The current financial crisis is causing the conspiracy theorists and self-taught economists to emerge from all the dark corners and crawly undersides of the political landscape. I am not going to pick on any one blog post, because the errors are too common. But I think it's worth explaining why some of the more lunatic theories are wrong.
Item One: The Iraq War did not cause this problem
Iraq is probably contributing somewhat to headline inflation. But it is contributing by making oil somewhat more scarce, thanks to production shortfalls and hoarding by speculators. Real factor scarcity does not create the kind of inflation that touches off asset price bubbles. Only inflation of the money and credit supplies, by giving speculators money to borrow and spend on their favorite asset, has the (arguable) power to create these financial manias.
Nor does the government's borrowing create these bubbles. If anything, it mitigates them by soaking up excess capital from the markets and thus raising interest rates higher than they would otherwise be. Essentially, the government took money out of the housing market and used it to blow things up in Iraq. Bad for Iraq, but probably good for the financial markets.
Item Two: The Bush tax cuts also did not cause this
As noted above, government budget deficits do not create financial manias. What the tax cuts gave to the economy in terms of stimulus, they took back in the form of higher interest rates.
Moreover, there's a strong argument to be made that the Bush tax cuts actually exerted some downward pressure on house prices. That's because when the tax rates fell, the value of the mortgage interest tax deduction also fell. Some of the money that people got back in the form of lower taxes probably went to the housing market, but you have to net out the amount of money leaving the housing market as the tax deduction became less valuable.
Item Three: Being on the gold standard would also not have prevented this mess
There are a lot of hucksters out there writing books and newsletters telling people that a gold standard (or some other commodity currency) is the cure for all their worries. The way they tell it, "hard" currency is a sort of broad-spectrum economic snake-oil, the ginseng of the financial markets. Only adopt their plan, they beseech, and America will no longer be plagued by exchange rate fluctuations, government profligacy, trade deficits, inflation, speculative mania, financial panics, or indigestion. This is triple-distilled balderdash.
There is nothing wondrously transformative about pegging your currency to the atomic weight of 196.97, or any other magical metal. America managed to have a regular supply of speculative booms and spectacular busts throughout the nineteenth century despite the soothing presence of gold in our money supply. The international gold standard in the 1920s and 1930s was marked by speculative mania, catastrophic deflation, competitive devaluations, massive exchange rate and trade imbalances, and of course the worst economic contraction in living memory. The depth and duration of which, I must point out, many economists attribute to America's fierce determination to defend her currency.
A little closer to home, you might look at Argentina--Paul Blustein's excellent book is a good place to start. Argentina's dollar peg was essentially a commodity currency--they didn't control their money supply, and got a contractionary monetary policy when their economy was in recession. Nothing about a dollar peg forced the government to stop borrowing, the bankers to stop speculating--or people from suffering when the government was forced off the peg.
Item Four: Among the many other things that did not cause the current crisis was the repeal of Glass-Steagall
A little history: Glass-Steagall was a major act of the mid-thirties, which set up the FDIC to insure and regulate banks, and split off commercial banking operations from investment banking. In 1980, the feds repealed one of the act's major provisions, Regulation Q, which had allowed the regulation of interest rates on banks. This is why you now get a competitive interest rate on your bank account instead of a free toaster when you open an account. In 1999 Gramm-Leach-Billey repealed the separation of investment banking and commercial banking, which is why JP Morgan has a big enough balance sheet to buy Bear without fear of failure.
Neither of these provisions created securitization, which got going in the late 1970s and early 1980s (a decent history can be found here, or you could just read Liar's Poker again). They also didn't create the march into ever-more-exotic financial instruments in the late 1990s and of course, our current decade.
Item Five: The collapse of Bretton Woods--also not a cause of the current crisis!
See above. Commodity/pegged currencies have exchange rate problems too, notably worsening balance-of-trade problems when currencies within the fixed-rate system become over or undervalued. Like, say, having the Chinese propping up the dollar to keep their exports competitive . . .
Item Six: The long twilight of American economic might is not yet upon us
Decade-long recessions like Japan's, or long declines like Argentina or Britain's (pre 1990) are caused by structural problems in the real economy that keep resources from being allocated efficiently: Argentina failed to industrialize, Britain was hostage to moribund state-owned firms. We could develop those sorts of problems, but as of now, America is admirably adept at moving capital and killing off our dead companies. We may have a nasty, nasty recession, but it's not yet time to brush up on your subsistence farming skills.
Later, if I have the strength, I'll muster a defense of fractional reserve banking.
Update Before the Austrians crawl out of the woodwork to yell at me, yes I know that not everyone who supports the gold standard is a crank, though I still find arguments in favor of it wholly unpersuasive. But the arguments being advanced as to the role of fiat currency in the current crisis are bizarre. If anything, a gold standard would have increased the inflow of money from Asia, which was one of the major factors inflating the bubble.
"...late 1990s and of course, our current decade...." so awkward! Why not, "..the nineties and the noughties..."? See, that wasn't hard!
You're a brave soul trying to list the things that have not caused a recession or financial market crisis.
During a boom, many investors leverage their portfolio, which is a risky strategy.
People with a lot of influence gambled and lost this time around. I'm not sure how to tie this to theory.
The real point is there was stupid behavior by smart people. How to model this is problematic.
The international gold standard in the 1920s and 1930s was marked by speculative mania
Such a serious commentator as yourself, making such a basic mistake? I suggest you read Rothbard's "A History of Money and Banking," and you'll see that the so-called "gold exchange standard" was not really a gold standard at all, and was in fact an inflationist policy with some vague backing in gold. But the important feature of any commodity standard (which is qualitatively different from Argentina's dollarization: they might have not been able to change it, but that didn't stop the US government from expanding the money supply by about 10% per annum) is that the money supply is constant (or relatively so – not much gold is produced every year compared to the existing stock). And yet, governments were definitely expanding that base all throughout these supposedly "gold standard" days.
