The really bad news is that, even if we get through our current problems in half-decent shape, there are some disturbing storm clouds on the horizon, and these are much more ominous than the current crisis itself. FULL ARTICLE by Kevin Dowd
Source link: http://archive.mises.org/12426/the-current-financial-crisis-and-after/
The Current Financial Crisis – and After
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It’s great to find the transcript of Kevin Dowd’s speech here. Thanks.
How long before Daniel Kuehn comes here to complain that Dowd is ignoring the existence of a liquidity trap (his standard response to anti-Keynesian arguments)?
or lee kelly, to defend the paradox of thrift (in certain circumstances)?
Re: The first thing to appreciate is the power of ideas. And one point that this crisis has conclusively demonstrated is the enduring hold of Keynesian economics.”
I think that it’s time for free-market advocates to state publicly, over and over, why Keynesian economics is so popular among “policy makers.” The answer, of course, is that Keynesian economics gives them the intellectual cover they need for their interventions. These interventions include tax breaks for special interests that are justified as being for the “public good,” stifling of competition via regulation, price fixing of interest rates rather than having them set by the market, a giving a private bank a monopoly on the creation of money.
Also, the Keynesian economics in use for the past several decades should be exposed as being a bastardization of Keynes’ economics. Keynes advocated that governments accumulated a surplus while the economy was expanding. That surplus was to be used in a recession to provide the stimulus. The federal government, as I remember seeing, has run a surplus for only two years of the past 43 and that was in 1993 and 1994.
Please understand that I’m not advocating true Keynesian economics; I want to see the collectivists and interventionists lose the intellectual cover that they have with their pseudo-Keynesian economics.
As succinct an explanation of the current situation, and forecast for the future, as I’ve ever read. Anyone who manages their own money knows you can’t borrow/spend your way out of debt. Yet I still find otherwise intelligent people who insist that we’re pulling out of recession. The education system, media progaganda, and economic manipulators have manufactured a perfect storm of misinformation.
The Tea Partiers are just the tip of the iceberg. Wait until SHTF.
The danger looming beyond the short term and long term crises of inflation and debt default is fascism. Expanding the health insurance rolls, creating national service programs, biometric IDs, increased SEC and Fed regulatory powers, unlimited powers of eavesdropping, arrest and detention etc. are all steps down this path.
It will be ineffective to use the federal political system (i.e. party politics and voting) to stave off this danger. There are too many ways for those in charge to scam the system. Freezing out honorable candidates like Ron Paul and elevating amoral puppets like Obama and Palin is like child’s play to the establishment. There is much more to be gained from getting behind the nullification and secession movements, applied from the level of the UN and federal government all the way down to the state and municipal level. On a personal level it is also possible to peacefully nullify and secede from the regulatory and banking systems. Hunkering down and boycotting as much as possible the schemes of the fascists will help to starve them of the cash they need for scratch and the votes they need for credibility.
Los Angeles is broke because a utility newly hit with eco-regs has refused to pay its taxes, the
taxes needed for municipal workers. The mayor cut their week to three days. Yeehaw!
The problem is the international fractional reserve banking system. It is a house of cards and depends on the maintenance of confidence imposed by the government power brokers and their clients, the ruling elites. The bankruptcy of the large banks and the mark down of their assets and liabilities would have been imposed on the solvent banks by their accountants effectively bankrupting the entire industry worldwide as it should. Loans particularly large commercial loans are supported by the underlying value of property, goods (e.g. commodites, produced goods, etc.), revenues and cash flows. Any sustained drop in values, revenues and cash flows would cause commercial loans to go into default. Loss of jobs and loss of income which supports car loans, home loans, personal loans along with a fall in real estate values would result in massive loan defaults by individuals. This would have been the end of fractional reserve banks and the banking cartel as it should be. The global financial crisis is the market’s correction of a system that is divorced from the reality of the market as a result of the fiat currency issued by central banks all around the world and the result of the fractional reserve banking system which exists around the world. When it became obvious that the savings-consumption ratio of the individual market participants had not changed and then when this realization hit the financial industry (banks stopped leading to other banks) the GFC was upon us. The ruling elities supported this in the only way availabe o them – steal more tax dollars and print more money. Thus we had bailouts and stimulus and nationalizations. More wealth will be destroyed by stealing more wealth in the form of taxes and devaluing the currency through inflation. This is how wealthy nations become poor nations.
