Lilburne @ Mises : Federal Reserve

The 19th-Century Bernanke: Featured on Mises.org

Daniel James Sanchez — Tue, 01 Sep 2009 22:59:00 GMT

My article The 19th-Century Bernanke (originally posted here ) is featured today on the Ludwig von Mises Institute web site. Here are the links for... the article comments MP3 audio file (read by Floy Lilley) I hope you will enjoy reading or listening...(read more)

Ben Bernanke Was Wrong: YouTube Mashup

Daniel James Sanchez — Fri, 14 Aug 2009 18:05:00 GMT

Somebody did a cool "mashup" ( defined in Wikipedia as "a digital media file containing any or all of text, graphics, audio, video and animation drawn from pre-existing sources, to create a new derivative work") of my Mises.org article...(read more)

The 19th Century Bernanke

Daniel James Sanchez — Sat, 08 Aug 2009 23:20:00 GMT

There is something disarming about a technocrat. While it is easy to dismiss elected officials as blustering panderers, there is something comforting in the image of the specialist civil servant toiling away with industry and equanimity. Poring over statistics...(read more)

Ben Bernanke Was Wrong: Featured on Mises.org

Daniel James Sanchez — Tue, 28 Jul 2009 18:11:00 GMT

My piece Ben Bernanke Was Wrong is a Daily Article today on the Mises Institute web site. Here is the article and the comments page. I've fleshed out my commentary on the transcription to make it more of an actual article. I've also updated the...(read more)

Ben Bernanke Was Wrong

Daniel James Sanchez — Sat, 18 Jul 2009 20:41:00 GMT

We now have the diametrical opposite of the famous " Peter Schiff Was Right " video (a compilation of 2006 and 2007 clips in which Schiff, a financial expert who subscribes to Austrian economics, predicted the deep recession that would follow...(read more)

Krugman's Rearguard Apologists: Featured on Mises.org

Daniel James Sanchez — Tue, 07 Jul 2009 17:33:00 GMT

My article Krugman's Rearguard Apologists (originally posted here), which follows up my Krugman's Intellectual Waterloo Mises Daily (also orginally posted here) has been published today as a front-page Mises Daily. Please check it out and contribute to the comments.

My sincere thanks again to Jeffrey Tucker and BK Marcus.

Here's an excerpt...

This brings us to the key point that all the Krugman apologists egregiously ignore: namely that it would be surprising if such an arch-Keynesian economist as Krugman (he's written extensively on what he has called "the greatness of Keynes") didn't adovocate a housing bubble to replace the dot-com bubble, since doing so would dovetail perfectly with basic Keynesian doctrine. As a Keynesian, Krugman should have wanted lower interest rates (as he actually did want, as is revealed by the previous quote). To quote Keynes himself,

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom. (General Theory, p. 322; emphasis added, but the exclamation point is Keynes's own.)

To be true to his Keynesian principles, Krugman ought to have to welcomed the housing bubble, since to him

it was a good way to achieve his coveted "soaring household spending", and

it was the likely result of Keynesianism-prescribed lower interest rates.

Krugman's Rearguard Apologists

Daniel James Sanchez — Wed, 24 Jun 2009 17:05:00 GMT

As most readers will know, a collection of damning quotes has surfaced recently, exposing Paul Krugman, the doyen of the economic left, as having been completely backward on the most material economic event in our generation: the housing bubble. My recent article on the subject, Krugman's Intellectual Waterloo, has elicited some pretty heated rearguard apologetics, which, in the present article, I'd like to sum up, and knock down.

The first quotes which surfaced are from a 2002 editorial by Krugman. This was followed by a cluster of even more damning 2001 quotes collected by Mark Thornton. The first editorial could be twisted, if one was inclined to twist, into something seemingly benign. The second wave of quotes is much harder to mischaracterize (which is not to say Krugman ditto-heads don't try). The laziest tactic of the Krugman apologists is to only address the more stretchable 2002 editorial, and completely ignore the 2001 quotes. But, not even that approach, if accepted, helps Krugman' case, since the 2002 editorial is damning enough on its own, once the benign interpretations of Krugman's apologists are shown to be nonsense.

One protestation offered has been that a quotation offered in my "Waterloo" piece which read...