Stephen, if you think that Argentina's problems were caused by an excessively expansionary monetary policy, I suggest you buy the Blustein book.
Megan, if you think that Stephen is saying that Argentina's problems were caused by an excessively expansionary monetary policy, I suggest you read his post again.
dave.s: I agree about the need for less words where feasible, but "noughties" for 2000-2009 just sounds weird, as does its less-weird version, "oughties". I'd recommend "00s" pronounced "double-ohs".
But I don't get to decide what terms go into common use ...
Great post. Please do explain fractional reserve banking, because I hate not having ammo when a crank brings up the topic, and I'm too lazy to look it up.
A peg is theoretically equivalent to a commodity currency; they differ only in the potential increase in the money supply. (Though it should be noted that there have been inflationary periods with gold strikes.) They are both ways to mitigate currency risk.
Stephen argues that "they might have not been able to change it, but that didn't stop the US government from expanding the money supply by about 10% per annum". This sounds to my perhaps unsubtle ears like he is arguing that the problem was that the US government was expanding the money supply by about 10% per annum. But Argentina's problem was that a commodity slowdown pushed its economy into recession, and US monetary policy was too tight, not too lose.
We can argue about fractional reserve banking another time; I note only that I find it interesting that the first thing many paleolibertarians want to do, when they get to their ideal state, is outlaw huge classes of financial transactions.
@ 1 & 2 - Its not the war or the tax cuts per se, but the message budget & trade deficits send to currency traders. Fact is, Americans spend more than we make an until thats fixed its coming out of the dollar. Perception and confidence matter when you're trying to rely on foreign investors to keep strength in your economy, and a massively unpopular war surely doesn't help on that front.
Do you really think we'd be in the exact same situation if you wiped out the massive increases in military budgets over the last few years - say, invested that into just about anything else? Any reduction from the tradition of massive federal spending increases would be a benefit to the financial balance sheets.
Megan:
The Argentina comment was more of an aside. However, I don't think it's a stretch to say that the bank panics of the 19th and early 20th century had their roots in inflationist monetary policy. That money supply expansion would flat-out not have happened under a real gold standard, or under free banking in which the most sought-after currency was the one that held its value best. Which is why I think it's relevant to your assertion that the gold standard would not have solved the problems of "exchange rate fluctuations, government profligacy, trade deficits, inflation, speculative mania, financial panics, or indigestion." (Pray tell, how exactly would price inflation come about under a true gold standard?) How can you say that? I mean, I suppose it's possible that a gold standard/free banking wouldn't have helped matters, but it's intellectually lazy to say that we tried the gold standard and failed. We tried to pretend to be on the gold standard and it failed.
independent - but if you look at the budget deficits of Germany, France, or god help us Japan, you will see that their finances are in much worse shape than ours.
VW is about to annouce a new factory in the US, BMW is laying off 8,000, Seimens is down 20% unable to compete with GE when pricing in dollars, Airbus prices its planes in dollars but pays its employees in EURO and will soon need a government bailout.
As I read Stephen's original post, he made the following claims:
the monetary supply was expanding by 10% during Argentina's crisis (I have no idea if that is true or not)
therefore Argentina's dollar peg cannot be fairly described as a commodity currency.
He doesn't address the cause of the crisis at all in his post; you can just as easily read into it "and the crisis continued anyway despite the expansion of the money supply" (how I interpreted it) as your interpretation of "and this expansion caused the crisis".
Excellent post and I have just listened to your blogging heads with Mark Kleiman.
I agree with much of what you say but I think you are so close to the system that you are missing the bigger picture. Your defence seems to be that there is no easy fix--none of the fixes that people propose will work. Your arguments are powerful and like you I am suspicious of hindsight regulation.
Nevertheless I do believe there is a convergence of factors that will pose some very tough challenges and they are very structural, and some of them may take a long time to work their way through. In short, I am extremely sceptical about your number six. The end of cheap oil I think is going to have some dramatic challenges for the US economy, as will the switch out of the dollar: let's face it the empire is going bankrupt. And the extreme disparities in income (discussed with Mark) are not going to help. The huge irony is that it will have been the PNAC maniacs that brought it all on.
Don't get me wrong--this is not doom and it need not be gloom, and managed well (as I am sure it will be) it has the potential to be a real golden age.
Keep up the thoughtful commentary and to push back against the simplistic bar-room analyses (and here is another one to dismiss).
Meghan,
I have a question: If I start a software company (who's primary product may or may not be arround in 20 years) and sell it to SAP for $20 million that is counted as a capital outflow. If Lufthansa buys $20 million worth of jet engines (again that may or may not be servicable in 20 years) from GE thats counted as an export.
But, just like GE can make more engines, I can start more businesses. With the US being so entreprenurial does this explain some of our trade deficit?
I understand the accounting profession is having trouble valuing knowlege based businesses. It's easy to value a steel mill, value of land, buidling, depreciated equipment, etc. It's much harded to value Doubleclick. Maybe trade economists are having the same problem?
Tax cuts on dividends made equity cheaper relative to debt, which reduced some of the pressure to increase leverage. Without the tax cuts on dividends, it's likely that companies would have been even more highly leveraged and the crash would have been more severe.
I once informally debated fractional reserve banking over a beer with Dr. Rothbard. He agreed that fractional reserve banks should not be outlawed but caveat emptor. He steadfastly believed most people would opt for banks which kept virtually 100% reserve in the vaults.