Just an observation on the analysis of bank balance sheets – Isn’t the problem fundamentally that demand deposits figure on the banks’ balance sheet as “liabilities”? Isn’t it just a reminder that the root of the problem is the answer to the question “Whose money is it once you deposit it (the money) in a bank?” ? I don’t see how this issue is going to be resolved once and for all until it is recognised that demand deposits have no place on a bank’s balance sheet. It is a moral and (hence) legal question, not an economic one. Foley vs Hill is still relevant and at the heart of the issue.
Quite so.
I wholeheartedly agree. Good observation on the legal distinction between deposits and loans.
Nothing original about it.
The observation was Rothbard’s in “The Mystery of Banking” (my introduction to Austrian thought in economics). However, if one were to take this legal position seriously, Fractional Reserve Banking and the act of creating demand deposit money out of thin air become nigh impossible. At the very least, it would become that much tougher to use accounting jugglery to cover up what is actually currency debasement. That sort of addresses Bennet Cecil’s “call” for eliminating fractional reserve banking.
I therefore see it as a very important point in this debate and find it a little disappointing that not much discussion is being generated on this issue. Hope this observation of mine triggers it.
Warehouse can be robbed and still you would have a claim to those monies even when bank cannot provide them..
Seriously, it is banks and its lenders decision if they want to make a loan arrangement where lender has a right to transfrom banks obligation instantly to cash.
There is nothing illiberal in that.
The way to prevent inflation is to eliminate fractional reserve banking. Let the banks hold US dollars or treasuries notes. They are in bed with the Fed; force them to hold a dollar for every dollar they lend instead of make believe money! This is politically impossible now but who knows what will be possible with new senators,representatives and presidents?
The overspending will be corrected at the state and county government level before Washington cuts spending. Stagnant local economies are squeezing tax receipts. Voters refuse to pay higher property taxes, forcing cities to cut spending. When states try to raise tax rates, high income citizens move to a state without an income tax.
Savers should avoid lending money to governments. They can hold a portfolio of intermediate term investment grade corporate bonds instead if they need income. When the US defaults, many savers will be wiped out by their “safe” investment.
I never really liked the idea for anyone to be forced to go into 100% reserves by government, especially if it still remains just a fiat currency. I prefer free banking, preferably without a federal reserve — or just the decriminalization of competing currencies would do.
For those of us who need a simplified understanding of banking, I submit the following:
A Moral Analysis of Banking
The issue of banking is economic and political, yet much is clarified by presenting the moral dimension, particularly for resolving its problems. So I shall focus on the fraud and theft involved, treating the economic and political matters as secondary.
To get to the root of banking, consider a savings bank that keeps the money of its depositors on its premises. It is possible that the money can be stolen, or that an earthquake or fire demolishes the bank. Yet safeguarding the money is guaranteed, in the sense that no fraud has occurred. On the other hand, when the bank loans out some of its depositors’ money, there is some probability that all of it cannot be immediately returned. One cannot provide a formula for that probability, since it depends on many intangibles, such as the state of the economy and the frame of mind of the depositors. However, that probability increases with the fraction of money loaned. Thus a bank that loans 1% of its holdings is less vulnerable than one that loans out 99% of its holdings. In any event, when that bank tells its depositors they are guaranteed to have their money redeemed, they have committed fraud. It may be noted that any given probability of failure provides a statistical guarantee of failure over time. For example if the rate is 10% per year, in 30 years, the probability of failure becomes 96%, and in 40 years becomes 99%.
There would not be fraud if depositors were informed that not all of their money would be immediately redeemed. That would be akin to a business investment, such as the purchase of a stock. Different banks would compete in terms of their probability of redeeming deposits. So customers could select in which bank to store their cash.
The fact that several banks back one another up in the event of a run changes the probability of redemption, but does not remove the fraud. Nor is this changed by a FED that backs up all of the banks. The fraud would be removed if the money were completely insured, but not when only some of it could be covered, which is the actual case.
There is another aspect to the fraud. If one owns a piece of property (say a house or a car), and uses an IOU for collateral, there is no fraud, no matter how many trades take place. However, when the owner provides several IOU’s for his property, this constitutes fraud. Such is the case with fractional reserve banking. When there are say five IOU’s for which the banks have only one unit of funds, that is fraud.
