Hyperinflation

[MetalHeadz]

but unfortunately I also think that they're sometimes a little too stuck in an Anglo-Saxon perspective.

Anglo-American? Agreed, it's very neoliberal, 'market knows best'.

[MetalHeadz]

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.

Point taken, and I agree. However, every causality needs to be judged upon the aspects of of it's preconditions. If there is such an unmistakable, inextricable link between two separate events it suggests highly of causality. I've previously resented the notion of Political Economics as being a 'science', yet the biological phenomena of 'limiting factors' seems appropriate.

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.

This is not logically sound and I wish to diverge from Jerome here. I don't have time to go into the mathematical complexities of this, but essentially the central bank indebts financial institutions relative to their particular output and that of the economy, relative to GDP. If it can be paid back, over time, such 'artificial' injections are a necessary, but not sufficient, way of stimulating growth.

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 subprim
e lending in the first place. There are probably many other causes that I don't even know about.

Using the same tools of scepticism that you implore, how can you confidently say that they were indicative of rule rather than exception?
Perhaps in these cases their were factors which diminished the impact that low interest rates had on the financial sector, rather than in this case contributing to it. Does a historical precedent warrant eternal vindication?

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.

Again, I refer to the 'limiting factors' argument. It is very difficult for you to have a banking system that loans freely; in subprime markets; at low interest rates with high central rates: it's simply not financially viable. AKA, it is logically reducible to this one limiting factor. The factor and cause are mutually inclusive, it is literally inconceivable that a bubble could come into existence without low interest rates (if not, admittedly, the other way round.)

[Galleleo]

MHz just always reminds of the guy from Good Will Hunting.

[Jerome Scuggs]

Zerz - you show me a company that forces its employees to labor under threat of guns, whips, or chains - show me a company that forces a consumer to buy their product under those same means - and I will concede your point about slavery. Until then, metaphors and sketch rhetoric are as close as you'll get. If you'd like to perhaps delve into the truth behind the empty words and rhetoric you use, perhaps this would serve as a good place to start.

Anyways, Epi, I'll try to take this on a point-by-point basis.

1) To show that fractional-reserve banking cannot exist without central banks, just look to the time before central banks exist. While it is true that banks could, in an "unregulated" market, engage in high leverage in terms of reserves-to-loans, doing so puts a bank in an incredibly risky position. Banks can be as "opaque" as humanly possible, but anyone with a calculator and some free time could figure if a bank was over-loaning funds to a dangerous degree - and such is why "bank-runs" occurred before central banking. The second word got out that a bank's deposits weren't actually covered, people would rush to get their money out... so they won't be the guy who loses their physical savings.

There is, of course, nothing that stops a bank from pursuing such a business strategy - except the nature of its inherent 'volatility'. On the flipside, though, a bank who extends more loans than its reserves can sustain if it is very, very careful in who it loans money too - since the bank cannot afford to sustain many losses in such a risky, high-leveraged position.

I suppose I should revise my initial analysis - fractional-reserve banking is only necessarily destructive when its destructive tendencies are supported in part by a central bank. I would still argue, though, that a majority of banks would keep a majority of their reserves well-capitalized. Fractional-reserve banks who pursue such a strategy would, in my opinion, perform a better function as investment firms, where customers front capital, investors decide where the capital could turn a profit, and proceed to invest, expecting a profitable return with which to increase a customer's initial investment.

The important thing here is allowing risk. In such a system, the potential for risk would be very high and undiluted by any sort of "guarantee" or "insurance" on a loss. That's not to say "insurance" against a profit loss wouldn't exist - in the status quo, we call them derivatives, but I'll discuss that later.

2) I'll start here with your two historic examples. Japan is far from "okay", in fact after their economic crisis in the early 90's and the resulting by-the-book Fed prescriptions caused a ten-year period of stagflation known as 'The Lost Decade'. As for America, the 1950's was followed by the 1960's, and then... the 1970's, a period of "economic crisis". It is interesting to note that then-chairman Paul Volcker proceeded to raise reserve ratio requirements and let the interest rate rise to a (relatively) staggering 20% - and within a few years the economy was back on track. Yes, it took a few years - but compared to what happened to Japan two decades later, a few years is nothing compared to ten or fifteen.

