Economic laws of conservation

I do not have detailed knowledge of this situation, but I am pretty familiar with what might be called "economic laws of conservation", and the bailout violates several of these.

When some crackpot inventor claims that he has created a perpetual motion machine or similar impossible device, and he has a long, detailed argument as to how and why this machine works, you have two choices:

1) You can spend the next several hours or days of your life going through his argument to see whether it is correct. You are likely to get this wrong, because the errors in a long argument, especially one which fooled the inventor, may be subtle and easy to miss.

2) You can point out that a perpetual motion machine violates fundamental physical principles. One example I've seen is a machine which violates the law of conservation of momentum. The inventor claimed that his machine managed to accelerate without pushing back on anything or throwing anything back, which is a straightforward violation of the law of conservation of momentum. Another law which is likely violated by any perpetual motion machine is the law of entropy, the second law of thermodynamics.

One of the economic broad principles that I am familiar with is that, while the market can be wrong, you (whoever you are) are almost certainly unable reliably to do better than the market. Claims that the government will probably recoup its investment and even profit violate this principle.

Another of the economic broad principles that I am familiar with is that the market works by no other means than rewarding wise investment and punishing foolish investment. That is how it works. A more general broad principle, upon which this relies, is that you get more of what you reward. The bailout violates this principle as well. Miron appeals to this principle when he writes:

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

One can go on.

Miron, and other economists who have spoken out against the bailout, have tended to make arguments that I find comprehensible and persuasive, because they appeal to broad economic principles that I am familiar with and have long since accepted. Those who have spoken out in favor of the bailout - well, for one thing, rather than see actual arguments from them I have seen appeals to authority, appeals to hidden knowledge, sky-is-falling warnings that have no actual content but serve merely to shift the reader into panic mode, vehement attacks on those who disagree, and the like. I've seen glimpses, here and there, amidst the ocean of invalid argumentation, of something that looks like an actual argument, but what I have seen has displayed that narrow focus, that missing-the-forest-for-the-trees aspect, which I remember from arguments of the inventors of perpetual motion machines.

Good economics since Bastiat has been largely about noticing "that which is unseen" - i.e., noticing the forest while the rest of the world obsesses over the trees. The arguments against the bailout have that look to them. The arguments for, the ones that I have seen, do not.

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Markets are subject to crowd

Markets are subject to crowd psychology. Irrational mass panic may infest a market and cause short-sighted damage (such as pushing firms into bankruptcy that are perfectly viable in non-panic conditions). This panic might be recognized by an outside actor with no financial interest in the market. Such an outside actor would be uniquely positioned to stop a panic or mitigate the damage it does by taking certain corrective actions. The cost to society of the corrective actions may be less than the damage done by an uncorrected panic.

I believe this is the Keynesian case for a bailout. I think it's flawed, but it's not obviously wrong at first glance.

(such as pushing firms into

(such as pushing firms into bankruptcy that are perfectly viable in non-panic conditions)

How does a low stock price prevent you from paying the interest on your debt ? A company becomes bankrupt when it cannot meet its obligation. The fact that the stock is down means people are less likely to issue new loans to the company, but if the company needs new loan to pay the interest on its old loan, it's not in a great shape anyway, regardless of "market psychology".

Lenders have the discretion

Lenders have the discretion to pull the credit lines that financial institutions use to fund their day-to-day operations. If a lender is the first to pull its line, it will probably get paid back. However, if it is the last, then it will probably not get paid back. This makes lenders very skittish and apt to bolt at the first sign of weakness. Many firms have been forced into bankruptcy because of lender psychology even though their cashflow from operation was more than enough to service their debt and pay their operating expenses. Government intervention is aimed at soothing lenders and preventing this kind of mass psychology from sinking profitable firms.

And this can't be done privately?

Government intervention is aimed at soothing lenders and preventing this kind of mass psychology from sinking profitable firms.

The lenders will themselves be among the ones hardest hit by their own skittishness. You don't think they can genuinely work something out ahead of time with the business to stave off this risk and thereby benefit themselves? If they are not doing it already, it is presumably because they are relying on government to step in - and not because there is a fundamental need for government to step in. And this brings us right back to some of the explanations that have been given of the current crisis, namely, that people were relying on government to bail them out.

And if government bails them out, then this will only encourage dependency on future government bailouts, producing an even worse crisis down the road.

The lenders will themselves

The lenders will themselves be among the ones hardest hit by their own skittishness.

The LAST lender to pull out will be hurt by his complacency. The FIRST lender to pull out benefits from his skittishness. Thus, skittishness is incentivized.

In the absence of government regulation and anti-trust laws, it might be possible for lenders to organize large cartels to coordinate their actions as they did in financial panics before the Great Depression. However, the banking industry has grown without the incentive to address this need for at least eight decades. GIVEN the current state of the world, a case can be made that government intervention can do more good than harm.

I am assuming that

Thus, skittishness is incentivized.

I am not denying this, I am accepting it, agreeing with it, and assuming it in my response. I am disagreeing with this:

The LAST lender to pull out will be hurt by his complacency. The FIRST lender to pull out benefits from his skittishness.