To fight this recession the Fed needs…soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

...omits the context which shows that Krugman was "merely" quoting someone else. The last sentence quoted reads in full:

And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

"Disingenuous partisan misquoting!" the apologists cry, "It was this Paul McCulley fellow who said that, not Krugman!" But lets pull the lens back even further, and add even more context by including the whole paragraph, and the one preceding it.

A few months ago the vast majority of business economists mocked concerns about a ''double dip,'' a second leg to the downturn. But there were a few dogged iconoclasts out there, most notably Stephen Roach at Morgan Stanley. As I've repeatedly said in this column, the arguments of the double-dippers made a lot of sense. And their story now looks more plausible than ever.

The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble. (Emphasis added.)

So the first paragraph introduces the "double-dipper iconoclasts", and then clearly states that he, Krugman, agrees with them. The second paragraph then outlines the "basic point" of the double-dippers, which again, he agrees with. And the basic point in question is that to "fight this recession the Fed...needs soaring household spending." Krugman then continues to say how the Fed would need to accomplish this goal, which again, he supports; he says that the recession needs to be fought with soaring household spending, which Alan Greenspan needs to induce by creating a housing bubble to replace the Nasdaq bubble. By writing, "as Paul McCulley of Pimco put it", Krugman is not "merely" quoting another person; he is using someone else's phraseology to express his own opinion.

Another protestation is that Krugman was saying the housing bubble won't work, since later in the editorial he wrote:

Judging by Mr. Greenspan's remarkably cheerful recent testimony, he still thinks he can pull that off. But the Fed chairman's crystal ball has been cloudy lately; remember how he urged Congress to cut taxes to head off the risk of excessive budget surpluses? And a sober look at recent data is not encouraging.

But this protestation completely ignores the fact that when Krugman wrote in the editorial...

Despite the bad news, most commentators, like Mr. Greenspan, remain optimistic.

and...

But wishful thinking aside, I just don't understand the grounds for optimism. Who, exactly, is about to start spending a lot more? (Emphasis added.)

...he was clearly characterizing a housing bubble as an object of optimism, whether or not he thought it was possible. In other words, at best, Krugman could be interpreted as saying that it would be great if Greenspan could pull off a housing bubble, but that he, Krugman, doubts whether he'll be able to accomplish such a worthy feat.

So it should be clear that the Fed causing a housing bubble in order to bring about "soaring household spending" was Krugman's optimal situation, whether or not he thought it was do-able at the time. Given the consequences of the housing bubble that did ultimately happen, that alone should be enough cause for the public to stop listening to this fellow.

Another question is, how did he see the Fed bringing about his optimal situation? He answered this question himself in a 2002 interview with Lou Dobbs (which can be found here, though not at the page originally linked to in Thornton's collection):

Low interest rates, which promote spending on housing and other durable goods, are the main answer. (Emphasis added.)

This brings us to the key point that all the Krugman apologists egregiouslly ignore: namely that it would be surprising if such an arch-Keynesian economist as Krugman (he's written extensively on what he has called "the greatness of Keynes") didn't adovocate a housing bubble to replace the Dot Com Bubble, since doing so would dovetail perfectly with basic Keynesian doctrine. As a Keynesian, Krugman should have wanted lower interest rates (as he actually did want, as is revealed by the previous quote). To quote Keynes himself,

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom. (Font emphasis added, but the exclamation point is Keynes' own.)

John Maynard Keynes, The General Theory of Employment, Interest, and Money, p. 322

To be true to his Keynesian principles, Krugman ought to have to welcomed the housing bubble, since to him (1) it was a good way to achieve his coveted "soaring household spending", and (2) it was the likely result of Keynesianism-prescribed lower interest rates.

Now let's take a look at some more recent and more directly damning evidence of Krugman's pro-bubble economics. In my recent article, I pointed out that in Krugman's 2001 editorial, he implicitly agreed with the Onion's facetious call for a new bubble to replace the old one. In a brilliant comment left in Krugman's own blog (which you can still read until it gets "moderated" (purged), as is the fate of many critical comments there), one "M Ingelmo" reveals, in a most devastating manner, that in 2009 Krugman explicitly agreed with the Onion piece.

Mr. Krugman,

I don’t know if you were on the grassy knoll, too, but you certainly were in Spain in March, chatting with that most fervent of your admirers, Prime Minister Mr. Zapatero, and interviewed in the Spanish public TV channel.