While the problems that arose in each situation (and in the current one as well) were the result of many other particular factors, the Federal Reserve's policies are a fairly consistent presence in each one. Looking at the three scenarios - America in the 70's, Japan in the 90's, and America/the world today, the only thing that remains consistent is the actions of the central banks.

This brings about an interesting note - a NYT article from 1978 claimed that the then-current system had been "tilted in favor of business deregulation and against new rules". Since then, the Federal Register (the document keeping a comprehensive list of all Federal laws and regulations), has increased by over ten thousand pages - bringing the current total up to 73,000 pages. I find it hard to believe that the government could have somehow missed all the specific things that created the later crises while simultaneously bearing little to no responsibility for any of the problems.

As for the Dutch tulip bubble, a few things can be said. The first is noting that in order to find a comparably-sized economic bubble, one must travel back to the late 16th century - a period not known for its free trade but for its mercantilism - the economic system in which governments were highly intertwined in their respective economies. But it's also interesting to see that it only took one such bubble to show the marketplace that such wild, risky speculation would cause a serious potential for disaster - a trend which does not re-emerge until after the global shift to free-trade and the rise of central-banking.

From the position that I am taking, my assertion is that Keynesian fiscal policy creates a volatile framework for an economy that opens itself up for disaster - and that it allows people who are greedy and want more than they deserve to engage in potentially risky business decisions. It is from the design of our monetary system that such problems emerge - in this case, it started in the housing market and all relevant actors.

Of course, one could also argue that welfare programs entail "greedy" people getting more than they "deserve" - I earn my paycheck by working, some other guy earns his by having a third party take money from me in order to finance his nonproductive living. From this discrepancy I think that such arguments are highly subjective, which is why I draw my bright-line from studying natural law/human rights - the bright-line being, as we've discussed, that no-one deserves anything except what they earn beforehand.

3) I did make an error, but it's not one of monetary calculation. Consider my view of our economy as in a period of "excess", fueled by money created from nowhere.

In order to continue, I should be specific in pointing this out: the "credit crisis" is related to, but not the same as, the concurrent recession that seems to be looming over the horizon. A recession is a time where markets that have been seriously distorted, and capital that has been seriously mis-allocated, begin leaving certain markets and/or entering new ones.

As I've mentioned, smaller banks are doing well and have sufficient capital because they did not engage in the same types of lending practices that caused the major banks to fail. Following from this, then, my assertion is that businesses that were truly beneficial in the market will have no problem finding capital. This also means that businesses which were not sustainable or profitable will not be able to find capital, since banks cannot afford to make risky/unprofitable decisions, such as making loans to subprime borrowers. This manages to explain the current situation - from what I gather from the news, the "freeze" is starting to "thaw" - but apparently not fast enough for the Fed's liking. This is because banks are paying closer attention to exactly who they make their loans to.

The sad result is, in the meantime, that yes - people will go out of business. Many companies will have to close their doors. There might be a few years of massive unemployment and an 'economic slump' - but, as Volcker showed in the 70's, such a period is highly preferable to a long, drawn-out process that would result if the Fed attempted to fight fire with fire. In short - there are businesses operating right now, using money that otherwise would not have flowed to them, had the Fed not given them the means to acquire capital. These businesses need to cease in order for a sustainable growth to eventually occur.

4) Initially yes, the "bailout" was going to use taxpayer dollars. I mentioned that this is no longer the route being pursued by the Treasury/Fed.

The new plan is a massive injection of new money, in an attempt to lower interbank interest rates. This is why the Fed and Treasury are lumped together in my analysis. Neither, on their own, has the power to 'monetize debt'. It is a multi-step process in which the Treasury issues bonds, the Fed 'buys' them (in reality - just prints the bonds' worth of new dollars), and the money is then used - in this case, banks are 'buying' the new dollars. The actual payment of such a 'loan' is tossed in with the rest of the national debt, and if things go like they have been since the 1930's, that debt will never have to be re-paid.