(Sort of a "Good banks drive out the bad banks."
twist on Say's Law.) I just as steadfastly believed that there would be a fractional risk continum and individuals would bank where the risks were comfortable to them.
What is the minimum reserve requirements that regulations impose on banks today? I've heard of 20 and 30 to one ratios which seem very risky.
Where do banks display their ratios?
Stephen wrote: That money supply expansion would flat-out not have happened under a real gold standard, or under free banking in which the most sought-after currency was the one that held its value best. Which is why I think it's relevant to your assertion that the gold standard would not have solved the problems of "exchange rate fluctuations, government profligacy, trade deficits, inflation, speculative mania, financial panics, or indigestion." (Pray tell, how exactly would price inflation come about under a true gold standard?)
This reminds me of some past conversations with unreformed ubersocialists who insisted that we should be open to the possibility of communism in the future, and that the past catastrophic failures of communist societies don't count because "those weren't real communism anyway."
I mean, sure -- "real" communism and a "real" gold standard do have some meritorious points. However, you will never get either one of them in the real world outside of a very small society of like-minded individuals, because either system places odious restraints on behavior in difficult times, while there are numerous incentives to game the system and hefty rewards for doing so.
The minimum ratio of 10% is set by the Fed.
jmo:
The last thing I want to do is end up like France or Japan! However, the budget deficit isn't the only factor putting downward pressure on the dollar - you have to include the trade imbalance, interest rates, *and* a lack of, well, popularity.
America has been running on a very favorable global financial deal, but a big part of that deal was keeping our dollar buyers happy. We need external dollar buyers, or we take a collective pay cut. That is unavoidable and it cuts directly to the war.
jmo:
The last thing I want to do is end up like France or Japan! However, the budget deficit isn't the only factor putting downward pressure on the dollar - you have to include the trade imbalance, interest rates, *and* a lack of, well, popularity.
America has been running on a very favorable global financial deal, but a big part of that deal was keeping our dollar buyers happy. We need external dollar buyers, or we take a collective pay cut. That is unavoidable and it cuts directly to the war.
"The minimum ratio of 10% is set by the Fed."--MM
This is, too, inaccurate, like most of the tripe in the post.
This: "I once informally debated fractional reserve banking over a beer with Dr. Rothbard. He agreed that fractional reserve banks should not be outlawed but caveat emptor. He steadfastly believed most people would opt for banks which kept virtually 100% reserve in the vaults.
(Sort of a "Good banks drive out the bad banks."
twist on Say's Law.) I just as steadfastly believed that there would be a fractional risk continum and individuals would bank where the risks were comfortable to them.
What is the minimum reserve requirements that regulations impose on banks today? I've heard of 20 and 30 to one ratios which seem very risky.
Where do banks display their ratios?
Posted by wkdave | March 20, 2008 11:54 AM
to me, comes closest to providing a workable schema for all parties. Allow banks, and their currencies, to compete.
Reserve Requirement Ratio:
http://www.federalreserve.gov/monetarypolicy/reservereq.htm
Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors has sole authority over changes in reserve requirements. Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks.
The dollar amount of a depository institution's reserve requirement is determined by applying the reserve ratios specified in the Federal Reserve Board's Regulation D to an institution's reservable liabilities (see table of reserve requirements). Reservable liabilities consist of net transaction accounts, nonpersonal time deposits, and eurocurrency liabilities. Since December 27, 1990, nonpersonal time deposits and eurocurrency liabilities have had a reserve ratio of zero.
The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution. The Garn-St Germain Act of 1982 exempted the first $2 million of reservable liabilities from reserve requirements. This "exemption amount" is adjusted each year according to a formula specified by the act. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent was set under the Monetary Control Act of 1980 at $25 million. This "low-reserve tranche" is also adjusted each year (see table of low-reserve tranche amounts and exemption amounts since 1982). Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent.
I have a couple of Q’s based on two of these points (that no doubt reflect my rusty economics):
Item One: The Iraq War did not cause this problem
My Q: though I think it plain the war did not cause the problem, the point that government borrowing did not create these bubbles is where I might be missing something. Is it fair to conclude that the government is soaking up excess capital from the markets when so much of that borrowing is from overseas lenders? Would that money otherwise be flooding the markets? It’s not obvious to me that there is a crowding out effect to the U.S. borrowing habit. Also, due to the overseas lenders, might it actually keep interest rates down?
Item Two: The Bush tax cuts also did not cause this
Couldn’t they, though, partly contribute to the severity of whatever recession might lie ahead? It seems that the tax cuts have not been coupled with any spending cuts (in fact spending has increased), and that they have really been financed by, again, borrowing from abroad. I also don’t think economic growth can fairly be said to have absorbed the loss of revenue. It seems somewhat akin to LBJ’s budgets during Vietnam, and I wonder if this isn’t all kindling for rapid inflation?
I have a couple of Q’s based on two of these points (that no doubt reflect my rusty economics):
Item One: The Iraq War did not cause this problem
My Q: though I think it plain the war did not cause the problem, the point that government borrowing did not create these bubbles is where I might be missing something. Is it fair to conclude that the government is soaking up excess capital from the markets when so much of that borrowing is from overseas lenders? Would that money otherwise be flooding the markets? It’s not obvious to me that there is a crowding out effect to the U.S. borrowing habit. Also, due to the overseas lenders, might it actually keep interest rates down?
Item Two: The Bush tax cuts also did not cause this
Couldn’t they, though, partly contribute to the severity of whatever recession might lie ahead? It seems that the tax cuts have not been coupled with any spending cuts (in fact spending has increased), and that they have really been financed by, again, borrowing from abroad. I also don’t think economic growth can fairly be said to have absorbed the loss of revenue. It seems somewhat akin to LBJ’s budgets during Vietnam, and I wonder if this isn’t all kindling for rapid inflation?
