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Source link: http://archive.mises.org/11083/can-asset-price-bubbles-be-harmless/

Can Asset-Price Bubbles Be Harmless?

November 23, 2009 by

Frederic Mishkin believes that the Fed should continue with its loose stance, even if doing so blows more bubbles. Mishkin is known as a close confidant of Fed Chairman Ben Bernanke. FULL ARTICLE by Frank Shostak


Stephen Grossman November 23, 2009 at 1:46 pm

Mishkin noted some current coincidences and has an arbitrary, provisional “theory” to “explain” it. This is the pre-scientific mentality without a system of necessary relations.

“It is not enough just to stand back and look at points on a chart going up and down, smiling when things go up and frowning when things go down. That is the nihilism of an economic statistician who employs no theory, no notion of cause and effect, no understanding of the dynamics of human history.” MISES

Also, Richard Salsman, in _Breaking the Banks_, noted that 19th century US banks formed a clearinghouse which automatically minimized inflation of money and credit because banks with excessive checks would not have them honored by other banks. This was, I believe, with fractional reserve banking.
Apparently, each bank’s fractional reserve was monitored carefully by the other banks.

Alex November 23, 2009 at 5:16 pm


From your article, Mishkin seems to agree with you that bank credit expansion (hence, money supply expansion) can create asset bubbles or make them worse than otherwise. However, he argues that bubbles not enhanced or created by bank credit expansion will not cause bank losses and bank liquidity problems when the bubbles pop. You seem to agree with him about this.

But since, at present, there is not significant bank credit expansion (in spite of the expansion of bank liquidity by the Fed) wouldn’t you agree with Mishkin that, at present, Fed action is not creating or enhancing any asset bubbles.

Another point, even without a central bank, wouldn’t a competitive banking system find it profitable to set up a system of lending/borrowing reserves among them to allow for fractional reserve banking?

K Ackermann November 23, 2009 at 7:16 pm

I think you are both right.

The thing is, credit expansion will come about through any wealth effect that can be manufactured by a bubble.

The Fed is counting on a wealth effect.

billwald November 23, 2009 at 8:59 pm

Consider the tulip bulb bubble or the south seas bubble – - – or the Florida land bubble of the last century. The only people hurt were the greedy people who wanted something for nothing and the stupid (in florida) who bought swamp land without looking at it.

Second, the commodities exchange was invented to even out prices and assist the people who use the raw materials in planning future production costs. It was never intended to imitate the stock market.

If I buy summer’s wheat at whatever price because I think I can make money bread with wheat at that cost then I have limited my up side and downside but all other things being within limits, I will make money on next fall’s bread production.

If I buy summer wheat at $5 and next summer it is $6 or $4 I have made or lost money but that doesn’t effect the guy who bought his wheat supply this fall or the guy who buys the bread.

Harold Simpson November 24, 2009 at 7:20 am

As a non-economist, yet a guy that would like to make some sense out of our current economic mess, I would ask:

Is it not then the concept of “fractional reserve banking”, whether one has a monetary or hard money system, that is responsible for bubbles?

Timothy E. Buchanan November 24, 2009 at 9:07 am

One difference between 2009 and the two bubble years given as examples is that excess bank reserves are now much higher. I wonder what part this will play in the sudden decline in the the Fed’s growth? Does the Fed expect the banks to start lending, thereby cushioning the effect? Or should we expect an asset crash in January?

billwald November 24, 2009 at 11:28 am

“Is it not then the concept of “fractional reserve banking”, whether one has a monetary or hard money system, that is responsible for bubbles?”

True! But, for most of the 6,000 years of available history, when the money system was based on gold and silver, the vast majority of the population never had an opportunity to even touch gold and had very little silver.

The Bible gives an example: The annual temple tax had to be paid in gold. The people didn’t have gold. The money traders got rich off the observant Jews. The money traders were the only people whom Jesus got physical with. Jesus ate with tax collectors, not with money traders.

The middle class didn’t start to grow until fractional banking was invented. Fractional banking is functionally different than the traditional clipping of coins that corrupt governments have always done.

Federal Reserve November 24, 2009 at 11:13 pm

“The annual temple tax had to be paid in gold. The people didn’t have gold.”

The annual income tax, property tax, etc. has to be paid in Federal Reserve Notes. Only the counterfeiting monopoly can create Federal Reserve Notes.

Iconoclast421 November 25, 2009 at 2:20 pm

You make a serious error in reasoning with your analysis of fractional reserve lending. If the bank loans $50 to Bob, and Joe takes his 100 out, the bank is only “caught” if the loan to Bob was unsecured. This is not very likely to be the case, in the absence of fraud. What is more likely is that Bob provided collateral that could be sold to recover at least $50 if need be.

Fractional reserve lending does not create money out of thin air. It is merely a tool of wealth transfer. By making a loan to be used to purchase an asset, you are in effect driving up the cost of that asset. But you are not creating any new money. When home prices surged in 2003-2006, no new wealth was actually created! What happened in reality is that the value of the dollar was destroyed. That is why food, energy, tuition, etc all increased dramatically during the housing bubble. As the housing bubble collapsed, all those other prices began to fall. What has kept those prices from falling further is speculation that the Fed would print new money to buy fictitiously priced bubble securities. That speculation proved correct. Once the Fed turned on the printing press, that is when the new money was created. Had they not printed, all the fictitious wealth would have dissipated, bankrupting anyone who borrowed against that fictitious wealth.

Alex November 25, 2009 at 3:09 pm


The bank is “caught` with a liquidity problem.

The Fed creates money out of thin air, as you say. With 100% reserve banking, no further money could be created. But with less than 100% reserve banking, through the granting of loans, the banks create additional bank deposits (money).

You are right that money creation doesn`t create wealth, but simply raises the prices of existing wealth.

scott t November 25, 2009 at 3:45 pm

i received loans and credit cards without any ‘colateral’ except a rating of sorts. if thats collateral.

are you saying that with FRB (which i assume to be an actual phenomena, if not say so) when depositor deposits 100 of money and 90% of deposit is loaned, the depositor has 10 of money plus 90 of bank-credit, that can spend like money….but since the 90 of bank credit is ‘backed’ somehow by a collateral that no new money(although in credit form) has been created out of thin air???

T. Ralph Kays November 25, 2009 at 4:08 pm


The mistake is yours, banks do not own the collateral put up to secure loans. They cannot sell the collateral at will, the borrower must first default on the loan and the bank must foreclose before they can sell the collateral. So if Joe does take out his $100 and Bob doesn’t default on his loan the bank is caught.

Beefcake the Mighty November 25, 2009 at 6:12 pm

Excellent point, T Ralph.

Beefcake the Mighty November 25, 2009 at 6:13 pm

Excellent point, T Ralph.

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