That is true at the moment of pull-out, but that is not the context of my statement that the lenders are all hurt. I am talking about the lenders as they stand initially. Initially, the lenders do not know who will pull out, so initially they have the possibility that they will be the last to pull out. From their point of view, subjectively, this uncertainty is a bad thing. So they are motivated to work something out ahead of time.

GIVEN the current state of the world, a case can be made that government intervention can do more good than harm.

A case can be made if we ignore the forest - the same sort of the case as the case that can be made that breaking windows can improve the economy. The tree is that this particular business and these particular investors are saved. The forest is that the very dependency that produced this mess - and everyone agrees it is a mess - is encouraged.

If it's only petty day to

If it's only petty day to day cash we're talking about, wouldn't it be better for the firm to finance itself ? For an epsilon loss in profit, you protect shareholders from the threat of panic induced bankruptcy?

If you can lend at 6%, then

If you can lend at 6%, then your gross return on capital is 6%. After you take out your operating expenses, that will be much smaller and probably negative.

If you borrow at 5% and lend at 6% and can borrow up to 95% of the amount you lend, then you earn (6-5)*19 + 6 = 21% on your capital, minus operating expenses. Now we're talking about a viable firm.

The problem comes when the people you have borrowed from ask for their money back. You've already lent it out. Ordinarily you could just sell the loans you've made on the open market and use the proceeds to pay your lenders, but right now there is no market. Any bid on loans right now is far less than full price (say $0.50 on the dollar). The result is bankruptcy, even though the firm would have been able to pay its debt and operating expenses had the lenders not asked for their money back.

Looks like an example

This looks a bit like the arguments of the perpetual motion machine inventors. This little ball will be flung in that direction, will be caught by that arm there, be brought around, and so we take this force and this force and this force and we add them up and look:

(6-5)*19 + 6 = 21 > 0

they don't add up to zero. So the machine achieves acceleration. Works even better littered with jargon.

Not saying you've said anything wrong or misleading here. Just saying, this sort of low level argument can easily support arguments that miss the forest for the trees and at the same time be nearly impossible for any reader to untangle in reasonable time.

This is insane:

If you borrow at 5% and lend at 6% and can borrow up to 95% of the amount you lend, then you earn (6-5)*19 + 6 = 21% on your capital, minus operating expenses. Now we're talking about a viable firm.

I'd call that a lot of things, but "viable" is not one of them. That exposes you to tremendous risk. I'm supposed to bail you out if that "business plan" goes south? Forget it!

I'd call that a lot of

I'd call that a lot of things, but "viable" is not one of them. That exposes you to tremendous risk. I'm supposed to bail you out if that "business plan" goes south? Forget it!

Congratulations, you've just rejected all of modern finance. I'm afraid I can only let you do so if you provide a reasonable alternative.

I should note that there is a second class of financial insolvency. Using the example above, some financial firms earned much less than the expected 6% on their assets because of excessive defaults. If this yield gets too close to their cost of borrowing (in this case 5%), then the firm will be unable to meet its operating expenses. If the yield dips below 5%, then the gross return will be negative and someone somewhere will make a joke about how the losses are okay because the firm will make it up on volume.

I'm not sure which kind of insolvency is more of a problem right now. A case could be made that the government ought to address the first kind of insolvency (pure investor skittishness) and not the second ("true" insolvency, assets yielding less than debt cost).

As far as the "perpetual motion machine" goes, you can only stretch an analogy so far before it breaks.

Modern finance must be scrapped

Congratulations, you've just rejected all of modern finance.

All I the taxpayer have done is refused to bail you the financier out. Under "modern finance" you get to make obscene profits by seriously exposing yourself to market fluctuations, and then when one of those fluctuations finally occurs I am supposed to bail you out.

People get low interest when they are safe to lend to. The only thing that makes you "safe" to lend to (and therefore deserving of a 5% interest rate while you charge the people you lend to 6%) is a safety net provided by me the taxpayer, who will bail you out. So in effect I'm paying for the safety which you are profiting from. This is modern finance? Well then, modern finance is a massive involuntary wealth transfer from taxpayers to financiers. It is not as though I am even one of your customers.

Surely banking can exist without the obscene profits that you describe. The market will adjust. The market does adjust when the interest rates change. The economy doesn't suddenly stop working when interest rates go up. You the financier may not be able to make obscene profits by relending other people's money once your taxpayer-funded safety net is taken away and you are forced to make hard choices, but I simply do not buy your claim that these obscene profits are necessary to pay for the unavoidable overhead.

The idea that a business must do X, Y and Z in order to stay in business is relative to the state of the market. In the context of a market in which your competitor bankers can sustain their own businesses by borrowing at 5% and lending at 6%, then the only viable business model may be what you describe. But what I am envisioning is an across-the-board refusal to bail out the banks. In that case the market should adjust on all sides until some new equilibrium is reached that makes banking possible, because all your competitors will be in the same boat. In a market, prices all around adjust to a point where business is sustainable. Even banking.

Example: suppose you are a gas station and you now must pay double for gasoline. This would be disastrous if you kept charging the customer the same amount. And if none of your competitors had to pay that same new high price then you would be driven out of business since none of your customers would be willing to pay more than they can pay elsewhere. But of course, your competitors all have to pay double as well. The market adjusts, you are able to charge a new higher price and thus sustain your business. In a similar way, I would expect the banking industry to adjust to an across-the-board change, allowing many banks to remain in business, operating under a new business model.

