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Source link: http://archive.mises.org/17032/the-likely-consequences-of-freezing-the-feds-balance-sheet/

The Likely Consequences of Freezing the Fed’s Balance Sheet

May 20, 2011 by

Once Fed policy makers freeze the balance sheet of the US central bank, the growth momentum of the money supply will slow down. Bubble activities that emerged on the back of the rising growth momentum of the money supply will come under pressure. The Fed might back away from QE3.

FULL ARTICLE by Frank Shostak

{ 20 comments }

Joe R May 20, 2011 at 10:06 am

Why is fractional reserve banking different from cattle rustling and why aren’t bankers who get caught at it hung like cattle thieves?

Or, put another way… If someone could produce counterfeit cows, would cattle rustling be just another legitimate business practice?

I think I know the answer to both questions, but I regard it as insane.

Deefburger May 20, 2011 at 10:07 am

This is one step outside your excellent analysis, but like a heroin addict, the receivers of the funds for bubble activities will be pounding on the door of the pusher.

The biggest problem the Fed faces is a backlash from their benefactors. If they stop buying Treasuries, who will? They will be under pressure from Wall-Treasure to sustain “Industry” and “Commerce” even though that sustenance was bubble making.

When the machines on the casino floor get tightened up, the first to hear about it are the doormen and the cash clerks. When the drugs are scarce, the first to hear are the pushers.

Gerry Flaychy May 21, 2011 at 11:34 am

1- Do you mean ‘benefactors’ or ‘beneficiaries’ ?

2- To whom are you refering by ‘they’ ?

That makes your intervention not very clear for me.

Roger May 20, 2011 at 11:12 am

Um, then what caused all those panics before there even was a Fed?

nate-m May 20, 2011 at 11:22 am

other failed attempts at government intervention quite often. Do you think the Fed banking system was the first one of it’s kind in our country? The Fed was NOT the first attempt at starting a central bank. There has been a number of central banks that have been setup, then failed, and then was repealed. Also there was a number of fiat currencies that have been implemented, that failed, and needed to be replaced with gold standards.

Besides that there were a large number of other mistakes made. One example is how the government attempted to set a fixed transaction rate between silver and gold for the purposes of making accounting easier. However there is no fixed rates in a natural market and thus the fixed government rate became out of sync with the international exchange rates. Smart people would exchange their wealth for gold, go over seas, trade it for silver, come back and then exchange it for gold, go back out and exchange it for silver, etc etc. This lead to a ‘monetary crisis’ which spawned more government intervention, which caused more problems, etc etc.

Nobody says that there will not be market fluctuations with a completely free market economy. Uncertainty is the driving force behind entrepreneurism and businesses fail all the time.

However the so-called ‘business cycles’ and huge swings that out economy goes through is _usually_ going to be caused by government schemes to control and force the markets to behave in a certain manner for political ends.

economics9698 May 20, 2011 at 12:40 pm

Well the 1907 Knickerbocker failure was a result of Teddy Roosevelt treasury Secretary Shaw pretending he was a central bank inflating the currency. Pick a disaster, I will tell you the real culprit, government.

CT May 20, 2011 at 1:55 pm

Simple. Fractional reserve banking. Von Mises, Hayek, Rothbard, and the rest have all developed the theory and analyzed historical events. During the 19th century, there were central banks, granted, but even in the periods where there were not, banks were still allowed to lend deposits out. So the answer to your question is as long as investments are made where there are no savings to back them up, you will get a boom and a bust.

Btw, I understand many “Austrians” put too much emphasis on the central bank, so I’d read the “Theory of Money and Credit” to get a full understanding of the issue. Rothbard also does a good job of explaining the theory – but in a much simpler fashion. Finally, deSoto has in my opinion the best explanation of ABCT for the layman.

vcif May 20, 2011 at 5:57 pm

Same $#!+, different day.

Complete answer found herein:
A History of Money and Banking in the United States: From the Colonial Era to World War II
http://mises.org/misesreview_detail.aspx?control=216

economics9698 May 22, 2011 at 9:24 pm

I do not buy that fractional reserve banking causes failures as a automatic position. I think a gold standard and a 35% reserve requirement would be stable.

billwald May 20, 2011 at 11:16 am

The US government has not kept an honest set of books for at least 100 years and thanks to ENRON we now know that neither do the big corporations. I’m generally against the death penalty but any CPA who intentionally cooks the books should be hanged in the town square and left for the crows. Even the Mafia knows that they require an honest set of books for their internal operations.

economics9698 May 20, 2011 at 12:42 pm

98 years.

David J. Sanchez May 20, 2011 at 9:18 pm

What is and isn’t real ? The government is in cahoots with the Fed and is the problem as I agree with most of the above commentators completely. The Federal Reserve is only the latest and strongest of central bank manipulators to monopolize our currency. Dave S.

Jeff Harding May 22, 2011 at 1:58 am

Dr. Shostak:

1. If unemployment remains stuck at 8%+, which will occur if they freeze their balance sheet, wouldn’t that increase the likelihood of Q3? Isn’t unemployment a more significant concern for the Fed than inflation.

2. If the euro remains under pressure as a result of sovereign bailouts, would that help alleviate pressure on Treasurys?

JH

economics9698 May 22, 2011 at 9:27 pm

The PPI is up over 20% for two months in a row. Inflation is a very real concern with the Fed. I think the floodgates will open around August/September but that is just a guess.

K. Chris C. May 22, 2011 at 3:30 pm

Great analysis Mr. Shostak.