Megan:
If I am to understand correctly, you are claiming that the government's policy of running up massive increases in spending, combined with low interest rates and tax cuts, didn't create a bubble market? That this was actually good for our economy? And Bush telling folks to "go out and spend" didn't affect our savings rate at all?
"self-taught economists to emerge from all the dark corners and crawly undersides of the political landscape"
Attention pot, stop calling kettle black! Maybe you should switch to posting about scarves?
The massive spending/tax cut was financed by borrowing, which soaked up extra capital; much of that spending was then done in Iraq. Net effect: uncertain, but not large in either direction.
There's little evidence of anything Bush said having affected spending.
Bush had no control over interest rates.
Bush was neither good nor bad for the economy; the president doesn't have much control over the economy. Thank God.
Mmmmkay, so if the president decides to spend, say, 1 trillion dollars over 5 years on a project that has a ROI of zero, like maybe a city on the moon or - hey I know, a war in Iraq...that doesn't have much affect on the economy? Certainly nothing large in either direction!
"Mmmmkay, so if the president decides to spend, say, 1 trillion dollars over 5 years on a project that has a ROI of zero, like maybe a city on the moon or - hey I know, a war in Iraq...that doesn't have much affect on the economy? Certainly nothing large in either direction!
Posted by freddiemac | March 20, 2008 3:23 PM"
If you look at Total size of US economy vs. Total cost of war in Iraq, that sounds about right to me.
Intuitively, the government spending more than it collects has some effect. What they spend it on - not so much.
Intuitively, the government spending more than it collects has some effect. What they spend it on - not so much.
Posted by 40 degrees south | March 20, 2008 3:42 PM
Bastiat, Frédéric (1801-1850)
Title: Selected Essays on Political Economy
Published: Irvington-on-Hudson, NY: The Foundation for Economic Education, Inc., trans. Seymour Cain., ed. George B. de Huszar, 1995.
First published: 1848, in French.
For downloads and more, see the Card Catalog.
What Is Seen and What Is Not Seen
In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.
1.1
There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.
1.2
http://www.econlib.org/library/Bastiat/basEss1.html
If the government spends 100 billion a year to subsidize universal medical insurance, it's a shanda (a scandal, for you goys). But if the government spends twice as much on a useless war, it's OK. I've learned a lot by reading this blog.
So if the government were to spend 1 trillion dollars over the next five years on, say buying up mortgages that are underwater, that will have not much effect on the economy? Or if the government takes all funding from defense and homeland security and spends it on bubble gum, and Mr. Bin Laden begins blowing up buildings in downtown Manhattan, that too will have not much effect on the economy? Boy I'm glad we have this blog to put all the errors of self taught economists in check!
Stan wrote: If the government spends 100 billion a year to subsidize universal medical insurance, it's a shanda (a scandal, for you goys). But if the government spends twice as much on a useless war, it's OK. I've learned a lot by reading this blog.
If the government spends $100B/year in the creation and/or expansion of entitlement programs that have a long an ignoble history of never going away, and are forseeably projected to demographically cascade into future obligations of an enormously greater magnitude, then yes, that's a problem. Moreover, it's a different type and size of problem than the one under discussion, so...what was your point?
Simple logic is all you need to tell you that a fiat currency must fail eventually, based on the record of past governments that have implemented fiat currencies. The beauty of the gold standard is that while it does not stop the worst aspects of economic behavior with respect to currency, it can strongly mitigate the damage that government would otherwise do.
If the government cannot magically print money whenever it needs some because dollars must be pegged to gold, silver, copper or some other relatively expensive material, it cannot hide its fiscal irresponsibility. It also cannot launch dangerous foreign adventures.
Gosh, I can barely decode all the mumbo-jumbo: dollartization, Glass-Steagall, fractional reserve banking. Maybe even the Smoot-Hawley tariff will creep in.
How about the dollar is sinking (as it has been for years) because the Gov't is printing too much money (Fed or Fed not)? How about the loan crisis is due to a lot of folks making a lot of bad loans (perhaps under the influence of Gov't pressure). Perhaps the two are almost completely uncorrelated, as variables often are.
Perhaps the war in Iraq/Afghanistan is merely another government expense, bigger than some, smaller than most, and roughly uncorrelated with either a weak dollar or the loan crisis.
And maybe the decrease in economic growth just might be correlated with a decrease in the growth of productivity, which sometimes happens because progress progresses in fits and starts, and not in accordance with any extrapolation of any theory. Sometimes no one thinks of a good way to do stuff better and so we coast for awhile.
At the rock bottom, that's all that matters: Can you build better stuff cheaper? Everything else is a Gov't conceit: We can control the economy.
Iraq is probably contributing somewhat to headline inflation.
So does and will Medicare Part D.
Nor does the government's borrowing create these bubbles.
No, but that debt has to be honored and paid back some day, yes? The government is paying back yesterday's debts today. Either you pay back today's debt out of today's real wealth -- which means taxes -- or you "print up" some cash and "pay it back" with that.
And looky there, that causes inflation -- which effectively reduces the *real* debt!
Which leads to the real reason why the gold standard would not prevent messes like this one. The gold standard constrains government from inflating the currency, which removes the obfuscatory elasticity of fiat currency and makes it easier to see that government consumption of wealth is a net loss for the economy, no matter how the theft is perpetuated. The gold standard makes the pain more immediate to its cause -- and in the long run, less deep, because not as much of a "hidden hole" in the nation's wealth can be built up by the government before the economy notices and accounts for it.
