A cousin of my wife is an investor (his political beliefs are moderately conservative). I've been having a discussion with him about Austrian economics and the current events. He is clearly not an Austrian, and although I read articles on Mises.org, I am a biologist, and he is an investor, so he clearly knows more than I do. I was interested what people might say to some of his arguments (not so that I can rebuke him, but so that I understand more clearly why he is wrong).
I am quoting from his latest reply:
1. The money supply needs to increase along with the growth rate of the economy to get zero inflation. That way, there are more dollars out there when the total value of goods and services goes up. [In the previous e-mail, he claimed that while excessive inflation if clearly bad, some level of inflation needs to happen. So, once the government establishes that "healthy" level of inflation, things will be hunky-dory.] I agree that going off the gold standard caused much of the hyperinflation of the '70s. Since that was brought under control, inflation has been relatively tame. It was the transition to fiat currency that caused the hyperinflation, not being on it. Yes, the economy grew in the 19th century, but it was a tiny fraction of the growth we have had in the last 30 years! Lack of inflation doesn't lead to no growth, it leads to very slow growth. 2. It's just not true that most booms and busts are caused by monetary policy- throughout history there have been booms and busts, caused by various factors, including environmental, mercantile, emotional, etc. The great depression was before fiat currency, as was tulip mania in The Netherlands, countless famines, and hundreds of other crises of tremendous severity. Mistakes managing interest rates can cause booms and busts, but not managing at all practically guarantees them, and ones of much greater severity. 3. [I am particularly interested in a response to this point:] The national housing crisis is over already, so it's not possible for it to continue. Housing prices in much of the country have already begun to come up. The exceptions are places with unusually large numbers of forclosures, where it will be awhile before those can be worked through. Those areas will hinder growth somewhat in the near term, but will not have a huge impact. Many of those numbers cited were just the federal government giving a large enough backstop to banks and others so that the market would not question their ability to pay- those huge amounts never changed hands and never will. They could have doubled those numbers yet again and it would have zero impact. If students of the Austrian school had made all of those decisions in 2009 [to let the banks fail, etc.], we would be in a depression right now, because there would have been a domino effect among failing institutions, most large companies would be wiped out (including ones that were never in any danger under the scenario that actually took place), the unemployment rate would be about 10% higher, and the US government's balance sheet would actually be worse (because the depression would reduce tax receipts by much more than they "spent" on the bailouts and stimuli. We wouldn't be falling as long because we would have hit rock bottom too quickly. The economy might have begun rising more quickly (though I'm not convinced), but still would be way behind where it is now, and probably would be for another 5 years, because it would have fallen so far.
1. The money supply needs to increase along with the growth rate of the economy to get zero inflation. That way, there are more dollars out there when the total value of goods and services goes up. [In the previous e-mail, he claimed that while excessive inflation if clearly bad, some level of inflation needs to happen. So, once the government establishes that "healthy" level of inflation, things will be hunky-dory.]
2. It's just not true that most booms and busts are caused by monetary policy- throughout history there have been booms and busts, caused by various factors, including environmental, mercantile, emotional, etc. The great depression was before fiat currency, as was tulip mania in The Netherlands, countless famines, and hundreds of other crises of tremendous severity. Mistakes managing interest rates can cause booms and busts, but not managing at all practically guarantees them, and ones of much greater severity.
3. [I am particularly interested in a response to this point:]
Thanks...
Neodoxy:The fact is that there are a large variety of problems with the current financial system, all arising from the inherently unbacked nature of modern fiat currency. To let the banks fail would have meant the death of the modern financial system. There would never have been a crash like it because there would have been an utter collapse of the banking system, specifically because they couldn't repay their loans or make up for their current losses. I would have to say that no matter how the situation was handled then the fact would have been that the costs of the bailout were less than what the alternative would have been. The chain reaction would have caused the dollar itself to collapsed and standards of living would have decreased drastically because interest rates would have skyrocketed and new businesses would have had an extremely difficult time funding themselves. With all of this said this whole problem is caused by the failures of the current system, of the fractional reserve process, all of which was the fault of the government and the federal reserve. So you couldn't just let the banks fail, but the problem and the reason why you couldn't is due to the nature itself.