So I don't really see the problem. You challenged me to provide an alternative to modern finance, but I don't see why finance would not adjust to a new situation, one without the safety net. Of course I can't describe exactly how it would adjust. But why must I give a description in order to be confident that an adjustment is possible? I see businesses all around me adjusting to economic changes. Some fail, new ones replace the failures. Why must I describe how businesses would change in order to be confident that they would adjust and that banking would not simply disappear off the face of the Earth without a government bailout?

(It is the reliance of this business model on taxpayer-funded bailouts that spurs me to call these profits obscene. I don't consider an honest profit to be obscene even if it's a thousandfold return on investment.)

This needs to be a main page

This needs to be a main page post as well. Make one, and I'll frontpage it. You've been on a roll lately, Constant.

It's a mess

I don't know. This one is a bit of a mess, I think. I'll think about it.

Blog posts don't need to be

Blog posts don't need to be scholarly theses. Yours had much value added, and that is what is most important for blogging. When you cross over to the other side of the quality versus quantity divide, there are many people who will be sure to let you know. Trust me. :p

The only thing that makes

The only thing that makes you "safe" to lend to (and therefore deserving of a 5% interest rate while you charge the people you lend to 6%) is a safety net provided by me the taxpayer, who will bail you out.

No, the business model is sound providing a once-in-a-hundred year event doesn't occur. It is "safe" because it is, well, safe 99 years out of a hundred. These unusual events, famously dubbed "black swans" by Nassim Taleb, occur so infrequently that it is impossible for anybody to predict when they will occur. The sample size is too small.

Predictably unpredictable events are handled very well by probability theory and modern risk management. Black swans are unpredictably unpredictable events, and risk management fails.

A market so skittish that it prices a group of performing loans at $0 is a black swan. Banks do carry reserves in case the market turns against them, but no bank is ready for the market price of their assets to fall near $0 just as lenders pull their credit lines.

No investor has a long enough time horizon to reserve for a once in a hundred year event. If a company's management team held a large amount of cash in treasury bills in anticipation of a Black Swan, its investors would be up in arms by the time a few decades pass since the last big crisis. The market will not adjust to handle the risk of black swans.

As an example, suppose that in a 100 year period, the financial markets behave normally for 99. Then there is a huge crisis for 1 year. There are two business models that firms can follow: 1) the Modern Business Model which generates a lot of value in the 99 years of calm but will fail in the 1 year of shitstorm or 2) the Conservative Business Model which is prepared for Armageddon but will generate far less value in the other 99 years. Investors and the economy are all better off if firms choose the Modern Business Model and the government helps them through Armageddon.

The firms going out of business provide valuable services to the economy. They are going out of business because of a temporary dose of panic and mob psychology. Many of the failed firms would be viable during any time when the market was not suffering from such "animal spirits". Value will be destroyed when these viable firms fail and their services are eventually replaced once the markets return to normal. More value destruction and suffering will occur if the panic spreads and leads to a second Great Depression, which as you'll recall was precipitated by the widespread failure of financial firms. To the extent that government intervention ameliorates the negative effects of mob psychology and prevents a Great Depression, it saves more value than it destroys.

Constant, you make a very good statement of the case AGAINST the Keynesian viewpoint. However, it is widely viewed as too abstract, impractical, long-term, and idealistic. To converse about the crisis with people across the political spectrum, it is necessary to understand both accounts. I find truth in both of them, though when it comes to political policy I am squarely aligned with the laissez-fare crowd.

The public good of depression prevention

Let's see if I got this straight. Market hiccups of this nasty type are so rare that businesses will behave essentially as if they never occur. So businesses will follow the Modern Business Model despite the fact that this Model blows up once a century or so. They will do this regardless of whether government does or does not follow the advice of the Keynesians. Furthermore, even if the government does not follow the advice of the Keynesians, the overall damage will be limited because the hiccup is so rare. The policy recommended by Keynesians, moreover, does not kick in 99 years out of 100. It is strictly a rainy-day policy. And it has essentially no effect on the behavior of businesses for those other 99 years for the same reason that the once-in-a-century market hiccups have no effect.

Moreover, the picture of the crisis that you are painting is of a hiccup, a kind of temporary insanity, which has no deeper roots than that. This is in contrast to, say, the Austrian picture which sees economic crises as caused by, and as corrections of, an accumulation of errors in the years previous. In this alternative picture, preventing the correction exacerbates the underlying problem. In the Keynesian picture, preventing the hiccup does no lasting damage because the hiccup was not a symptom of an underlying problem. You said nothing about the underlying problems, did not so much as nod in the directin of this aspect, from which I infer that the Keynesian picture that you're describing does not take it into account and possibly even denies it, treating the financial crisis as a mere confluence of momentary insanity.