But the fact remains that government consumption is always bad for the economy. All that fiat currency (and bad economics) change is how and where the destroyed wealth is accounted for and the resulting loss absorbed. Sometimes it comes in a recession/depression, where the loss is more direct in capital losses (from taxation, and from misallocation caused by government-sourced distortions in demand patterns); sometimes it comes in the form of inflation, where the loss of value of each dollar in the economy represents the government's consumption of wealth via printed dollars; or in a combination of both (the so-called "stagflation").
But the fact remains that government consumption is the dominant harbinger of economic performance over decades, when all the noise and obfuscations are cancelled out. What the government eats today comes out of our pockets tomorrow -- period.
"Great post. Please do explain fractional reserve banking, because I hate not having ammo when a crank brings up the topic, and I'm too lazy to look it up."
Actually Megan's the crank on the issue of the gold standard and what Austrian economics has to say about the subject. She absolutely doesn't know what she is talking about. Take this sentence as an example of her ignorance on the subject:
"Only adopt their plan, they beseech, and America will no longer be plagued by exchange rate fluctuations, government profligacy, trade deficits, inflation, speculative mania, financial panics, or indigestion.'
As far as I know Austrian economics, the school of economics that proposes we use commodity money, does not make those claims. In fact the entire section on the gold standard in this article was filled with drivel. She's basically operating on a straw man misunderstanding of the claims being made.
No exchange rate fluctuations? Don't be silly. No government profligacy? Get real.
No trade deficits? Ridiculous.
No monetary inflation? Again ridiculous. Not only would there be inflation but deflation.
No speculative mania? Again not the position.
No financial panics? Why not? I don't see it in the theory.
No indigestion? Well, less indigestion.
Megan absolutely does not understand Austrian economics. She also does not actually understand the history. As far as I know all the manias were driven by monetary inflation, which can occur under a gold standard, or one based on silver. Tulip mania coming to mind as one that happened with a silver based currency.
Austrians absolutely believe that monetary inflation can occur under a gold standard with fractional reserve banking. Especially if a central bank is set up, as happened during tulip mania, the Mississippi bubble, and the roaring twenties.
Monetary inflation can also occur under precious metals standards in other cases. During tulip mania the trade with China was causing lots of silver to move in. A large gold strike can have the same effect.
The basis for sound fiscal policy must be annotated by a demand of logical price controls that will ameliorate fluctuations in denominational consequences of price.
If a recession alone cannot decide which economic structures will suffer adversely, then surely the quota percentage of long-term strategic economic goals cannot also be quantified.
The American economy is built of more than pure fluff and fancy; understanding the differentials of broad based reform will be the guide for resourcing ourselves back into a market of resolved liquidity.
"In 1999 Gramm-Leach-Billey repealed the separation of investment banking and commercial banking.."
Actually, it was Gramm-Leach BLILEY, Tom Bliley being our district's Congressman and chaifrman of the Commerce Committee at the time. See http://banking.senate.gov/conf/
"In 1999 Gramm-Leach-Billey repealed the separation of investment banking and commercial banking.."
Actually, it was Gramm-Leach BLILEY, Tom Bliley being our district's Congressman and chaifrman of the Commerce Committee at the time. See http://banking.senate.gov/conf/
It's been a few years since I paid much attention to the Fed Funds market, but maybe I can help clarify a few points.
The reserve requirement is variable, but it used to be about 13% maybe 5 years ago. This doesn't mean what it looks like at face value, though. The Fed checks the reserve deposits of banks every other Wednesday. Banks that anticipate being short on any given Wednesday will typically execute an overnight interest swap with another bank with a long position. The term "overnight swap" means that the funds appear for one day in the account of the buyer, then are transferred back to the seller, so on other days, there is no restriction on the position of most banks (well, if a bank defaults on other payments, or is otherwise in trouble, then its reserve position is subject to auditing).
Transactions in the overnight Fed Funds market generally have enormous principals. The minimum used to be $500 million, but that may have changed. You can get some idea from the typical brokerage rate (as of maybe 5 years ago) of 50 cents per million of principal. The amount of interest owed (which is the cost of the swap) is pretty small, too, about $100 per million of principal.
Since we're exploding myths, let's explode one perpetuated by Megan herself:
"Essentially, the government took money out of the housing market and used it to blow things up in Iraq. Bad for Iraq, but probably good for the financial markets."
It would only be bad for Iraq if more Iraqis were suffering than before 2003, and if a majority of Iraqis preferred to return to rule by Saddam Hussein. Neither is the case.
I think the only reason Glenn sends us to Megan's site is that he is rather weak on economics. Great on many other things, but the economy is not his thing.
If it was he would recognize that Megan has an authoritative style of writing that masks a glaring lapse in logic. It's a style that is typical these days of her recent employer, The Economist.
Look, the UK went back to the gold standard in the '20s and it was a frickin' disaster.
"If the government spends 100 billion a year to subsidize universal medical insurance, it's a shanda (a scandal, for you goys). But if the government spends twice as much on a useless war, it's OK. I've learned a lot by reading this blog."
The funny thing about wars is that they
1) end
2) don't increase in cost by a (compound) 20% every year until the sun or your calculator explodes
Let me see if I can help the math challenged.
War = 200 bn. Economy 13 trn.
200 bn/13 trn = .2/13 = a little under 2%.
So the war amounts to a regular 2% hit on profits. It is known and affordable.
Compare that with a single day 1 trn drop caused by 9/11. Financial chaos.
Now there is no certainty that the war has prevented another 9/11. All we know is that despite numerous threats we haven't had a problem. So it is possible that it is working. Osama is having trouble recruiting because he is losing. That has got to be a help.