So you couldn't just let the banks fail, but the problem and the reason why you couldn't is due to the nature itself.
Do you think such a systemic collapse is now guaranteed not to happen in the future? Or do you think it's been merely delayed by the bailouts and such?
The keyboard is mightier than the gun.
Non parit potestas ipsius auctoritatem.
Voluntaryism Forum
"2. It's just not true that most booms and busts are caused by monetary policy- throughout history there have been booms and busts, caused by various factors, including environmental, mercantile, emotional, etc. The great depression was before fiat currency, as was tulip mania in The Netherlands, countless famines, and hundreds of other crises of tremendous severity. Mistakes managing interest rates can cause booms and busts, but not managing at all practically guarantees them, and ones of much greater severity."
Spoken like a true investor. Ask him to explain how not managing rates 'practically guarantees booms and busts'. Ask him what interest rates are, and what they signify to investors and then come back with his answers.
Also Business Cycle Theory does not depend on the existence of a central bank like the Federal Reserve System. National Treasuries have often behaved like central banks by adjusting reserve requirements and "injecting liquidity". (See: L.M. Shaw and Lyman Gage)
"The national housing crisis is over already, so it's not possible for it to continue. Housing prices in much of the country have already begun to come up. The exceptions are places with unusually large numbers of foreclosures, where it will be awhile before those can be worked through. Those areas will hinder growth somewhat in the near term, but will not have a huge impact" "Many of those numbers cited were just the federal government giving a large enough backstop to banks and others so that the market would not question their ability to pay- those huge amounts never changed hands and never will. They could have doubled those numbers yet again and it would have zero impact."
"Many of those numbers cited were just the federal government giving a large enough backstop to banks and others so that the market would not question their ability to pay- those huge amounts never changed hands and never will. They could have doubled those numbers yet again and it would have zero impact."
Prices rising on homes doesn't necessarily mean that the housing market has hit its true floor. When the Fed purchased massive amounts of Mortgage securities at top dollar it raised the actual housing floor from what the price level would have been.
"If students of the Austrian school had made all of those decisions in 2009 [to let the banks fail, etc.], we would be in a depression right now, because there would have been a domino effect among failing institutions, most large companies would be wiped out (including ones that were never in any danger under the scenario that actually took place), the unemployment rate would be about 10% higher, and the US government's balance sheet would actually be worse (because the depression would reduce tax receipts by much more than they "spent" on the bailouts and stimuli. We wouldn't be falling as long because we would have hit rock bottom too quickly. The economy might have begun rising more quickly (though I'm not convinced), but still would be way behind where it is now, and probably would be for another 5 years, because it would have fallen so far."
So what did we do instead? We bailed out insolvent banks and put the cost on the taxpayers. This is clearly immoral. But such arguments have no traction and are relatively meaningless in a case of 'what should be done for the best outcome'. So what's next?
There's stacks on stacks of new money sitting in the reserves of the big banks. Should the economy recover and cash circulation picks up again, this cash will be dumped onto the market causing inflation. We already have some significant inflation despite the bank's tenuous lending practices. Meanwhile the government's interventions have prevented the structures of production from re-alligning to actually existing price signals. They have kept prices from falling, thus disallowing a structure of production that would be more profitable in todays' conditions. Granted it is true that this action prevented monetary contraction and numerous bankruptcies. Despite that act, there is the looming cloud of the coming depression. Companies laid off workers to 'strip off the fat', banks are holding reserves out of fear that the long whip of debt exposure will snap in one of their faces, all the while food stamp participation has been skyrocketing (and this service is contracted to JP Morgan by the way). The economy is defined by fear. Consumers are afraid to put their cash out while the government continually attempts to coax them out, simultaneously making it easy for the government to continue spending and the banks to have a chance of survival.
So instead of letting the shock wipe out the debtors (causing bankruptcies and unemployment), readjust the structures of production to the needs of the consumers, we have floated the banks, given the big companies breathing room, loaded the citizens with debt, inflation, and less unemployment, and there's still the bigger shock on the horizon.
