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Source link: http://archive.mises.org/4944/sowing-the-seeds-of-the-next-crisis/

Sowing the Seeds of the Next Crisis

April 25, 2006 by

The data indicate promising production and employment gains. But one should not get carried away by wide spread euphoria. Taking into account the lessons learned from analyzing monetary matters from the point of view of the Austrian School of Economics it becomes crystal clear that the very foundations of the monetary system on which economic prosperity of the industrial countries so heavily depends keep deteriorating at a rapid pace. FULL ARTICLE


David White April 25, 2006 at 8:09 am

“The crisis will be attributed to the failure of the capitalist system rather than the failure of a government controlled monetary system.”

Absolutely, as the logical outcome of the present course is marshal law. But as marshal law represents a last-ditch effort by the government to hold onto power, the real question is what happens after the center collapses. That is, where will mankind turn when “Western liberal democracy” — which Francis Fukuyajama famously dubbed “the final form of human government” — proves to be as big a failure as any other statist form of government?

Will free government finally get a chance? Or must history repeat itself in yet another cyclical nightmare?

William April 25, 2006 at 9:53 am

The biggest problems are not crisis economy wide but heavy pain in some areas and a little pain in others. The industries that depend on commodities like steel, chemicals, autos and heavy manufacturing, etc will take it the hardest as equipment, energy, raw materials and other prices rise while the entity has to compete with foreign competitors who have not experienced the artificial price increase.

Most other consumers will have less pain than job loss but still see it in higher commodity and asset prices like realestate and energy.

So consumers get hurt and manufacturers really get slammed.

The most ironic part of all this is that while they are getting blasted consumers and manufacturers are busy thanking the central bank for easy credit and a very short lived price advantage during the period where the economy adjusts to the devaluation of money.

David C April 25, 2006 at 10:26 am

“Will free government finally get a chance? Or must history repeat itself in yet another cyclical nightmare?”

I really see a lot of hope. First there are the fundamentals, after the crash – most people will probably understand that the government can’t and won’t take care of them, and that gold is real money. I renember that duing the 80′s economic chrises, people elected Regan instead of Carter – Regan was still “big government”, but it shows that people were willing to choose freedoms over freebies when things got bad. Also, the fact that people in the US were recently protesting in favor of immigrants while people in france they were protesting for a welfare state, and job guarantees is very heartening for the US.

Second, we’re entering the information age and the attitudes on the internet tend to be a lot more sympathetic and honest about libertarian values than the monopolized media. It is harder for the government to controll, and even harder for to lie about inflation and interfere with voluntary transactions.

Thrid, the USA still has 100 million gun owners. As much as the statists would like to impose a police state, it will simply cost too much to impose. Renember Waco? Ruby Ridge? When it got too militant it backlashed into a milita movement and Oklahoma City. Clinton was forced to back down to keep it from escalating out of controll.

Fourth, other than the state of the dollar and the trade imbalances caused by bad policy, the US still ranks very high in terms of economic and political freedoms compaired to everyone else – and has a very large infrastructure to boot. It beats China, India, and Brazil hands down on the economic freedom rankings. If we open the immigration floodgates and use real money, I think we will be able to compete vary well after the collapse.

Ohhh Henry April 25, 2006 at 10:57 am

Sooner or later it must become apparent that this economic situation is built on sand.

This is quite literally true, when you consider the billions of dollars being poured into reconstructing New Orleans on the sand and mud of the Mississippi delta, while many more billions are being expended building an empire on the sand of the Middle East. And don’t forget the many billions of credit being used to build expensive vacation homes on beaches and dunes from one end of America to the other.

The crisis will be attributed to the failure of the capitalist system rather than the failure of a government controlled monetary system.

This is right out of today’s headlines, in which Bush is promising to investigate “gas price cheating”. I mean, the dude was an oil executive himself. Either he announces his own resignation and turn himself in the Houston DA, or else he’s nothing but a hypocrite and a demagogue.

Paul Marks April 25, 2006 at 2:37 pm

The article makes the key point that people blame busts on “capitalism”, not on the government credit-money bubble.

Of course banks (and other private financial institutions) are involved in the effort to lend more money than exists in real savings (i.e. in income that other people have chosen not to consume)and there have been busts in the United States since 1819. But it is government that declares these book keeping tricks “legal” (i.e. not fraud) and it is government that supports credit expansion far beyond the limit that the most demented private banks would ever do on their own.

Since the foundation of the Fed in 1913 the system has got beyond a joke. Money today has no conection to any commodity, and credit expansion is on a scale that would have once been unthinkable.

Of course this house of cards must fall, and the real question is “what happens then” – how will people react to the vast economic chaos and widespread distress?

As we all know it depends on the beliefs of the people.

If the population blame “free enterprise” for the collapse then there will be even greater statism (even if the Federal government collapses there will still be local warlords), but if people can only be shown that statism is the cause (not the cure) of the slump then real reform is possible.