The war is also a form of signaling fitness. We can spend an extra $200 bn a year on a war without breaking a sweat. That is also a form of deterrence.
pour l'encourager les autres
Even if the war is doing no good directly it may have benefits in the realm of the psychology of our enemies.
However, we do know one direct good. K-daffy gave up his nuke program and WMD program because of the war. The Pakistani distribution of nuke technology was at least slowed if not halted all together.
What is it worth to put off a nuke/chemical/bio war for a few more years? Probably more than it is costing us.
The basis for sound fiscal policy must be annotated by a demand of logical price controls that will ameliorate fluctuations in denominational consequences of price.
If a recession alone cannot decide which economic structures will suffer adversely, then surely the quota percentage of long-term strategic economic goals cannot also be quantified.
The American economy is built of more than pure fluff and fancy; understanding the differentials of broad based reform will be the guide for resourcing ourselves back into a market of resolved liquidity.
A beautiful example of pomo speak applied to economics. Funny.
The advantage of fractional reserve banking is that the economy can grow faster than it would under a relatively fixed money supply.
Of course the problem is that some times it causes faster unbalanced growth. Manias.
On balance if managed properly (it never is) it is a good thing. Even given human frailties it is probably still a good thing. Provided the bankers are moderately prudent.
Take the dot com bubble. It left a lot of fiber infrastructure behind that was fully discounted lowering communication prices several years in advance of better manufacturing and deployment technology. It set the stage for the next boom.
BTW the all time gold standard inflation debacle was when the Spanish discovered that there was a lot of gold that could be stolen from the New World. The real hurt was that it diverted the Spanish from production to theft.
The British were better off because their profits from their colonies depended on manufacture, agriculture, and other forms of production (invention being a big one).
Only inflation of the money and credit supplies, by giving speculators money to borrow and spend on their favorite asset, has the (arguable) power to create these financial manias.
If the source of bubble and I would say other forms of malinvestments is expnasion of money and credit supplies, then sound money policy would be built to prevent credit expansion. Pretty much rules out fiat money, central bank authority to set the rates and fractional reserve banking.
Don't you people understand, we SPENT MONEY on the Iraq War, we SPENT MONEY, SPENT MONEY SPENT MONEY!! If we hadn't SPENT MONEY we'd HAVE MONEY NOW you dogfucking syphilitic morons we SPENT MONEY and we don't HAVE MONEY NOW!
PS I think we should go to the gold standard because I have this childish belief that if I can't see something, then it doesn't actually exist. Also I have a dream of one day owning all the money in the entire world, and without a gold standard this will be impossible. Also my private army will blow up every gold mine in the world to stop currency devaluation. And I will have a pony called Moonbeam.
independent, we can start by cutting all the government departments not authorized by the Constitution, like, say, Education. When we've eliminated unconstitutional spending, then we can look at the ones that are mandated, like DEFENSE.
Your point about reduced taxes lowering housing values (through lowering the value of the mortgage interest deduction) is intriguing, perhaps for its counterintuitive charm, but unpersuasive.
There is a strong correlation between housing prices and taxes -- mostly local property taxes. The price of a house reflects the total cost of ownership, not merely the selling price in this era where few people pay cash for a house. Hence, ceterus paribus, increases in interest rates will lower selling prices because it's a change in the factor prices -- the rent for the money went up relative to the housing price. Similarly, as real estate taxes go up, prices come down because the annual cost of ownership his gone up.
A long, long time ago, I did some analysis of housing prices in LA County from 1950-1970, using both census cross section data and time series data from real estate sources, including some interesting comparative data for a couple of neighborhoods where the housing stock was essentially identical, but one part was in Bevery Hills (relatively low tax burden at the time) and the other part was in LA (relatively high tax burden at the time). Something on the order of 80% of the variation in housing prices for similar housing could be explained by looking at the present value of the tax payment streams.
If mania is an extreme form of investment that results in irrational behavior eventually ending in negative real returns then we are witnessing two real manias right now. One is the securitization issue and the other is the Iraq war. Securitization was built on a fanciful interpretation of government policy regarding housing and debt instruments. The other is the cost of the Iraq war at a time when there was not an identifiable income stream to pay for it. The failure to observe our ability to pay versus our ability to consume (it doesn't matter if it is government policy or private investment) is the key issue. The issue cannot be discussed as a percent of GDP issue. There are simply too few dollars at the margin to pay for either mania. We only made the decision to consume, not to save. Neither provides a real economic profit.
"If the government cannot magically print money whenever it needs some because dollars must be pegged to gold, silver, copper or some other relatively expensive material, it cannot hide its fiscal irresponsibility. It also cannot launch dangerous foreign adventures."
And if pigs had wings they'd be pigeons.
From the time when some functionary at the Lydian court came up the idea of stamping the royal seal on lumps of electrun as a guarantee of weight and purity, to the final repudiation of the gold standard by the West between (depending on your spin) 1914 and 1973, point out one instance in which the adherence to specie prevented fiscal or military irresponsibility.
As anony_mouse_ indicates, the gold standard is like Marxian communism, in that both assume that everyone agrees to restrict themselves to playing by the same rules.
SDN: Totally agree with ya, but I still think our definition of defense is out of whack. Even beyond the spending component, we're reliant on international good will so long as we're reliant on external funding.
Selling our sovereignty for some increased cash? Basically, but you can't have it both ways.
Did the Iraq War cause the Tech Bubble in the late 90's?
Did the Bush Tax cuts cause the Tech Bubble in the late 90's?
Would the Gold Standard have prevented the Tech Bubble in the late 90's?
Did the repeal of Glass-Steagall cause the Tech Bubble in the late 90's?