So the question is: do you prefer 2 financial shocks with a depression in between, giving a chance to the banks to make off like thieves? Or 1 financial shock. Both options are painful, but most of us are under the impression that if we can just keep the DJIA at a certain level, the second crash won't come. But the money printing hasn't made the economy more productive or profitable, it's simply sustained the structures of production that were incompatible to the consumers by cheapening debt.
I guess there is a third option, and it is foreseeable: that the central banks continue to cheapen debt and print money until the currency loses is value. This option is in-line with the state academics/intellectuals refusal to acknowledge a problem with their models and also with the powerful interests associated with the Fed that don't want to see their asset prices sink like a stone.
P.S. Cantillon Effect.
The Anarch is to the Anarchist what the Monarch is to the Monarchist. -Ernst Jünger
FlyingAxe:A cousin of my wife is an investor (his political beliefs are moderately conservative). I've been having a discussion with him about Austrian economics and the current events. He is clearly not an Austrian, and although I read articles on Mises.org, I am a biologist, and he is an investor, so he clearly knows more than I do. I was interested what people might say to some of his arguments (not so that I can rebuke him, but so that I understand more clearly why he is wrong). I am quoting from his latest reply:...
I am quoting from his latest reply:...
I have to admit, it was a total chore to read his nonsense, but I think it will be useful to have proper responses here.
The money supply needs to increase along with the growth rate of the economy to get zero inflation.
Mmmkay. And my cat's breath smells like cat food. So?
That way, there are more dollars out there when the total value of goods and services goes up. [In the previous e-mail, he claimed that while excessive inflation if clearly bad, some level of inflation needs to happen. So, once the government establishes that "healthy" level of inflation, things will be hunky-dory.]
Who says we need prices to stay exactly the same? And what the hell makes him think a handful of people in an expensive room in Washington can micromanage an economy of 300 million people? Is he still under the impression that central planning works? Did he miss the day they taught history in history class?
I agree that going off the gold standard caused much of the hyperinflation of the '70s. Since that was brought under control, inflation has been relatively tame.
You mean since the way inflation is officially measured has been changed, official measurements of inflation have been relatively tame...right?
It was the transition to fiat currency that caused the hyperinflation, not being on it.
First of all, that's like saying "it was setting the house on fire that caused it to burn...not the house being on fire."
Second, what hyperinflation? When? What is he talking about?
Yes, the economy grew in the 19th century, but it was a tiny fraction of the growth we have had in the last 30 years!
Source? Where is he getting this from? How is he defining "growth"? And more importantly, how is he measuring it? Did he just make this up and is expecting it to be true?
Lack of inflation doesn't lead to no growth, it leads to very slow growth.
Source?
2. It's just not true that most booms and busts are caused by monetary policy- throughout history there have been booms and busts, caused by various factors, including environmental, mercantile, emotional, etc.
Emotional booms and busts? Is he serious? Is he trying to sound knowledgeable by just throwing out words? Honestly he sounds like the pony. "Emotional booms and busts." Give me a fucking break.
Didn't everyone already try that one on the current crisis? Wasn't I told that "greed" was the culprit? Kind of like the time I was told "gravity" was the reason the plane crashed?
The great depression was before fiat currency
I guess it's clear being an "investor" doesn't qualify you as a historian. (Read: he needs to go back to class)
as was tulip mania in The Netherlands
No one said anything about fiat currency being necessary for bubbles to occur. It's about increases in the supply of money.
countless famines, and hundreds of other crises of tremendous severity.
Name the ones you're thinking of and I'll help you understand their origins.
Mistakes managing interest rates can cause booms and busts, but not managing at all practically guarantees them, and ones of much greater severity.
I suppose he's under the impression the things he listed prior to this sentence serve as supporting examples of this ridiculous claim, but in fact they don't. I provided two separate links to excellent resources regarding the only two specific crises he named, and if he would be so kind as to offer examples of any others, I could do the same for those.
3.The national housing crisis is over already, so it's not possible for it to continue.
I'd really hate to see this "investor's" portfolio.
Housing prices in much of the country have already begun to come up.
Right. And I'm sure those are perfectly reasonable, market prices....not at all inflated or propped up, or in any way affected by the tax credits, tax deductions, guaranteed loans, and any of the 18+ programs designed to artificially influence consumer behavior in the housing market...let alone the trillions in new money the Fed continues to create out of thin air.