Sione Vatu April 25, 2006 at 4:37 pm

David C

You mentioned, “Clinton was forced to back down to keep it from escalating out of controll.”

I wasn’t in the US at the time. How did the president back down? What happened?



David C April 25, 2006 at 11:54 pm

In response to Sione, there was later a standoff in Montanna I believe, and because of the outrage from before they handled it with kid gloves (well far better than Waco). Also, Clinton was pushing very hard for all sorts of gun controlls and gun laws (even on bullets, I believe), especially after Oklahoma City. People lashed out at him hard for that and he quickly bakced down and for the rest of his term the gun debate was rather silent.

Sione April 26, 2006 at 8:07 am

David C

Thanks. That was not well reported here. I did hear a bit about Ruby Ridge but that was never really big news in NZ or Aust.

Later on the Australian govt. managed to ban all sorts of firearms as the result of a multiple killing in Tasmania. As may be guessed illegal firearms are now extremely easy to get. Even the TV people have had to report that.

Interestingly enough the Aust. govt. is about to introduce electronic smart cards as unique identifiers for citizens (a “heath” card which will be voluntary fpr the present- promise).


Jim Bradley April 26, 2006 at 11:03 am

think the arguments for “deflation” are weak. deflation won’t happen unless it’s politically decided upon.

a synopsis of arguments, prechter’s (referred to in the article) at the end …

i note an entire economy can collapse (banking, etc.) and employment be near zero and there still be galloping inflation … it’s only when the political forces (perhaps the strong capital holders) force the government to back off that the direction switches.

frankly, would like to ask prechter WHERE will investors go if dashing out of dollars? unless there’s a currency (after all, a rush to goods would be inflation) that can absorb the flow, there’s no real deflationary threat of creditors to ditch the dollar — not to mention that the fed can oscillate the expansion of credit to force enough pain (via debt repayment difficulty) so that the next round of inflationary money in the system will be held as precautionary balances even as inflation picks up again.

basic assertion: until there’s another viable currency (china 2030 or 2040?), or a change in political will, we won’t deflate.

the fed / banks are getting money for free. the idea that they won’t “devalue their reserves” is nonsense. they’re devaluing their reserves all the time (we wouldn’t have inflation unless that were true). they don’t want to devalue reserves too fast but they’ll devalue faster if need be, because they don’t pay for reserves … the taxpayer does.

basic assertion: reserves are, & will be devalued.

the other problem with the argument is lack of throughput analysis. china gets dollars and buys dollar debt. but the dollars china used to buy debt don’t disappear, we just export debt and import dollars, the converse of the prior of importing chinese goods and exporting dollars. the dollars (except those that have been kept offshore for balances) have come back onshore. the question is, where is liquidity circulating and staying? if it stays in financial assets, the there’s a “boom” in financial assets.

basic assertion: dollars, even credit dollars, under a fiat money regime, aren’t destroyed, they remain in circulation. and credit can be changed into dollars at any time by fed policy. it is fed policy that sets the conversion (or lack). the fed is beholding to banks and the federal government, neither of which are going to cry “uncle” anytime soon.

you’ll note prechter makes a circular argument: “But by flooding the market with FRNs, the Fed would cause a panic among bond-holders, and their selling would depress the value of the Fed’s own reserves.”

i.e. the fed can’t combat deflation because it would be inflationary? What? so the fed combats some deflationary impulse by increasing money by $1, all hell breaks loose and we’re in hyperinflation … no? what about $2? what about $100 billion? you get the idea. there’s some point at which the fed could increase money in a deflationary environment and it wouldn’t be hyperinflation but a reduction of deflationary forces. that won’t stop bankruptcies and it won’t help mom and pop feed the kids (i’d rather have deflation when i’m out of a job as my savings are become more valuable). so hedge accordingly.

bottom line – the fed can combat deflation by lagging a the rise in interest rates as government spending picks up the slack. deflation won’t happen until the political forces cause it to happen …


It seems that the U.S. Federal Reserve is committed to a course of ever-increasing liquidity and credit expansion. Even with a rising Fed Funds Rate, the Fed has found other ways to pump money into the economy. Given this behavior, is it not equally – or even more likely – that we will experience an inflationary depression as opposed to a deflationary depression?

Responder: Multi-Author Date: 3/20/2006
Here’s our very latest, detailed answer to this frequent question, as seen in Bob Prechter’s November 2005 Elliott Wave Theorist (part of the Financial Forecast Service):

“The consensus appears to be that the long term expansion in the credit supply will continue or even intensify under the Fed chairmanship of Ben Bernanke. One reason many people share this belief is their recollection of Bernanke’s November 2002 speech, “Deflation: Making Sure ‘It’ Doesn’t Happen Here,” in which he likens the Fed’s printing press option to dropping money from helicopters. There are reasons to believe, however, that the outcome will not be as the majority expects.