Since these days a video is worth a thousand words, allow me to quote you and say: “guys, watch it for yourselves”. The program is about other things, innovation, and in Spanish (sorry), so go straight to the 35 seconds in the interview after minute 2:50. Under the Spanish translation I’m sure you’ll be able to hear the English original. Quite enlightening:

“To be honest, a new bubble now would help us out a lot even if we paid for it later. This is a really good time for a bubble…

There was a headline in a satirical newspaper in the US last summer that said: “The nation demands a new bubble to invest in” And that’s pretty much right.”

http://www.rtve.es/mediateca/videos/20090502/innovar-para-salir-crisis-informe-semanal/495712.shtml

Not a piece of policy advocacy? Just economic analysis? Will it look like it to all your defenders and commentators here? Personally I am delighted with the words “pay for it later”; are we paying right now for the last one, advocated in 2002, or maybe not enough yet, Mr. Krugman?

If governments follow your “not-a-piece-of-policy-advocacy-just-economic-analysis”, (as it seems certain at least with ours), when that new bubble thus inflated eventually bursts, and we are “paying for it” in a few years time, what will you write in your blog then, Mr. Krugman?

But perhaps the most instructive lesson out of all this is that, implicit in Krugman's quotes, there is a big fat finger of blame pointed directly (and correctly) at the Federal Reserve. Krugman himself would only admit to blaming other factors for our present crisis. But, if...

as any sane person will recognize in hindsight, the housing bubble was disastrous for the economy
as Krugman himself stated, the Fed can induce such a bubble by lowering interest rates, and
as the public record shows, the Fed did drastically lower interest rates in the time leading up to, and in the thick of, the housing bubble,

...then according to the vanishingly few economic principles Krugman actually gets right, he should blame the Fed for the present crisis. Although somehow I doubt, he'll be supporting the Audit the Fed campaign, or Ron Paul's Federal Reserve Transparency Act anytime soon.

As it turns out, Krugman's apologists shouldn't demand more context for his notorious quotes, since it only shines even more light on his confused backwardness as an economist.

Krugman's Intellectual Waterloo

The Second Coming of Keynes

My Take on the ABCT (Simple Version)

Daniel James Sanchez — Sat, 20 Jun 2009 01:25:00 GMT

Below is my take on the Austrian Business Cycle Theory.

Stages

1. Money Supply Increase causes a general

2. Credit Supply Increase, which causes a general

3. Interest Rate Decrease, which causes a general

4. Longer Term Investment Increase, which causes a general

5. (a) Demand for Labor Increase and (b) Demand for Capital Goods Increase, which cause a general

6. (a) Wage Rate Increase and (b) Capital Goods Price Increase, the first of which causes a general

7. Credit Demand Increase, which causes a general

8. Interest Rate Increase, which, along with 5(b), causes a general

9. Longer Term Investment Decrease back to normal

There is nothing inherently circular about this progressive response to artificial credit expansion. The theory might even be called the Austrian Business Blip Theory (ABBT) were it not for the government's recurrent interventions into the markets for money and credit.

Causal Explanations

1-2. The money supply increase in the present system is in the form of bank money. This bank money is made available as new and additional credit.

2-3. The interest rate is the price of credit. Increases in supply cause decreases in price. Therefore, a general increase in the supply of credit will cause a general decrease in interest rates.

3-4. The lower the interest rate, the more viable are longer term projects funded by investment borrowing.

4-5. Longer term production processes generally require more labor and goods than shorter term production processes.

5-6. Wage rates are the price of labor. Increases in demand cause increases in price. Therefore, a general increase in the demand for labor will cause a general increase in wage rates.

6-7. This is my own either new or independently formulated contribution. I've been avidly reading works and listening to lectures to try to understand the ABCT. It was tough at first, partially because I was trying to foist up price inflation as the dominant element in my understanding of it. It only started making sense when I let that drop and read and listened more carefully; this led me to realize that what the theory was chiefly concerned with was not price inflation but artificial credit expansion and its temporary effect on the interest rate.