[Jerome Scuggs]

5) The period you mention - the first 'Bretton Woods' international monetary system - was not a 'gold standard'. Government dollars from each country was simply 'pegged' to gold - but the actual 'pegging' was, at the end of the day, basically a fancy way of saying that governments could say that the dollar was worth a random amount of gold.

Such a policy has a useful advantage, fully exploited by FDR in the 1930's. During the Depression, FDR confiscated all public gold, promising to hold onto it until a later date (presumably when the economy got back on track). Of course, a year later FDR did an about-face and announced that the gold forevermore belonged to the US, and the public would never be allowed to get their gold back - only its worth in dollars, which was conveniently whatever FDR decided the value was worth. After that, the government then changed the price of gold in terms of the dollar rapidly - sometimes it would be $20/oz, and then a few days later rise to $35/oz, or settle to $15/oz. This led to people choosing to not redeem their gold - because they could never tell whether or not they would be getting a good deal, since the dollars' value changed so fast.

Why did FDR do this? Because if he seized gold at, say, $15/oz - and then eventually settled on, say, $30/oz - then that means that FDR would get an extra $15 for every ounce of gold in the government's possession. The Federal Reserve conveniently printed out the difference's worth in dollars - which gave FDR a hefty three billion dollar surplus that he proceeded to use in order to finance his welfare programs. This is why I find it safe to say that the modern American welfare state started with the biggest legally-approved theft of the American taxpayer in history.

This also gives insight into why the system was dumped - since the market was always re-evaluating gold in terms of its actual worth, the discrepancy between that value and the 'government' value led to serious economic problems. At this point, there was a choice to let the system collapse, or to continue on - and Nixon made the decision for every American citizen, declaring "We are all Keynesians now."

This brings us, then, to deflation. Like many other things - fractional-reserve banking, derivatives, etc - it's not deflation in-of-itself that is problematic, until you bring in government intervention. This also includes the gold standard - I believe the 'standard' should be decided by the market. This means that if gold by itself cannot cover the value of the paper dollars floating around, then other 'valued' items of exchange - such as silver - would emerge to compliment gold and take up slack. Such a system, of course, would be mind-bogglingly complex - which is why I think its management should not be left up to central authorities. But further discussion would probably de-rail the point, so I will stop there if or until you decide to bring that point up.

As you stated, deflation serves to discourage spending and encourage saving - but that is exactly what brings an economy out of recession. Because when people save, banks' capital reserves are refreshed - and a new round of investment begins. This new round of investment, being made during a recessionary period, tends to be more discriminatory - and therefore, banks initially lend to profitable ventures with little risk. As these ventures develop, capital begins flowing again, and eventually banks can begin pursuing their regular process of loaning, which then allows greater and greater access to loans. On the back of the most prudent investments, then, the new economy grows. But such a process is necessarily dependent on giving bankers free choice in who they loan funds to.

The current game plan the government is pursuing is an attempt to sustain current markets - of which there is no really visible way to discern which are truly profitable/beneficial and which aren't - while simultaneously creating a new round of investment. I think the two are mutually exclusive - the 'old' market and its excesses need to be liquidated in order to sustain the new round.

6) The crisis in 1908 did occur before the creation of the Federal Reserve - but to say I have not acquainted myself with history would be a stretch. I believe I have shown in another thread how the cause of this - and the other 'recessions' occurring before 1913 - were caused by the earlier attempts at a 'National Bank'. The post in which I mention this was not dealing with the current crisis, but rather the nature of the 'business cycle' and its boom/bust cycles.

Coming out of the 19th century, the US government was still experimenting with a fiscal setup that was attempting to centralize banking. After the National Banking Act, State banks had grown rapidly by pyramiding their loans and deposits on top of national bank notes. This was fine - until the pyramid collapsed, much like today, and the recessions were incredibly hard-hitting.