“One reason that Bernanke is likely to preside over a deflation in credit is that everyone believes the opposite. Investors have poured money into commodities, precious metals, stocks and property in the belief that if anything is certain, it is death, taxes and inflation. When the majority of investors thinks one way, it is likely to be wrong. This is basic market analysis.

“A more complex answer begins with the understanding that analysts constantly confuse credit creation with money creation. In fact, just today an essay became available on the Internet that includes a presumptuous edit of a statement by the dean of Austrian economics, Ludwig von Mises. In Human Action (p.572), Mises said, “There is no means of avoiding the final collapse of a boom brought about by credit expansion.” This statement is true and undoubtedly reads as intended. Yet the author of the article felt compelled to explain von Mises, with the following insertions: “There is no means of avoiding the final collapse of a boom brought about by [bank] credit [and therefore money] expansion.” First, a credit boom does not have to be financed by banks. As Jim Grant recently chronicled, railroad companies financed one of America’s greatest land booms, which, as Mises predicted, went bust. Second, credit is not money. Economists speak of “the money supply” as if they were referring to money, but they are not; for the most part, they are referring to credit. The actual supply of dollar-denominated money, legally defined in today’s world, is Federal Reserve Notes (FRNs), i.e. greenback cash. That money provides a basis for issuing credit. Credit may seem like money because once extended, it becomes deposited as if it were cash, and the depositor’s account is credited with that amount of money. But observe: the account is only credited with that amount of money; the actual money upon which that credit is based is not in the account. Every bank account is an I.O.U. for cash, not cash itself. Needless to say, the $64.3 billion in cash in U.S. bank vaults and at the Fed is insufficient backing for the 38 trillion dollars worth of dollar-denominated credit outstanding, not to mention at least twice that amount in the implied promises of derivatives. The ratio is about 1 to 600. This ratio has grown exponentially under the easy-credit policies of the Fed and the banking system.

“When credit expands beyond an economy’s ability to pay the interest and principal, the trend toward expansion reverses, and the amount of outstanding credit contracts as debtors pay off their loans or default. The resulting drop in the credit supply is deflation. While it seems sensible to say that all the Fed need do is to create more money, i.e. FRNs, to ‘combat deflation’ it is sensible only in a world in which a vacuum replaces the actual forces that any such policy would encounter. If investors worldwide were to become informed, or even suspicious, that the Fed would follow the ‘copter course, it would divest itself of dollar-denominated debt assets, causing a collapse in the value of dollar-denominated bonds, notes and bills. This collapse would be deflation. It would be a collapse in the dollar value of the outstanding credit supply.

“Contrary to popular belief, neither the government nor the Fed would wish such a thing to happen. The U.S. government does not want its bonds to attain (official) junk status, because its borrowing power is one of the only two powers over money that it has, the first being taxation. The Fed would commit suicide by hyper-inflating, because Federal government bonds are the reserves of the Fed. That’s why it is called ‘the Federal Reserve System.’ U.S. bonds are the source of its power. As long as the process of credit expansion is done slowly, as it has been since 1933, people can adjust their thinking to accommodate the expansion without panicking. But by flooding the market with FRNs, the Fed would cause a panic among bond-holders, and their selling would depress the value of the Fed’s own reserves. The ivory-tower theory of unlimited cash creation to combat a credit implosion would meet cold, harsh reality, and reality would win; deflation would win. Von Mises was exactly right: ‘There is no means of avoiding the final collapse of a boom brought about by credit expansion.’ Observe that he said ‘no means.’ He did not say, ‘No means other than helicopters.’”

(Bob Prechter is Elliott Wave International’s founder and CEO. He is the editor of the monthly Elliott Wave Theorist, part of the Financial Forecast Service.)

np April 26, 2006 at 1:03 pm

i’ve been following Prechter for 15+ years. he’s an idiot, and possibly the worst elliottician out there. a complete disgrace to the wave theory. he himself is a pathetic market analyst.

i wouldn’t bother reading anything he has to say. unless you plan on using him as a contrary indicator.

tz April 26, 2006 at 3:19 pm

I would also point to “The Credit Bubble Bulletin” by Doug Noland at Prudent Bear. He often cites Hyram Minsky and his stability creates instability, and talks about the global credit bubble and how it is practically out of the hands of the central banks including the Fed, though they can cause some annoyances – but anything effective will result in a crash. It is currency traders, Hedge funds, and big banks with derivatives. Between interest rate and default swaps you can move all the risk under the carpet titled “systemic risk”. His analysis is usually at the end of the article (the top are news clips and what the market did that week).

for 2005 use

billwald April 26, 2006 at 6:14 pm

It is the commodity market that controls the world econ system. The money traders only provide a service to the commodity traders.

The big change is that due to automated production, manufactured items are taking on the nature of commidities – large voluume with small unit value.

billwald April 27, 2006 at 6:23 pm

Who or what class of people does David suggest we shoot if the market collapses and how will that improve the situation?

PK Blinds March 5, 2011 at 9:13 am

Informative post, Im now one of your site followers

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