I would like to add that the Fed. system is building massive “excess reserves,” now about $1.6Tril. They plan on using this lucre to create massive amounts of bank credit to offset the effects of the changing/freezing of the Fed’s balance sheet.

There will be no QE3, as they know that that would immediately lead to a more rapidly deteriorating dollar situation. No they will “surprise” us all with no QE3 and then quietly expand the money supply through the bank/credit market using the pent-up “excess reserves” (The banksters “only” receive less than 1% on these funds, giving them a major incentive to play along.).

Mark my words, we will all again soon see our mailboxes filled with cheap credit come-ons.

economics9698 May 22, 2011 at 9:31 pm

I agree. Obama knows the only chance to get re-elected is to time the money bubble perfectly and delude everyone prior to the election that everything is 2005 again. Only problem is inflation and the short time between bubbles makes this strategy very risky.

Chris May 22, 2011 at 7:45 pm

For the most part, I believe the Austrian School is consistent with economic reality. I read the articles on this site often, I’ve read Mises books, Rothbard books, and so forth. I even like this article. But I keep hearing the same messages. And although the school might be growing in some ways, there are two problems. One, it is not filtering into mainstream economics in the Universities. Two, it is not having effects that are leading to changing government policy (indeed, we are getting more statist by the day).

Now, before those who are involved in the Austrian School get all offended and feel under-appreciated, let me repeat, I deeply appreciate this site and the entire school. However, I am here to tell you if you want to really have an impact on mainstream economists and policy, Austrians are going to have to do less theory (since it has already been laid out time and time again), and PROVE your theory with much more robust emprical data. Specifically, Austrians are going to have to go extensive analysis to demonstrate that it is indeed the Fed (or any Central Bank or government controlled montary system for that matter) that is the cause of the boom-bust cycle and all of its ugly after-effects.

I would argue that true capitalists in general (as opposed to crony scum that dominate Washington and Wall St) have not done a good job of such analysis. Instead of going to Harvard and fighting them, instead of going to University of Chicago and fighting them, we populate community colleges and the fringes of the financial press. Ignore me if you want, but if you want to have some real change, you got to be willing to go onto their turf and fight them. And you got to be willing to do some hard core research and analysis to prove the truth. in the words of Edward Demming, “In God we Trust”…all others bring DATA.”

economics9698 May 22, 2011 at 9:54 pm

Why would any university hire a Austrian professor? The game has been rigged by the federal government since the early 20th century. Think about it. Would a government university like the University of Central Florida, supported by millions in state dollars, hire a Austrian economics professor telling students that government makes them poorer, even though this is a obvious statement to any sane economist? Doesn’t make sense and government actively discriminates against Republican academics and most certainly Austrian economist. Most professors (90%?) are Democrat. As one who has been in the academic world in high school, college, and at the university level once they find out you are a “Republican” (I am a Libertarian aka “Republicans who smoke dope”) it is over for you. You get bad reviews and they try every possible way to rid themselves of your presence. Some are honest and even tell you they have to make you look as bad as possible. But that was the intention of the federal and state governments for a century. Hire bright smart people in their universities that will make them look good and create a demand for government. So when I see some of these guys employed with a regular paycheck, even at a community college, it is heartwarming to me.

Be thankful there are are some honest people out there who will tell students the truth about economics and how government creates our disasters. The research is pretty damning if you read and great economist and can put two and two together. Ahamed, Friedman, Rothbard, read them all. Its all there. Just put it together. Plenty of research available.

If you want to get rich and have a nice government job become a registered Democrat and learn Keynesian economics. Being a Libertarian and a Austrian economist is not the easy path. The only chance we get for people to listen is when the house of cards collapses. We need to take advantage of it.

Ken May 25, 2011 at 2:13 am

I hear ya Chris. This Austrian school junkie has been trying to spread the word to my children’s Charter school teachers to no avail for years. Given conventional econ is a strain for the average Joe one would think human action should resonate? Unfortunately economics9698 is correct in that one cannot prove anything if you are banned from the competition.

Getting Lew, Jeffrey or other capable Mises fellows invited to speak at major universities would be a hoot — like inviting the fox to the hen house :) Besides, it’s already been proven from Wealth of Nations to Human Action to History of Money and Banking … and on.

Unfortunately the Keynesian lie has been repeated enough times to become the predominance of truth. Much like climate change and going green, the state favoring Keynes has marginalized Smith in our time.

I predict Mises will eventually prevail when the masses get around to finding his messages.

Econophile May 25, 2011 at 2:21 pm

Chris makes a valid point, other than the fact that empirical analysis is rather frowned upon by Austrians. Putting that aside for the moment, ask the question: If we are so ‘correct’ why can’t we sell our ideas to the mainstream? The biggest crisis since the Great Depression just occurred (still occurring) and we had no seat at the policy table. Not an easy answer, but recall how long it took for socialists to take political power in America. They took over the Democratic Party and it didn’t happen overnight. Libertarians, especially Austrian theorists, tend to be intellectuals who dislike getting their hands dirty (I would include myself) but Rothbard called for more direct action and often pointed to the cadre system of the communists to spread the word. That’s not the entire answer, but it is one that is necessary. Another necessary path is that of the Mises Institute, but they need to do a better job of “selling” ideas to the masses. But they are doing a great job, so it’s hard to be critical. My goal, raise money to put a Mises Chair of Economics at major universities. It takes many millions, but universities like money.

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