankrupt. The banks did exploit and abuse the rudimentary conditions implemented by the central bank: but the central bank still set them.

My point is, while it is easy to say that the Fed's low interest rates were the primary cause of the entire bubble, and while you can even logically see ties between the two, just because there are ties, doesn't mean there's causality. To use another example, in medicine there are frequently new drug treatments which are created because they are specific chemicals which target specific systems in the body. They are tailor made to achieve certain targets (i.e. lower blood pressure, lower cholesterol) and in many instances can even be very similar to existing drugs, but when actually used in real life, it is frequently found that these products are actually not so useful and sometimes may even have the opposite effect as predicted. The take home message is that, just because you can 'logically' work out something, it doesn't mean that's how it actually plays out in real life.

So Jerome advocates that in general the central banking system is a failure because whenever it creates money out of thin air, it is artificially managing the system, and a consequence of adding too much money to the economy is the formation of economic bubbles as the money has no where to go. Logically this is a sound argument, and can be worked out. But if in general, lower interest rates cause bubbles, why doesn't this happen all the time? Why didn't it happen in the past when interest rates were low like in the 1950s? Why hasn't it happened in Japan when interest rates have been around 0% for the last 5 years? Why hasn't a similar bubble happened in Canada whose economy and interest rates have been similar to the USA in the past decade?

Unless all other situations can be throughly explained away, then you must look at other causes of the bubble. Other causes that readily stand apparent include the fact that there is much less regulation in the American financial market. Other causes include the decreased amount of scrutiny that was allowed by creators of subprime lending in the first place. There are probably many other causes that I don't even know about.

But to draw a clear distinction that the Fed is solely or even primarily responsible for the bubble while ignoring all other central banks in the world and previous experience is irresponsible.

I am neither defending nor criticizing the central bank. I am still not sure who the real culprit(s) of this situation is. Furthermore, I am not sure whether the system is hopelessly dysfunctional as Jerome claims it is, or if it is better or at least on par with any other system that we could use, just that this current situation was the product of bad management of the system that we can draw lessons from in the future.

[Liquid Blue]

i found this to be ironic

[Nycle]

I know I said I wouldn't be posting anymore, but I found a really interesting article by The Economist (published today) on this topic which is also pretty much in line with my previous posts. The Economist is a British magazine which I personally regard as a high authority in the field of economics, but unfortunately I also think that they're sometimes a little too stuck in an Anglo-Saxon perspective.

Anyways, here it is:

http://www.economist.com/finance/dis...=features_box1

If you want to know what the actions as stated in the opening post article were good for, I recommend that you read it.