You mention the Great Depression, apparently as an example of government stepping in to save the free market from itself, but what I know about it is that the Depression was caused by government and exacerbated by government. The finance sector failure is, in the case of the Great Depression, the canary in the coalmine, the first indicator that something is wrong, rather than the ultimate cause. The financial sector is frequently the canary in the coalmine and is frequently also the scapegoat for government misdeeds. For example, I recall that it was common in Latin America to blame "speculators" for ruinous inflation of the currency, when in fact ruinous inflation was ultimately caused by government in essence printing fiat money with abandon. Speculators have a habit of anticipating and adjusting, which makes them easy targets. After all, if you say that tomorrow so-and-so will be assassinated (say), and then tomorrow so-and-so is assassinated, then you're now the primary suspect. A similar thing happened with oil. I recall speculators being blamed for the high price of oil, but all they're really guilty of is anticipating a rise in the price of oil and, by acting on this anticipation, adjusting the price earlier rather than later.

Finally I'll mention that you have not explained why the government is necessary. I see two possible keys to the government's role in this:

1) Government commands the fiat currency supply.

or

2) Government has deep pockets into which it can reach because of its capacity to raise taxes.

Both of these rely on the government's ability essentially to take people's wealth by force. So the picture I am forming is of an institution that is supposed to smooth over economic crises by seizing wealth by force and using the seized wealth to bail out the financiers. The question immediately arises: is a coercive solution really the best solution? I recall that whenever government is supposedly necessary, the role that it plays is essentially to solve a public goods problem. The Keynesian idea, then, seems to be that the prevention of an economic disaster is a public good - by which is meant a good that will probably be under-provided by rationally self-interested participants because of a large externality. Well, maybe, but you haven't, as far as I can see, actually argued that it is one. Yet. Furthermore, if indeed this is a public good, then the behavior that contributes to, rather than resolves, the crisis, should not be called "irrational". Rather, this is perfectly rational behavior which leads tragically to disaster because of the public goods problem.

Is the trackback dead?

This is a complete aside. Maybe I'm just not looking in the right places. It seems to me, though, that nobody uses trackbacks any more. True? False? According to Wikipedia:

Many blogs have stopped using trackbacks because dealing with spam became too much of a burden.

which seems to confirm my impression.

As far as I can tell, yes.

As far as I can tell, yes.

I think you can distill a

I think you can distill a few viewpoints from this:

1)The crisis is caused by irrational market psychology and is not symptomatic of a deeper underlying problem. However, this psychology may cause a large amount of harm and the government should do something to stop it.

2)The crisis is symptomatic of deep underlying problems in the marketplace. The market must be allowed to adjust to address those problems for it to continue functioning properly in the future.

3)The crisis is symptomatic of deep underlying problems in the marketplace. However, allowing the market to adjust to correct those problems on its own causes too much harm and creates the risk of a large depression. The government should try to limit the duration of the crisis while trying not to create too much moral hazard.

I mostly agree with (2) with a sprinkling of (1). However, if you don't give lip service to (3) than most people will look at you like you're crazy - "libertarians say its okay if we have another Great Depression".

I don't think we'll see anything as bad as the Great Depression again, at least not by the same mechanisms. We understand the monetary and policy actions that exacerbated it enough to not make the same mistakes.

One last note: it is interesting that the government is trying to prevent moral hazard by allowing equity holders to go to hell, but bailing out debt holders. In the future, this will make holding equity MORE risky and holding debt LESS risky, so firms will become even more leveraged than they are now, ceteris paribus. This should increase firms' vulnerability.

Kudos to Jacob

It's a dozen against one and you've held your own. I think you should post this as a new post as a summary of positions followed by your own take. I'll frontpage it.

Two against three

There may be a dozen anti-Keynesian ghosts haunting the blog, but for the record the actual participants under this entry have (if I've understood their comments) been Arthur B, myself, and Brian Macker on one side of the issue and Jacob and Dave on the other side - Jacob as a devil's advocate urging greater comprehension of the argument rather than an entirely loyal follower of the devil himself Keynes.

We'll see. Grad school and

We'll see. Grad school and girlfriends have the nasty habit of demanding my time.

And I don't quite feel comfortable calling my position "Keynesian". It certainly does draw on Keynes' insight that market prices are subject to crowd psychology. However, my argument also borrows bits and pieces from public intellectuals and other sources that mesh with the overall framework. It also contains my own extended improvisation. I'm sure a PHD with a specialization in Keynes would take issue with at least some of what I said.

Blah blah. Get your hands

Blah blah. Get your hands out of my pocket.

By the way, you are completely misrepresenting Taleb ideas, which are about the impact of the unpredictable, not the unpredictability itself. Using his ideas to defend a business model he condemns is, to say the least, misguided.

Way to converse

Blah blah. Get your hands out of my pocket.

Heh. Way to converse about the crisis with people across the political spectrum.

a) I'm confident enough

a) I'm confident enough about my knowledge of banking and finance to say "blah blah". If I'm attacked as dismissing argument I'll find time to answer them :)

b) At some point when you discuss immoral things, it's good to step back. I think a what-if discussion is pointless if it does not bring a recommendation. If one side of the issue is immoral, it cannot be recommended, making the discussion a bit of a waste of time.

c) The Taleb plug was too enormous for me to take the message seriously.

You're describing a bank

You're describing a bank which is a very specific kind of business.

Are we talking about panic induced bankruptcy or run on the banks ?