Then it all started to click, but still only incompletely. In expositions of the theory, the explanation of the boom phase generally made sense to me, but things would always get muddy concerning how the boom became a bust. Often the explanation would focus on why the bust was, according to capital theory, inevitable, with Hayekian triangles, and Bohm-Bawerkian insights into what the interest rate represents. I in no way doubt the veracity of these analyses, but too often the concrete human motivations and actions that actually embody the turn from boom to bust was left out. Even when those concrete motivations and actions were present, the causal links didn't quite make sense to me. For example, I would often read that workers, after getting their raises in stage 6, would (a.) go out and spend their additional money, and that would bring their savings and consumption back to their normal ratio according to their time preference and that this led to (b.) not enough savings being available to see all the long term projects in stage 4 to their completion. But in everything I've read or listened to, it's never been explained (at least for my understanding) exactly how (a.) leads to (b.). Again, I in no way doubted that it does happen; it seems theoretically necessary. But how?

Then, motivated by the recent post asking for a concise explanation of the ABCT, I started trying to construct the above step-by-step explication. I tried to make it as clear and direct as possible. But, I kept getting stuck at stage 7. I kept asking myself, "what is the bridge from 6 to 8?" Then I thought, "stage 8 is just the opposite of stage 3. Just as an increase in the supply of credit brought about lower interest rates, higher interest rates must come about from either a decrease in the supply of credit or an increase in the demand for credit." Then it finally hit me: the savings-to-consumption ratio is indeed essentially what determines the interest rate, but not immediately so. The concrete human action that embodies the reestablishment of the normal savings--to-consumption ratio is more borrowing. People generally have an income-to-debt ratio they're comfortable with, according to their time preference. If they get a raise, they don't suddenly become more thrifty than before; so they borrow more, generally in proportion to the increase in their wages.

7-8. This increased demand for credit then raises the interest rate, which causes, along with the increased capital goods prices (6b),...

8-9. the long-term projects from stage 4 to no longer be profitable. Boom gives way to bust.

Regarding the 6-7 analysis, I know I could very well be wrong. Or I could be right and silly at the same time, if that was what ABCT scholars were saying all along, and I was just dull to it. In any case, I thought I'd share my thought processes with you, my fellow travelers, who are also trying to teach themselves economics (and political philosophy, history, etc.) as best they can.

I would very much like to hear any comments and corrections you would like to offer.

My Take on the ABCT (Complex Version)

My Take on the ABCT: Objections Considered

Sound Money is the Only Solution

Daniel James Sanchez — Sat, 20 Jun 2009 01:15:00 GMT

Economics is seen by most as a something best left to the experts. But have so much trust when it becomes obvious that "the experts" are completely clueless? Almost every economist was completely by surprise by the development of the economic crisis. And the solutions they are offering don't seem to be working at all. Everybody in the world is worried about their economic future now. The economic experts had promised us a "new economy": one in which jobs would never stop becoming more plentiful and more profitable. We trusted them to make this "new economy" happend. We gave economists like the ones at the Federal Reserve in America and the European Central Bank lots of power to make it happen. They let us down. And now our futures are looking bleak. To save the situation these same economists are asking for more power and more centralized control. For example, many economists want the Internation Monetary Fund to become like a Federal Reserve Bank for the whole world! It is time we stop trusting the experts and started educating ourselves. And yes that means we need to learn economics. That may sound extremely scary. "Doesn't economics involve a lot of numbers and difficult calculations?" Mathematics does help to understand developments. But to understand economic theory math is unnecessary (and even unhelpful).

The times when unemployment is high are called "recessions". Times when unemployment is extremely high for a long period of time are called "depressions." The big question is, "What causes recessions and depressions"? One answer is that they are natural part of the "business cycle", which is itself as natural to capitalist economy as the "carbon cycle" is to natural eco-system. In capitalism, they say, greed and fear create ebb and flow of economic activity. When greed takes the reigns, an "irrational exuberance" spreads throughout society causing a general "over-doing it" known as an economic bubble. When fear take over, there is a panic as everybody runs for the exits In both phenomena, emotion feed on itself and spirals, and market activity is seen as mass psychosis.

That's one explanation. It's supporters point out that the business cycle wasn't seen until around the time of capitalism. But there was another economic development that occured at around the same time: inflationary banking.