Did the collapse of Bretton Woods cause the Tech Bubble in the late 90's?
Did the collapse of the Tech Bubble in the late 90's signal the twilight of American economic might?
Is this the first time that speculators have been spectacularly wrong? Did history begin when George W. Bush took office? Is there any difference if people speculate in tech stocks or real estate, particularly if those people are speculating with money they can't afford to lose?
My oatmeal is lumpy... I blame George W. Bush!
"The funny thing about wars is that they
1) end
2) don't increase in cost by a (compound) 20% every year until the sun or your calculator explodes"
1) not if we elect John "100 more years is fine with me" McCain
2) who said it would?
"It would only be bad for Iraq if more Iraqis were suffering than before 2003, and if a majority of Iraqis preferred to return to rule by Saddam Hussein. Neither is the case."
chip,
In relative terms, the former certainly is the case. Is oil production in Iraq at prewar levels? Agricultural output? Has life expectancy dropped? Quality of life? Are chances of being killed by violent attack up? To argue such things as being untrue seems very dishonest. Maybe Iraqis don't want a return of Saddam Hussein, not that it is possible, but that doesn't necessarily mean that they are better off now.
"As noted above, government budget deficits do not create financial manias. What the tax cuts gave to the economy in terms of stimulus, they took back in the form of higher interest rates."
Sorry Megan but the facts don't support your contention in the second sentence. Please take a look at this data -- http://www.mortgage-x.com/trends.htm -- a review the "Historical Graphs For Mortgage Rates: Long-Term Trends". From the period of 2000 to 2003 the interest rates were going down. Exactly the peak of the Bush cuts. The deepest being in the 1yr arm rates. Even now we are 2 full points lower than the same period this very month in 2000.
The balance of your agrument here is wispy thinking. Again look at this chart -- http://activerain.com/blogsview/383935/Tallahassee-Real-Estate-Market. This is in a North Florida market that has been reasonably stable as compared to So. Ca or even So. Fla. Your contention of course would be that the increase would have been even more. Maybe. But I have to tell you, tax calculation is not generally number one decision in the home buying matrix. That comes later. A combination of speculation and buy-in before you can't afford it was the trigger for the Ca. run up. There was no tax calculation involved.
Would you care to revise your analysis?
I feel like the cave man on the Geico commercial listening to the talking head explain something and his response is a totally shocked and amazed, "What?".
Good grief this is so simple.
Inflation, inflation, inflation.
- The Fed funds rate was about 1% for nearly three years
- This and this alone drove mortgage rates OF ALL TYPES to historic lows.
- During this time, the economy was recovering from a recession. People had more money to spend in 2003 than in 2001. Housing was cheap, and mortgages were very cheap.
- Home prices were rising so fast that it attracted speculators, but it also prompted many working people to buy a home before prices went any higher.
- By 2005-2006, housing prices were way up, and mortgage rates had started to rise, and home sales started to slow.
- Meanwhile, the wide credit spreads prompted Wall Street to start buying mortgages and levering them up 20x-30x. This was initially very profitable, and since housing was no longer a good investment, the stock market started to "go parabolic" in the summer of '06 (right after the fed stopped increasing interest rates, BTW).
- The net result was there had been inflation, not so much in consumer prices as in asset prices. Housing was inflated, stocks were inflated. Everybody felt rich.
- By 2007, housing prices had started to drop. Even hard-working people who bought conservatively had seen their down payments WIPED OUT. Everybody felt poor.
- in 2007, people started defaulting on their mortgages, starting with the weakest subprime borrowers, but ultimately, all were affected.
- Wall Street started losing money hand over fist.
- Wall Street, having forgotten the profits they made in the good times, starts telling America that unless we bail them out, the whole economy will fail.
- In 2007 the Fed started "bailing out" Wall Street, but only fast enough to keep the whole system from falling apart.
- The Fed could indeed have acted more aggressively, and saved Wall Street from many losses, by cutting rates earlier. Wisely, they chose not to support Wall Street at the cost of even higher consumer price inflation.
- By allowing some asset prices to fall, the fed destroyed much of the excess money supply without having to raise interest rates.
- Wall Street starts to experience layoffs from the bursting of the credit bubble. They thought it was funny as hell when it happened in Silicon Valley.
- As a result, Jim Cramer and his ilk proclaim that "They Know Nothing," and claim there's no inflation worry despite $1000 gold and $100 oil.
Greenspan got it wrong (with help from overseas central bankers). But Bernanke is getting it incredibly right.
"The advantage of fractional reserve banking is that the economy can grow faster than it would under a relatively fixed money supply."
More nonsense. All the benefits that come from fractional reserve banking can be accomplished with other banking methods, honest ones.
Lending money to someone long term while telling the saver he can get his money out short term will always lead to bad economic signals. The savers and the borrowers plans are not properly coordinated under a fractional reserve system.
Monetary expansion from fractional reserve causes overbuilding of long term projects and not "growing faster", a bubble. The "growing faster" only occurs in the wrong sector and for a short period during the boom. This is completely reversed during the correction that always follows.
The malinvestments made during the boom are not offset by the correction resulting in a net loss to the economy. So long term growth over time is reduced in the process.
John Mc: You might want to note that, in support of Megan's "whispy thinking," the federal funds rate hit 5.59% in January 2000 and 0.96% at the end of December 2003, the same period you cite. Coincidence? Or did Milton Friedman get it right?
I'm not an economist. Wouldn't want to be, since it's like being a weatherman -- you guess a lot even with the best information available. So, please, take my comments with a grain of salt. However, I spent 20 years on Wall Street, and you do manage to learn a few things even when you aren't a trader.