A bank

You're describing a bank

He seems to be describing a bank which has overextended itself, failing to protect itself and its lenders from unexpected market changes. Isn't one of the main businesses of finance the management of risk? And yet here it is handing off that responsibility to the taxpayer. Not only that, he goes on to describe loans whose market value is fifty cents on the dollar. Sounds like a bad business decision to me. And the market simply does not work, cannot work, if bad business decisions are not punished.

I simply cannot buy the argument that the financial industry is not able to manage risk. What I see is that, in fact, the government has taken over the responsibility to protect against failure, and naturally enough, the industry has allowed the government to do so (just as I would happily cash any check the government sent me) and has developed a business model that depends on it.

Trade Offs

In a nutshell you have shown the case for no regulation or government protection of the financial system. However the reason I am not down at my local bank standing in line right now instead of reading this is because of the FDIC. In reality purism sucks.
Dave

The reason you're not

The reason you're not standing in line is I'll be paying for you, regardless of the care you used in picking a bank.

So how much shit would you like in your soup ? Surely not 0, I gather you're not a purist.

Let Them Eat Words

Here is a paper from the IMF. I don’t know if you would consider this an appeal to authority or an appeal to data or if you think an appeal to ideology will suffice.This is an IMF study of 42 banking crises

Conclusions:

Policy responses to financial crises normally depend on the nature of the crises and some unsettled issues remain.
---in crisis characterized by liquidity and solvency problems, the central bank should stand ready to provide liquidity support to illiquid banks ---though such accommodative policies tend to be very costly and need not necessarily speed up economic recovery. All too often, intervention is delayed because regulatory capital forbearance and liquidity support are used for too long to deal with insolvent financial institutions in the hope that they will recover, ultimately increasing the stress on the financial system and the real economy."


http://www.imf.org/external/pubs/ft/wp/2008/wp08224.pdf

Dave

The conclusions says that -

The conclusions says that
- It's very costly
- It's does not necessarily speed up economic recovery
- Injecting liquidity to support bank on the hope they'll recover is bad

I must say I am surprised that a quasi world government entity tied to all the central banks in the world would produce such a balanced conclusion.

FDIC Insurance

"However the reason I am not down at my local bank standing in line right now instead of reading this is because of the FDIC. In reality purism sucks."

Yeah and the reason I'm not down there is because I'm holding all my savings in precious metals. Well, except my 401K which I'd have withdrawn six years ago if it weren't for the penalties.

Luckily, IRAs allow you to hold bullion and that is what I did, half a decade ago.

My response to you is what Arthur said plus the FDIC insurance kicking in is highly inflationary. It reifies the money supply increase caused by fractional reserve banking.

You put in $100 short term and the bank lends it out to someone long term, while still promising your money back. That's $100 cash pumped immediately into the economy while you still think you have yours on demand. When the bank fails and the government steps in to immediately return your $100 in cash the original $100 cash doesn't evaporate. You've just doubled the base money supply.

You then, what, stuff it in your mattress? Not with fiat currency, and FDIC insurance. No, you deposit it, and the new bank lends it out again.

What about the original value of the bank "assets" and isn't the debtor going to pay that money back extracting it from the economy? Well, no, the underlying asset was most likely they were overpriced during the inflationary bubble. The debtor if smart will walk away, or already had leading to the trouble in the first place. Even if every cent is eventually recovered it is at a much later date and the inflation caused by the FDIC insurance is in the present. Nor is the money paid back ever really withdrawn from the system as it will be shore up the cash reserves of the bank and be lent out again.

Besides, the FDIC is in trouble. Its assets are quickly being gobbled up by all the bank failures. Last I heard a dozen more bank failures and they will be insolvent and begging from the government just like Fanny and Freddie.

You see FDIC “insurance” is not really true insurance. If it were the rates they charge would skyrocket with increased global bank leverage, and increases in the money supply from other sources. It doesn't. It's just another scam on the taxpayer. Something designed to make people more willing to watch their savings gambled in an orgy of consumption.

These automated mechanisms, there are others, for inflating the money supply are going to ruin the dollar, and then all the foreign cash is going to wash in. Meanwhile since we have consumed our savings we have much less captial goods with which to produce consumer goods. We have plenty of long term consumer goods like housing, but the short term goods are going to be bid up by everyone.

Less short term consumer goods, more money, equals inflation. Heavy duty inflation. This time we won't be able to refinance your house to make up the difference, we've consumed that capital already.

Monetary inflation coordinates everyone’s errors to occur together. Likewise, Social Security, if people actually believed in it, would also. Just wait till the baby boomers start trying to retire.

What a government mess.

Gold Buggery Not the Answer

Yeah and the reason I'm not down there is because I'm holding all my savings in precious metals.

I don’t claim to understand monitism, but gold buggery isn’t the way to national or personal wealth. Companies have to have capital flowing into various projects in the form of borrowed funds. Consumer borrowing for immediate consumption is a disgrace, so I think we agree on that, but it does support the massive consumer economy which is the engine that was chugging along for many years. If you make money on gold, good for you, but remember gold peaked at around $900 per oz. in the late 70’s and them began a long sickening decline that lasted for almost 30 years. There were temporary rallies in times of trouble. Gold prices will always spike in times of crisis, but economic sectors rotate over time in ways that defy prediction. The idea that government will just sit idly by is not realistic, rightly or wrongly.
When this illiquidity trickles down to Main Street and there is mass unemployment and small businesses begin closing all hell will break loose.