Now the next thing that occurs when the banks face the aforementioned problems of insolvency, is that the Federal Reserve prints more money than is redeemable (by goods & services). This amounts to a redistribution of wealth. Here, those who are given that money increase their wealth, while the value of the wealth of the rest of the public is comparably decreased. That is, there is a fixed amount of goods & services corresponding to the money, in a zero sum game. Doubling or halving the amount of money cannot change that total. (Elsewhere, Robert Murphy shows how the process of printing money has to increase at an ever faster rate, which guarantees a bust.)
The bottom line is that if no fraud or theft occurs, there can be neither bank runs nor insolvency.
Quite. Trace any of the practices to their root and the true bottom line is always violence. I would not participate in the system unless I were forced under the threat of death. The entire system is based on Federal reserve notes. There are legal tender laws.You are forced at gun point to participate.
Bloated and confusing. This whole thing is one big pile of “Your life is going to get worse” Followed by “You can change things” When after all, we are all in an unchangeable position in life. We all get comfortable. We are all going to get comfortable with borrowing things until we die. We go to college and borrow money for horrible education for jobs that need three years of experience to get. Students can’t get these jobs because they spent time getting experience going to class and wasting their money. And more students will take out these loans and waste their time, when they could be getting real world experience. No one is doing this because its the acceptable thing to do. Its the comfortable thing to do. Even Monopoly is going to a no money system. A world of electronic money. Invisible money that is free to spend. And it’s getting more fun to do it. especially for the poor and the indebted college students with crappy education. Get unemployment benifits (Poof, money appears right in your account) Ask for deferments (Invisible debt disappears) Face it Writing long bloated drawn out essays are not going to fix anything. We are in the current. To put it another way there are better movies to go see, but what do Americans see instead? Hannah Montana movies. It’s going to get worse and there is nothing anyone is going to do about it.
I agree with you. the only thing any of us have any control over is some of our own actions. That is why I’m fed up with the fantasy land assumption that we are going to change the world by enlightening others. There are effective steps each one of us can take, and I do not think convincing others is on of them.
The federal government, in setting the US economy up for a massive inflation, is already repudiating a goodly portion of the current debt, which will lose value as the dollar plummets. This is the worst possible way to do so, of course, but does anyone really expect something different from politicians?
Let us consider banking without theft or fraud, when Mr. Smith considers depositing his money in the savings bank of Mr. Jones.
Smith: Are you willing to safeguard my money?
Jones: Surely, and you will get it back fully & immediately, except for emergencies.
Smith: What do I lose in value or time, given an emergency (such as a run on your bank)?
Jones: Based on history, the expected loss per year is 5%, with one annual run having an expected delay for reimbursement of 4 months.
Smith: So when you hold $100 for a year, I can expect to get back $95, and since this is 0 delay for 8 months, and then 4 months delay for 4 months, the average delay is 4/3 months.
Jones: Yes, and I believe that we will do even better in the coming years. Do we have a deal?
Smith: Perhaps, but I want to first compare these risks with other banks.
Allen,
that is how every customer should think when he/she makes this decision to put money into bank.
Except it might be a bit too much speaking about those probabilities. Bank could just say that sometimes whole economy can be hard hit and almost all banks suffer from bad loans. Then it might not be possible to get full amount back..
Perhaps deposits should be guaranteed, not by replacing them at taxpayer expense (moral hazard), but by force of arms of irate, defrauded depositors seeking restitution (and costs, via some private mechanism) from whomever defrauded them? Neglecting fire or other mechanisms which physically destroy deposits, the money must have gone somewhere. Follow the trail. This used to be called “property rights”, a quaint notion of our ancestors who designed civilization (the rules by which we cooperate for MUTUAL self-interest).
Adi, we could avoid probabilities, and simplify matters, by having a bank state that its average annual loss has been 5%, and its average delay has been 1 month. The point of quantifying matters was to encourage competition on the basis of performance (which avoids fraud). Perhaps on this basis, depositors would have used savings banks that did not lend out any money (or provided compensitory payoffs & acceptable delays).
Again, pooling banks, and providing insurance, changes the numbers, but the principle of incorporating the losses remains. I submit that had these built-in risks been understood, during the centuries of using banks, we would not have had the disaster of bank runs, the Federal Reserve, and the ever more rapid printing of non-redeemable currency.