Further discussion, I believe, would entail an examination of that period that would require alot of scholarly pursuit - and rival the type of close scrutiny that we are applying to today's crisis. But an analysis can be found in Murray Rothbard's Origins of the Federal Reserve, which is well-documented and sourced.

The model of banking followed globally has more or less been adopted from the American model, though at any given time these other central banks have acted differently - depending on the situation and the people involved. Though I cannot touch on them all specifically, I would welcome any particularly relevant historical examples. I also have difficulty in showing the validity of my argumentation, as a true "laissez-faire" economy has never developed in a highly-developed nation - the closest example one could point to would be Hong Kong, though even there you will find problems.

[Epinephrine]

Hmm interesting reply, I think we've finally gotten to a point where your arguments are specific enough that I'm satisfied with them at the core.

Just a few things though to nitpick:
1) My 'deflation' argument was actually that, if there was 'no one creating money', then by definition the amount of money is static, while real world experience is not. Here's an example:

100 billion dollars now / 6 billion people = $600/person
100 billion dollars 50 years from now / 12 billion people = $300/person

Therefore you are guaranteeing that there will be steady and unending deflation. While in practice this may not be (due to stocks having a 'virtual' price which will inflate the amount of available money), the actual money that can be spent at any given time would be fixed in the end. Endless deflation = people saving endlessly to protect their assets no matter the state of the economy.

2) One of the key benefits of the entire current system is that the amount of money moving through the system is always maximized. So in one extreme, you have a situation where most people end up saving money, and thus a lot of money is not doing anything of value, just sitting there. In our current system which in effect creates endless inflation, people are very much so encouraged to spend all their money, whether it is for goods and services or via more risky endeavors such as investment. This maximizes the economic value of money in the system, allowing economic development to proceed at a faster pace.

While this system inherently may perhaps allow for more bubbles and recessions in the end, the overall effect is that economic growth is severely maximized while the system is applied.

Obviously the proof of whether the last century's economic gains is due more to monetary policy, technology, or the entrepreneurial power of just having exponentially more people is hard to say and beyond the scope of our analysis. For that we'd need some rigorous mathematical analysis, beyond what you or I could probably give without writing a phd thesis on. But in the end even knowing all the faults of the current system, as long as it is managed well, can it be proved that no matter what is done, the system will one day fail?

3) While I can see how easy it is to make exceptions for other situations (Japan, 1950s, Canada in past decade), and talk about this situation as if this is the definitive proof of central bank->bubble == inherently unstable, couldn't the argument be made in reverse that this current system is an aberration in the central bank system, which is generally more stable than not?

I am also still not very sure about your answer to my Japan question. My question was that even with 0% interest rates, not only was Japan not stimulated, but no new real big bubbles ensued from that. Why was America so different after that dotcom bubble burst and interest rates when down? What was so different about America vs Canada which also lowered it's interest rates along with the Fed but did not experience anywhere near the same kind of asset bubble as the USA? Just dismissing it and saying 'lost decade' doesn't give me an answer I can be happy with.

In the end, because of the way I've been educated and because of the way I think, without an easy to digest statistical and mathematical analysis, I am still not completely convinced because it could really go either way depending on what the true data tells us. Or at the very least, a good answer as to why this time in the USA it was different, instead of 'this time this was the only one true example and all other examples can be explained away using exceptions'.



Finally, I just want to say that my final point is, while the 'free market' may in the end reach an equilibrium, is that what we actually want to achieve and is that 'enough'? We can walk to all our destinations, but why not run, or drive instead? I do not actually have an answer to this question. Philosophically, humans are greedy creatures who can barely see beyond their own lifetimes if that. If this past system generally worked so well for the last two generations, maybe for them irregardless of any other possibility that was the 'best' option for THEM.

These are philosophical questions which I think will only be answered if we start hitting the limits of growth, when we realize that we start to reach the limits of what we can exploit in terms of land, resources and people to reach never ending gains. It is then, that perhaps the 'true' free market may come to bear in making sure equilibrium is met to more effectively spread what few resources are left.