Dave

It's not gold buggery

Dave,

It's not gold buggery because I did it in response to economic conditions which were obvious. It was obvious the Fed was inflating and it was obvious that precious metals were going to go up. This isn't about "Gold spiking in times of crisis" and is about monetary inflation.

In fact, to show how little you understand about the why's of my thinking, I expect gold to drop short term if there is a financial crash. That's because I think a portion of the gold price increase is due to the general leveraging increasing the quantity of money. When money tightens it does so on gold too.

Besides it's sliver and only a portion of my savings.

"The idea that government will just sit idly by is not realistic, rightly or wrongly."

Huh? What are you talking about. I told you that I am betting heavy the government will continue inflating, and screw things up worse. They are going to throw gas on the fire, because they actually think like you. Does that surprise you?

Not only that I know that the actual cause of the crisis is NOT market irrationality but in fact government price controls over interest rates. They interfered with the market signals that are transmitted via prices and the expected results occured. Perfectly predicted by the theory. All the effects we are seeing today are predicted directly by government inflating the money supply by setting interest rates too low.

"Consumer borrowing for immediate consumption is a disgrace, so I think we agree on that, but it does support the massive consumer economy which is the engine that was chugging along for many years."

The Soviet Union chugged along for a great many years too. Economies that are mostly free can sustain plenty of damage, by why inflict the damage? Why do it when it runs perfectly fine without ANY intervention.

BTW, it's funny that you think it's consumer spending that supported the massive consumer economy. It's like if we want something we just print money and get it.

We'd have a massive consumer economy without fiat money or fractional reserve. It's the amount of capital that matters far more, and for that one doesn't need a fiat currency, central bank, or fractional reserve system.

"When this illiquidity trickles down to Main Street and there is mass unemployment and small businesses begin closing all hell will break loose."

Hoover injected masssive amounts of liquidity and it didn't stop the problem either. As I wrote in the other comment the problem isn't about what you think it is about. It's about the government trying to run a command economy and the commissars setting the price of interest too low in their five year plans. Lowering the prices again by 'injecting liquidity' is just more of the same. It will only push markets even further in the wrong direction, less saving and more consumption (of capital).

Have pics?

I'm intrigued and a little bit excited. Do you have pictures of "gold buggery"?

Constant wins the thread.

Constant wins the thread.

Going for the Gold

Did you see the episode on
South Park where Satan and Saddam....

For Brian --- I don't entirely disagree with you. There are two things here. The immediate problem is liquidity,which most economists think the bailout will possibly help.This will not prevent a large resession which will be fought be reflating the ecomomy with massive deficit spending,so long term we will all be getting it like Saddam .

Dave

Rumors

PS ,Constant,I have also heard rumors that there might be some of this on the Squarepant Spongebob Show.
Dave

Looks like speculation

How do we know that the "outside actor" will do better? What confidence to we have in this? Does the government in fact have "no financial interest"? Is not the government, in fact, infested with politicians who are daily bribed by lobbyists?

This argument is speculative, suppositional. We suppose that maybe, possibly, the market is being dominated by irrational mass panic. We suppose that it is somehow possible that firms are fundamentally viable but that nobody who has any financial interest has an incentive to invest. Which doesn't really make sense - surely those with financial interest are the most likely to seek out firms that are fundamentally viable but that have been grossly undervalued by the market.

And it's all supposition. Maybe, possibly, something like this might be happening. Maybe the firm is viable even though the market doesn't think it is. Or - maybe not. Maybe the commentator who thinks he's managing to outguess the market is fooling himself about the superiority of his own wisdom. In contrast, there are general principles such as that we get more of what we reward. I'll go with the latter.

Notice the words you use:

Irrational mass panic may infest

This panic might be recognized

Such an outside actor would be uniquely positioned to stop

The cost to society of the corrective actions may be less

A lot of "may" and "might", and a "uniquely positioned to" (do something good) as opposed to a statement that it will actually (or probably) do something good.

Situation A Case for Marxism

"I believe this is the Keynesian case for a bailout."

Which leads me to ask why you don't also think this is a case for a move to full blown Marxism.

"I think it's flawed, but it's not obviously wrong at first glance."

Other people are invoking Marx. This shows that Marx isn't wrong at first glace. So why not you? Certainly at first glace?

In fact this is a case for both Keynesiansim and Marxism at first glace, with little economic acumen surely.

What has happened is a classic government set ceiling below market price, on the time cost of money, interest, which is a price like any else. Price ceilings cause producers to produce less, less savings, and consumers to consume more, more borrowing and leverage.

The signs were all there of the distortion over the past twelve years. Low savings rate, incredible leverage, increase in money supply, trade deficit, increased commodities prices, stock bubbles, housing bubbles, consumption of capital, etc.

Problem is that the wrong economists were believed by Greenspan and his ilk. That you speak of Keynes as if he had even the inkling of a plausible hypothesis, let alone a theory, shows just how uninformed people actually are. Keynes was a buffoon of an economist on the level of both Karl and Groucho.