The exceptions are places with unusually large numbers of forclosures, where it will be awhile before those can be worked through.
Oh. So you mean the down market will continue. That's funny cuz two sentences ago I could have sworn you told me it was impossible for it to continue. Must have been my imagination.
Those areas will hinder growth somewhat in the near term, but will not have a huge impact.
Just like the crisis was "contained" in the subprime market and wouldn't "spill over" into prime mortgages? Just like we wouldn't see an overall dip in housing across the country because "housing is local?" Has he been listening to this guy again?
Many of those numbers cited were just the federal government giving a large enough backstop to banks and others so that the market would not question their ability to pay- those huge amounts never changed hands and never will. They could have doubled those numbers yet again and it would have zero impact.
What "numbers"? What the hell is he talking about?
If students of the Austrian school had made all of those decisions in 2009 [to let the banks fail, etc.], we would be in a depression right now, because there would have been a domino effect among failing institutions, most large companies would be wiped out (including ones that were never in any danger under the scenario that actually took place), the unemployment rate would be about 10% higher, and the US government's balance sheet would actually be worse (because the depression would reduce tax receipts by much more than they "spent" on the bailouts and stimuli.
...and of course he has proof of all that.
I'm quite interested how he's concluding that scenario...and even more interested where this 20% unemployment rate is coming from. Certainly not the government's figures. They said without the recovery plan unemployment would peak at 9%. As we all know, unemployment was well above that (even earlier than their time tables).
I don't even have to provide any counter evidence (even though I could), because he hasn't provided any of his own. He's given no support for anything he's said so far...just the same scare stories Congress gave while they were trying to pass a bill while trying to claim there wasn't even time to read it.
We wouldn't be falling as long because we would have hit rock bottom too quickly. The economy might have begun rising more quickly (though I'm not convinced), but still would be way behind where it is now, and probably would be for another 5 years, because it would have fallen so far.
I don't get it. It sounds like he just admitted we have farther to fall. Wasn't his whole premise that we are already out of the woods and growing again?
This guy is incredibly confused. Send him a copy of Meltdown or Crash Proof or Financial Fiasco. Also for more info you might check the links here and here.
:)
Thanks for the reply. I need time to process it.
Sorry, the "numbers" that I quoted my cousin-in-law talking about were from my previous e-mail. I listened to Doug French's talk on the housing market and said that the government practically bailed out the banks for 7.7 trillion dollars. Plus, whatever Mr. French said about the aid to BoA, etc.
Was there fiat currency in the US before the Great Depression? I am also an ignoramus.
"Do you think such a systemic collapse is now guaranteed not to happen in the future? Or do you think it's been merely delayed by the bailouts and such?"
It is not inevitable, but it certainly can happen again. If it doesn't happen, and current policy remains similar to what it currently is, then it will continually occur, or if it doesn't, then it's because the government boards up the hole, not because they fix the problem. This means that there's literally a never-ending possibility of total collapse, but it will almost certainly be better to try to fend that off than have it actually occur, no matter what the means. It's also very important to point out that the collapse is more likely for every reason so long as the debt crises keep up.
At any rate, the collapse is certainly not an inevitability as such because there's still ways it could be dealt with. In fantasy land new, real, currencies would start to be introduced and then over time bank protections and the fractional reserve system would be weaned away. The best answer is a slow transition, but we all know how likely such a policy is to in the modern democratic system.
Not exactly. There was the Federal Reserve System but also a state-set gold standard. So kind of a mix. I'm not completely sure how this works but I think the Fed could still print money, but since other nations were on the gold standard, severe devaluations of the dollar would have consequences manifested in gold draining overseas (to Britain or France, etc.) And then FDR stole everyone's gold.
"Was there fiat currency in the US before the Great Depression? I am also an ignoramus."