I would hazard to sy that biggest problem with the US economy, at the moment, has nothing to do with what some might call 'core economics', but is instead the result of a culture of stupidity amongst a supposedly-smart, monied class.
The first is a belief that the Stock Market is an indicator of economic health; it is legalized gambling. The only difference between your broker and Vinny the Nose is that he has a better suit...and a federal license which obligates him to report your income to the Federal Government. Instead of handicapping football teams or racehorses, he's handicapping stocks. And just like when Vinny needs a few extra bucks, he too adjusts his point-spreads and then talks up the underdog to lure the suckers in. Making money in such a rigged system requires two things the average person will never have: a large initial stake and inside information, available at a time when it will make a difference. No wonder the government has never adequately defined "insider trading'; in effect, all trading IS an inside game.
(For those who doubt this, I instruct them to do a Google search on S.I.A.C.,and find out just what it does, and why it does it.)
Giving $400K mortgages to those who make less than $50K a year, on the faulty premise that this portion of the market was "underserved", and was therefore a potentially-rich feeding ground, was a bad idea. You don't need to be a math major to figure that one out.
Next: credit is too easy to come by -- for both consumers and corporations. This is a result of far too much liquidity in the markets, spurred in part by a monetary policy which strives, before all else, to keep inflation in check, even when a little inflation might have been the best medicine.
Next: American corporations (aided and abetted by our own government) routinely send capital overseas in the form of outsourcing (particularly of skilled jobs) which bumps up the balance sheet and stock price, but which leaves the citizens of this country with less to save and spend. The sad truth of the "but-we-created-5-gazillion-jobs" mantra is that the jobs created were either at the very bottom end ('would you like fries with this?'), or at the extreme upper end (such as in genetic research and pharmacology), where a bachelor's degree and an internship just won't cut it anymore. You cannot expect to have a healthy economy when the people you depend on to put money into it have none, and no prospect of making any. If you doubt this, walk into any Wal-Mart and the only things you won't find marked "Made in China" are Pepsi, Doritos and Marlboros. A country which has limited production capability and in which it's workers cannot often afford what little they do produce, cannot, by definition, be "a strong economy".
Invest here first, and watch the general economy improve steadily without having to resort to interest rate and tax cuts, and accounting tricks on a consistent basis to do it.
Finally, there is a culture of stupidity and arrogance in the nations banks and investment firms. The pressure, supposedly, is to produce, but how many times does a failing CEO still get his $200 mil salary and golden parachute while his customers and employees suffer the consequences of his (typically-foreseeable) errors?
The problems we're now experiencing are NOT strictly economic; they are mostly cultural, and that culture is one of blind greed coming before reason.
Mitch interesting observation. But there is no correlation between FFO and apparent tax rates paid by consumers. Yes the FFO affects the component of deductibility as applied to Sched A. But unless you are in very peculiar economic circumstances its total component of your tax bill is only about 1/4. Again not factored by the owner at the time of purchase.
In comment boards such as this, the parochial obsession with money, as opposed to capital, always rears its ugly head. How we manage money is important, but it must always be remembered that money is merely the means that we use to allocate capital, not a thing of value unto itself.
The gold standard is just an arbitrary way of defining the limits of that allocation, one that has been tried and found wanting in the past. Gold itself has value as an electrical conductor, and in the production of pretty trinkets, but most of its value is psychological, and derives from its history as a medium of exchange. There is nothing otherwise particularly special about gold, except that it is a finite commodity, and appeals to those who are uncomfortable with the complexity inherent in negotiating infinite boundaries.
What matters in the real world is not how much money we spend, but how we allocate our resources, which are theoretically infinite, or as close to infinite as makes little difference. Thus, money "spent" on the Iraq war does not represent something lost, never to be recovered, but merely a temporary reallocation of resources. If the result is a tamed Middle East, it will pay for itself many times over through the freeing up of assets that otherwise would have been allocated to destruction of existing capital stock. On the other hand, $100 billion spent on medical insurance, if it is not targeted toward training new medical personnel or investing in infrastructure, would merely reallocate resources to a sector which is already well endowed. Our medical problems will never be solved through stimulating demand, which is already high. This path can only lead to inflation and/or rationing of care.
Re: - By 2007, housing prices had started to drop. Even hard-working people who bought conservatively had seen their down payments WIPED OUT. Everybody felt poor.
- in 2007, people started defaulting on their mortgages, starting with the weakest subprime borrowers, but ultimately, all were affected.
Two things: Not "everyone" felt poor in 2007. I certainly didn't, since 2007 was my highest paid year to date (and I don't own a house; I rent). Even among home owners there are many (a majority) who bought their houses before the run-up in housing prices. These people are still well ahead of the game, even if they are bit annoyed that their house is "only" worth five times what they bought it for rather six times.*
Also, mortgage defaults have risen bneyond historic rates in only certain types of mortgages: those with variable payment structures (ARMs, Interest Only Mortgages, Negatively amortizing mortgages) and mortgages that did not require income/asset verification (no doc or "liar loans"). People with income verified, fixed rate mortgages, even subprimes, are defaulting at very low rates generally for the reasons mortgage defaults have occured all along such as job loss, divorce, major medical problems etc.
* Those are realistic numbers, at least in S Florida. Houses in my neighborhood were selling for c 50K in the early 90s. They topped 300K in 2005-06, but are now headed down below 250K.
My completely uninformed, ingorant position: With so much bad press about Chinese medical production, so much bad sentiment toward Chinese imports last year (you thought the drop-off was only because of lower income? Tsk, tsk...) and a climate of fear about the American job base, not to mention the weaker dollar, I'm of the firm belief we'll see a return to manufacturing here. Call me a hopeless optimist...