There’s a difference between checking accounts and savings accounts, though it’s not as obvious as it used to be. A checking account is a demand deposit account. You’re *supposed* to be able to withdraw your money from your checking account at any time, and thus, banks should not be loaning out money from demand deposit accounts Savings accounts, on the other hand, are your basic, low-level investment account, and as such, are intended to be loaned out by the bank in order to earn interest for the account. It’s your savings account that should not necessarily be available for immediate withdrawal.
Modern banking practices and regulations have blurred the distinction between these two types of bank accounts, but it is well-worth remembering and understanding exactly why there are two different types of accounts.
Also, this talk about bank robberies is a bit disturbing, because it’s hardly a typical financial transaction, now is it? And the risk of robbery can be mediated with insurance (real insurance, not FDIC or other government “guarantees.”).
Kevin, many thanks for this lucid, spot-on and frightening piece.
No one else has mentioned it, so allow me to focus on a piece of your essay that I think has very wide implications that our leading lights at LvMI have been doing their best to ignore: the moral hazard and risk-shifting generation that is INHERENT in the state grant of LIMITED LIABILITY to corporate shareholders, and that has helped to encourage irresponsible behavior and increasing (and ultimately unsuccessful) regulation in the banking sector. It has also fuelled the cycles of corporate regulation, rent-seeking and political corruption.
I couldn’t agree more strongly with what you said hre:
“the financial-services industry needs serious reform. Hard to believe as it might be, there was once a time when the industry was conservative and respected, when it focused on providing straightforward financial “products” to its customers and did so well. We have got to get back to that. No more financial hydrogen bombs blowing up the financial system.
“The key to this is corporate-governance reform. I am talking, not about tinkering with the number of nonexecutive directors or a new Sarbanes-Oxley, but radical reform to make the banks accountable and to rein in the moral hazards that have run rampant. And the key to good corporate governance is to remove limited liability: we should abolish the limited-liability statutes and give the bankers the strongest possible incentives to look after our money properly.”
I believe that, as argued by James Glassman and William Nolan in a Wall Street Journal op-ed last February that referred to von Hayek, http://mises.org/Community/blogs/tokyotom/archive/2009/02/26/the-curse-of-limited-liability-wsj-com-executives-traders-of-big-financial-corporations-generate-risky-businesss-while-smaller-partnerships-are-much-more-risk-averse.aspx, unless and until owners and executives have “more skin in the game” – like the conservatively managed private partnership Brown Brothers Harriman, we will continue to ride a tiger of selfish risk-shifting, moral hazard, and ever more disruptive government regulation.
I have argued in a series of posts, starting with my review of Huebert and Block’s criticisms of Long, the state grant of limited liability to shareholders (in particular the grant vis-a-vis those injured by corporate acts and involuntary creditors, which is a pure grant from the state and cannot be contracted for) has led to a number of perverse results, which can be fairly clearly seen in the financial crisis: http://mises.org/Community/blogs/tokyotom/search.aspx?q=limited+liability.
I hope your post will contribute to a much more serious examination by Austrians of the role played by the state grant of limited liability to corporate shareholders in facilitating flawed and irresponsible risk-taking by executives and traders, as well as in perversely fuelling a vicious cycle of rent-seeking and further counterproductive regulation, both within and outside the financial sector.
Sincerely,
TT
I believe that Dr. Dowd is telling us something very simple–we have the power to repudiate the obligations imposed upon us by others. There is a basic, historical British maxim that says that no parliament may bind another, which means that we could legally scrap Social Security, Medicare, Medicaid, the FDIC, the Fed, the whole statist regime tomorrow. No one has a legal claim on any government entitlement. Children might be forced to support their parents, just as they did in older days, but so what? And retirees might be forced to seek some kind of employment, but so what? Let them peel off those awful bumper sticks that read “I’m spending my children’s inheritance.” Our knowledge of Austrian economics tells us that there is only one shortage in the world–the shortage of labor. There is always more to do than people to do it. I say, end the entitlements, end the Fed, end it all and return to a free society.
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Kicking the can down the road will not help too much. Stock and equities will continue to trend and move sideways (they will be trending downward if inflation is included into the picture…)
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