The Fed screwed up big time in targeting price stability in a deflationary environment of newly opening markets, of fudging the actual inflation numbers, of foreign banks increasing holdings of both currency and treasury bills, etc. This and the desire to bail out every correction, instead of letting them correct, has lead to one of largest monetary inflations in history. All based on a price ceiling below market prices.

Then you think the solution to the problem is to do a Keynesian bailout? This is precisely a lowering of the interest rate further from market prices. The market is trying very hard to raise interest rates, so the market interest price is going UP, not down. Interest rates need to go up, not down, to realign with what the free market commands.

Yet your solution is not even to keep the current ceiling level but to lower it even further? This will only distort the markets further. We will consume even more of our capital and we will be even poorer in the future for it.

This correction has to be allowed to happen in order to get back to a healthy economy.

Financially I have bet heavily that the government will NOT do the right thing. They will inflate. So I'll cheer you on while at the same time I admonish you. I have no doubt that my voice will be a whisper in a hurricane, and when all this is done free markets will be again blamed for the actions of a government controlled economy.

Damn you Alan Greenspan. Damn you Ben Bernanke. Damn you Franklin Raines, Maxine Waters, Gregory Meeks, Lacy Clay, Arthur Davis, Barney Frank, Obama, Clinton, etc. Damn Bush for being the economic idiot he is. Damn all the Long Island representatives, who to a one supported the current bailout, and anyone else behind this bailout.

Keynes was a buffoon of an

Keynes was a buffoon of an economist on the level of both Karl and Groucho.

You're not going to convince many people of your point of view if you go around saying that. There is a reason that most economists consider Keynes to be the most important economist of the 20th century, and it's not because they are dumb or leftist. Much of modern economics is derived from his ideas, including several branches that have won the Nobel prize. If you read The General Theory, you get a foreshadowing of fields like behavioral economics and the theory of assymetric information, and this was written in the 1930s. He was an iconoclast that deeply understood the predominant theories of his day and rejected them, which made him much more influential than just another Iconoclast.

The adjective most commonly used to describe Keynes in circles not populated by followers of Mises or Rand is "brilliant".

A boffo economist

Clearly what Brian meant to say was that Keynes was a boffo economist. He compared him to Karl Popper (whom he admires tremendously) and to Groucho, surely one of the great comedians of our time, who has left an indelible mark on cinema, novelty glasses, elephant pajama jokes, a sidewalk tile outside the Chinese Theater along Hollywood Boulevard, and Cerebus.

I stand corrected. And

I stand corrected.

And what's with Austrians and Randians rejecting the foremost thinkers of our time? They hate Karl Popper, too.

Have you actually read this

Have you actually read this book ? It's a mess. While Keynes himself was a very intelligent man, his ideas on macroeconomics remained extremely confused and he never held them for very long. I suggest you read the General Theory and then its criticism by Hazlitz.

Keynes is NOT the solution, he's the problem.

"You're not going to convince many people of your point of view if you go around saying that."

I guess by that, you mean, I'm not going to convince you.

Well actually it is already generally accepted that most of Keynes theories are wrong. Stagflation put the nail in that coffin. That is if you believe in applying empiricism to economics. Besides, as I said, Hoover pumped in liquidity and it did not work. Seems Keynes had empirical data to disprove his theories even before he made them.

I've convinced quite a few people of what I was saying about the Fed. Holding interest rates below market values has the same bad effects one would expect of any price ceiling. The smarter ones, and I work with smart people, understood it in under a fifteen minutes.

Keynes' theories are ridiculous on face value and with reflection.

"There is a reason that most economists consider Keynes to be the most important economist of the 20th century, and it's not because they are dumb or leftist."

I consider him to be one of the most important economists of the 20th Century also, and that's a bad thing.

I haven't talked with any economists that will admit to actually believing his theories. Do you believe that throwing money out of helicopters is a good thing?

Besides, why do you think I respect "most economists". Most economists thought that Greenspan was a genius, while those in the know thought he was a fool all along. "New Economy", ha, ha. The theories of "most economists" got us in this mess.

"Much of modern economics is derived from his ideas, including several branches that have won the Nobel prize."

Yes, and Yasser Arafat won the noble prize too. Along with several economic theorists with contradictory theories, including ones who contradict Keynes. It's not a mark of correctness.

BTW, how has running the economy based on these theories been working for you lately?

"If you read The General Theory, you get a foreshadowing of fields like behavioral economics and the theory of assymetric information, and this was written in the 1930s."

Sorry, I'm not impressed. Making observatons that everyone can see with their own eyes shouldn't impress you either. Nor should what other people read back into others writings. Otherwise, Nostradamus becomes credible.

Does Lamarck in your eyes get credit for "foreshadowing" theories that he never explicated just because he was trying to explain evolution? Did he forshadow Darwin or just fail? I say he failed. He failed because his ideas didn't even amount to a credible hypothesis. They had no plausible mechanism by which they could work. Neither does Keynes.

What should really scare you about Keynes is his actual theory, not what he "foreshadowed". Henry Hazlett did a superb job of desecting his actual theory and I suggest you read "The Failure of the 'New Economics': An Analysis of the Keynesian Fallacies." for a full criticism on his foolish theories. Keynes is to economics as Lamarkism is to biology.