There was not a fiat currency as such for most of U.S history (the greenbacks might have been but that was a passing phase, and there was paper money pre-constitution) but before the 1930's what you had was banks issuing more notes than they had gold to back up, which is known in jargon around here as "Fiduciary Media"
Here's a little more on inflation:
And if he wants to get into the history that he purports to know so much about:
And of course this one may be of particular interest:
OP, I would agree with your relative in that fiat currency isn't necessary to perpetuate bubbles but focusing on the nature of the money misses the crux of the ABCT. Namely, that the entrepreneurial "cluster of error" that characterizes a bust can only be explained by the expansion and subsequent contraction of the supply of fiduciary media. This applies to the whole economy as much as it does individual sectors. Viewed in this light Tulip Mania, for example, is actually a textbook example of the Misesian trade cycle theory rather than an event requiring some alternate explanation. From http://www.go2cio.com/articles/index.php?id=2383:
In the early stages of the tulip mania, it was common to pay for bulbs in kind, bartering them for land, tools, and farm animals. But with the advent of forward markets, where bulbs that were not owned were sold and bulbs were purchased for future delivery, a natural outgrowth was that the claim to ownership did not require any capital outlay. Money changed hands only once the bulb was delivered. Most traders did not have even the remotest intention of actually holding onto their contract to delivery, so they could buy the bulbs forward without the capital necessary to effect their physical purchase. The colleges were informal markets, limited in infrastructure to a secretary who made note of the transactions; there were no credit departments or systems for the posting of collateral. Indeed, while Holland had repeatedly legislated restrictions for trading on margin, the informality of the tulip market seems to have allowed it to remain outside the regulatory purview. Thus, a trader could sell bulbs he did not own, and had no connections to secure, and buy bulbs with no capital to purchase. He operated on the assumption that he would sell off his forward commitments long before they came due, and do so at a profit.
In this instance the tulip futures contracts act as a form of fiduciary media. Dutch Tulip traders bought and sold more claims to the bulbs than the number of bulbs they actually held or had the ability to obtain. They were able to do this because trading was done outside of any kind of formal exchange or clearing house and a trader did not need to possess the bulbs, or indeed any capital to purchase them in the future, in order to sell a contract. This would be like a bank allowing margin traders to post zero collateral with no position limits and no oversight. It's not hard to see how this would lead to an upward spiral of prices; the Dutch were effectively trading with infinite leverage, conjuring claims to a finite amount of underlying assets out of thin air.
**Edit: Also, they banned short selling:
Short selling was banned by an edict of 1610, which was reiterated or strengthened in 1621 and 1630, and again in 1636. Short sellers were not prosecuted under these edicts, but their contracts were deemed unenforceable.
http://en.wikipedia.org/wiki/Tulip_mania
Good post.
Re: tulipmania: but can you explain how expansion of money supply contributed to this behavior?
FlyingAxe:Re: tulipmania: but can you explain how expansion of money supply contributed to this behavior?
Go back to my post. I pointed you to a perfect resource on this. If you can't read the full thing (as short as it is), at least check out the introduction or one of the other articles in the links section.
I would say that the effect the expnding supply of fiduciary media had on the behaviour would be that it permitted the traders, whatever their motivations, to successfully make their futures bets while the expansion was still underway. This is a key point, because the growth (of the tulip futures bubble in this case) is only sustained by the continuing expansion of the supply of fiduciary media chasing goods. But if this contining chain of transactions stops for any reason leaving a significant portion of traders bound by the futures contracts they hold and they can't either deliver or pay... Suddenly a lot of contracts get extremely worthless extremely quickly. In fact I'd say Tulip Mania is probably an example of failing to properly gauge counterparty risk rather than some parable about madness of the crowds.
I should also correct an error in my earlier post: they technically didn't have infinite leverage, they paid %2.5 on each purchase. Which was still miniscule.
Either way, if participants had been conducting their trade on a legitimate exchange they would most certainly have had to put a significant chunk of capital up front to collateralize their levered investments which would have 1) reduced the number of participants to only those who could afford the margin collateral and 2) tied the maximum amount of leverage down to their initial investment. It falls to the exchange to decide the maximum amount of money they are willing to lend the trader relative to the collateral he/she put up. If they are prudent institutions they will not go beyond the maximum risk they can bear, effectively limiting the amount of credit that could be used to bid up prices of a given asset.
Oh, I didn't realize the whole book was available electronically. Thanks.