Monetary inflation is when more and additional money is introduced into an economy. Banks like to inflate the money supply, because the more money they create, the more they can lend on interest. Bank notes (like dollar bills) and checking accounts used to represent a certain amount of gold in the bank's reserves. Banks are always want to issue money representing more gold than they actually have, because they can collect interest on that extra money. This is very risky practice, though, and if banks who do this aren't protected by the government, they usually end up paying for it big time. Eventually competitor banks and customers realize what the inflating bank is doing and many demand gold at the same time. This is called a bank run, and it was an important part of keeping banks honest. Unfortunately, governments throughout history often did things that let the banks be dishonest. The biggest thing they did was to "suspend specie payment", which means that the government legislated that the banks did not have to give depositors their gold back.

But now things are much different, and much worse. In the early twentieth century bankers lobbied for a central bank/regulator. Bankers even helped write the legislation that ended up passing creating the Federal Reserve System in 1913. The Federal Reserve was given power to "manage" inflation. All the banks had their inflation coordinated, so the competitive checks were no more. In 1933, Franklin D. Roosevelt made an executive order stating the following:

"All persons are hereby required to deliver on or before May 1, 1933, to a Federal Reserve bank or a branch or agency thereof or to any member bank of the Federal Reserve System all gold coin, gold bullion, and gold certificates now owned by them or coming into their ownership on or before April 28, 1933"

Now, without anything real backing the dollar and without any competition among banks, the Fed has complete power to inflate as much as it wants.

When the Fed inflates, it not only makes the banks happy, it pleases the government as well. Inflation makes savers poorer and debtors richer, at the same time. It basically transfers wealth from the first group to the second group. And the federal government is a big-time debtor. If there was 10% more oil tomorrow than today, then oil would become less valuable. The same is true about money. When there is more money chasing the same amount of goods, prices of those goods get bid up. So people's savings diminish in value, because it can now buy less than before. However, price rises (which include wage rates) are good for governments, because it increases tax revenue, while their debt stays the same. So inflation is basically a hidden tax. This weakens democracy, because the people don't realize they're being taxed, and so don't get angry about what the revenue is being used for. Imagine if Bush had to raise taxes in order to go into Iraq. Would that have gone over well? But he didn't have to, because the Federal Reserve was right there ready to print up as much money as he needed.

It is inflation, not mass psychosis, that causes the business cycle. When the money supply increases the first ones to get it are the banks, not average consumers. Because of this, the new extra money sloshing around bids down interest rates before it bids up prices in general. This starts a "boom". The lower interest rates stimulate business activity. Projects that were seen as too ambitious, and too long-term under the older higher interest rates now seem practical. This increase business activity makes a greater demand for producer goods (goods used to make other goods) and labor. This bids up producer goods prices and wages. The increase in wages leads to an increase in consumption spending, which bids up prices of consumption goods. As prices generally rise in this way, people realize that money isn't as abundant as they thought, because the higher number of dollars stuffing their wallets basically buys the same amount of stuff as the older lower amount bought before. Money isn't seen as so "easy-come-easy-go" anymore, so interest rates go back up to their natural level. This is where the boom becomes the bust. All the big ambitious projects that made sense with the artificially low interest rate and all the easy money going around now are revealed to be non-practical. Businesses have to then go through the painful process of scrapping non-viable projects, and redirecting resources to viable ones. This is especially painful to workers who lose their bubble jobs. But it is a necessary process for viable jobs to be created.

Generally the post-bust rebuild is very quick. For example, during World War I, the Fed inflated massively to fund the war. This led to a bubble which burst in 1921. Nobody ever hears about this depression because it was so short. This is probably because the Fed didn't try to fix it. Unfortunately it start to inflating again, causing a massive bubble in the 20s. And unfortunately it did try to "fix" the 1929 bust by inflating the money supply even more. This only kept interest rates artificially low, which postponed the necessary restructuring and led to what is known as the Great Depression.

Now the Fed has pumped up the mother of bubbles, because they inflated so much as to cut interest rates to practically zero in 2001. The bubble has burst, and to try to fix it, the Fed is doing what it did in 1929: inflate even more. Two Fed economists even came out with a recommendation this past week to lower interest rates to negative five percent!

The government cannot be trusted with such an enormous power as complete control over money supply. The Fed needs to be abolished, and we need to allow other currencies once again. This will result in a return to a gold-and-silver standard. Only with sound money can the world avoid losing whole generation to depression, as it did in the 30s and as we might again do in next decade.