If Keynes is right then we should legalize counterfeiting during monetary contractions. Like now.

There is no important difference between counterfieters printing up their own money and people on the ground scooping up piles of cash thrown out of helicopters. Who spotted the helicopter first and claimed the pile is just as random a choice of who to reward. In fact, if anything the counterfieters actually deserve the money more because they actually went to the effort of printing it.

Computer models may shed light on topic

A propos to this discussion: Computer models reveal systemic reasons to conclude that a “free market” can become unstable, and why modest regulation can produce better results. But philosophical purists among the economists resist giving credence to such models.

Computer models have a

a) Computer models have a history of being horribly bad at making any realistic economic simulation. Agent models like these are definitely better than the big statistical macro models but a far cry from anything realistic.
b) This model assumes actors increase leverage. Does it affect the interest rate as it would in a free market, or is the interest rate independently set?
c) I don't think anyone said the free market was "stable". What does "stable" mean? Volatility?
d)This article is much more of a rant against "ideological free marketeers" than a scientific paper.

Model the government

Apart from what Arther wrote, two points.

1) Unless the computer model models the government, then it cannot be taken seriously as a comparison of the two alternatives, free market versus government regulation. For instance, does the computer model model an ideally optimal regulation, or does it model a more realistic crap sandwich regulation? Does it model the process by which the crap sandwich regulation is captured by the industry which it is supposed to regulate, and used for ends which had nothing to do with its original purpose, such as to raise barriers to entry so that certain companies can enjoy monopoly profits? Does it model the process by which the regulation is opportunistically turned to a political end such as providing loans to people who have no chance of repaying the loans? Does it model the process by which this eventually leads to an economic crisis of unprecedented proportions? Does it model the process by which legislators respond to the crisis by introducing an even bigger crap sandwich?

I'm guessing it doesn't.

2) The word "can". A free market "can" become unstable. Modest regulation "can" produce better results.

Yeah, I don't really doubt it. But being a chain smoker can save your life (any modestly gifted storyteller think up a plausible scenario). Following the best nutritional advice can kill you.

Computer models reveal

Computer models reveal systemic reasons to conclude that a “free market” can become unstable, and why modest regulation can produce better results.

I'm undecided (and skeptical) regarding the propriety and wisdom of using computer simulations to model something as complex as macroeconomic phenomenon on a scale as large as the U.S., but I do know that the two examples the author used in that article could in no way be described as a "free market."

Obviously, credit can be a good thing as it aids all kinds of creative economic activity, from building houses to starting businesses. But too much easy credit can be dangerous.

Since when is the supply of money (and interest rates) determined by a free market? Don Boudreaux pointed out this fallacy a week and a half ago:

Suppose Uncle Sam were the monopoly supplier of steel in the same way that he is the monopoly supplier of money. A (largely) independent board of Very Smart People meets monthly to determine the nation's steel supply. If this board gets matters correct, the resulting price of steel prompts producers and consumers to use steel wisely. But if the board guesses wrongly and, say, increases the steel supply too much, the market will overuse steel. Products that would have been better made with aluminum or plastic, or not made at all, will instead be made with steel. And production plans made in anticipation of a continuing 'easy steel' policy will be disrupted if the board changes course.

Unless this steel board gets things right with superhuman regularity, the structure of the economy will be become grossly distorted over time. In addition, producers and investors will be forever anxious about upcoming decisions of the steel board.

We avoid this fate because steel is supplied by markets, with competitive producers and consumers adjusting daily to new information about changing opportunities and costs of using and manufacturing steel. No one worries about getting the steel supply right, for markets do that job remarkably well.

Unfortunately, the same isn't true for money. Its supply is determined consciously by a board. Unable to know and adjust to changes in people's demand for money - and subject always to political pressures to grease the economy with the snake oil of easy money - the Federal Reserve distorts the economy with its inevitably mistaken decisions on the supply of money. Asset bubbles are part of the price we pay for this primitive way of supplying money.

Markets should supply money just as they supply steel - and experience (for example, Scotland and Canada in the 19th century) shows that they do so when given the opportunity.

Surely the U.S. cannot be accurately described as having a free market in money. And surely the author knows this. So it's simply dishonest to say that the instability is a result of a free market; it is clearly the result of an error in central planning of the money supply and interest rates. The author wants to argue that, because of this mismanagement of the money supply and interest rates, we need the government to "exert broader control over the leverage that we allow to develop" to counteract the speed up and eventual breakdown of the economy. But this is like saying that if one's foot is stuck on the gas pedal, one should balance this out by getting one's other foot stuck on the brake. A wiser strategy might be to remove one's foot from the gas pedal in the first place, and perhaps hand off driving to someone else, since clearly being in charge of driving the economy isn't the government's forte.

The other dishonest tactic in this article is the author's inaccurate description of what happened in California a few years ago as genuine deregulation. In fact, it was poorly designed reregulation, far from an actual free market in electricity. Whether this reregulation was motivated by too much "equilibrium reasoning" I do not know, but it certainly wasn't a result of having too free of a market.