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Source link: http://archive.mises.org/5245/artifacts-of-financial-engineering/

Artifacts of Financial Engineering

June 29, 2006 by

Inflation, writes Sean Corrigan, is properly defined as monetary creation, but this very act has seemed to reduce the kind of “inflation” that is routinely misdefined as a rise in the consumer price level. Lulled into false security by this seemingly benign outcome, the central bank will now be happy to keep interest rates lower for longer and so it will promote this very act of monetary expansion in the future. FULL ARTICLE


john morgan June 29, 2006 at 8:43 am

Great article. 2 issues I don’t quite understand:

1.Corrigan uses the term Money Trust. How is this defined? Is he suggesting that there is a financial institution for the auto industry analogous to Fannie Mae for the housing industry? Is the government monetizing these loans? If not, I don’t understand the problem of selling the loans to private investors.

2. Where does labor productivity fit in Greenspan’s formula of profits = selling price – labor costs- non labor costs?

adi June 29, 2006 at 9:04 am

I think that Mr Corrigan didnt actually mention labour productivity at all since in greenspanian world rising corporate profits are thought to represent rising productivity. Capital costs item in previous identity is artificially lowered throught fed policies..

Roger M June 29, 2006 at 9:13 am

Couple of questions:
1. Price indexes are poor indicators of inflation. What should we follow? M1 and M2?
2. In poor old Greespan’s defense, could he have been using the economic (BEA’s) definition of profits instead of the accounting one? The economic one is more accurate.

Paul Marks June 29, 2006 at 10:21 am

By the “money trust” my guess is that Sean Corrigan means the fractional reserve banks and other financial insitutions that lend out money they do not have.

In a sound financial system the savings of some people go as loans to other people, in an unsound one (such as the modern financial system) the quest for “lower interest rates” means that various complex book keeping tricks (such as fractional reserve banking) are used in order to lend out more money than has really been saved.

The reason this is not considered fraud is that the government’s statutes (and before that various court judgements) declare that it is not fraud to lend out money that does not exist.

Hence the boom-bust cycle that existed long before the Federal Reserve System was created in 1913.

Of course the Fed does enable these credit money booms (and the inevitable busts) to be on larger scale than they used to be. It also creates a long term inflation that twists and distorts the basic capital structure of the economy.

Where I would differ with Sean Corrigan is that I do not believe that auto companies (or enterprises in other industries) that tend to act in the way he describes prosper.

Customers are not all (or even mostly) morons. They tend to look for good quality products at low prices – not complex credit financing deals.

Companies that rely on these deals get into trouble – see G.M. and Ford.

The last I heard G.M. was selling most of its financial services arm (a classic member of the “money trust”) in order to cover its trading losses (that is a trick that only works once).

If the auto industry companies wish to survive they have to concentrate on high quality and low prices – not complex schemes. Of couse to survive the auto companies will have to break the U.A.W. (which means that the government statutes protecting the unions should go).

“We do not want to go back to the old days when the company told us what are wages and conditions would be and the only alternative was to get a job in a different line of work”.

Fine then you will destroy what is left of the auto industry and all be unemployed.

Wages and conditions must be based on real productivity – not the “strike threat system” (to use the term of W.H. Hutt). If people want to not turn up for work or walk out the door in the middle of a shift that is O.K. – just as long as they understand they have just resigned.

Student June 29, 2006 at 10:23 am

Thank you for an insightful and useful article. I have, for years, been a vociferous proponent of the idea that almost no one understands what inflation truly is, even though it is extremely easy to understand when explained properly.

Inflation, as a form of hidden wealth expropriation, is the most important tool by which our government extracts real wealth from the populace. Inflation is made possible, in our country, by a series of “legal tender” laws, which allow the federal government to create “money” willy-nilly, in multiple (many hidden) ways. Every episode of inflation or currency manipulation by government (aided by private bankers) in recorded history has “ended” similarly; with a crash or continued inflation.

This one, even though it is now nearly 70 years in the making, will be no different.

Thanks again.

Bill, Fed Hater June 29, 2006 at 10:50 am

This is another way to tell the same old story.

The government makes money and asset prices go up, while the real value stays the same. Consumers issue debt beyond what they can pay to buy these assets. Suppliers create more assets for consumers to buy and eventually over supply the market as consumers fail to pay for the loans or get nervous about paying for them. Then asset prices start falling….

In the 1990s stock suppliers using this new technology as a smoke screen over supplied the market with stock. Eventually it caught up with them.

Similarly, in the period form 1998 to 2005, housing suppliers using cheap interest over supplied the market with new homes and now prices are falling.

Vince Daliessio June 29, 2006 at 10:54 am

Student says, succinctly;

“Inflation, as a form of hidden wealth expropriation, is the most important tool by which our government extracts real wealth from the populace.”

I was born in 1964. I grew up in the late 60′s – 70′s. My dad had his own small business. I remember what a struggle inflation was for people in our economic status and worse – a catastrophe.

Inflation steals most from the poorest, from those who need to spend all of their income on necessities. It is a theft from the poorest by the wealthiest. Why don’t Democrats ever rail about this on TV? All I ever hear about is how Republicans want to enrich 2/10th of a percent with the Estate Tax repeal.

JimB June 29, 2006 at 11:05 am

If you’re savvy, you’ll get the “worst” financing deal (make sure there’s no prepay penalty) which lowers the cost of the vehicle the most — then immediately refinance (or better yet, pay for it in cash) thereby short-circuiting the game. I’ve done this with several vehicles and it’s worked great.

JimB June 29, 2006 at 11:55 am

Vince – Enrich? A tax repeal is returning what is rightfully yours, not creating new wealth. Talk about Orwellian … And the “richest 2/10″ is basically everyone right now. Properties and land and businesses are many times far, far in excess of the limits even for medium income-earners.

David Spellman June 29, 2006 at 3:03 pm

The crying shame about all this is that I have a perfect knowledge of how the financial shell game works but I have too much of a conscience to make a fortune by participating. At the end of my life, I hope I feel content to be a poor moralist rather than a rich sociopath.

billwald June 29, 2006 at 9:30 pm

“(inflation) is a theft from the poorest by the wealthiest.”

No, it is theft by the middle class who can pay off loans with cheaper money. The wealthy don’t have outstanding loans only the pseudo wealthy.

Inflation hurts the coupon clipping wealthy.

I suppose a libertarian who uses a credit card is as dishonest as the evil bankers for creating money out of thin air?

banker June 29, 2006 at 11:15 pm

Actually, inflation hurts poor people who are not exposed to Fed intervention in capital markets. One cannot consider the effects of inflation without first knowing where the new currency is being injected into the financial system.

This is akin to droping a rock in the water and watching the water ripple outwards. Rich people would be close torwards the center and poor would be on the outside. Don’t you hear people complaining about the disconnect between normal people and the robust economic data?

cynical June 30, 2006 at 12:38 am


You actually think inflation helps any so-called class in the long-run? I think it is easy to see that it makes production more difficult and inefficient, costing virtually everyone via a relatively lower standard of living.

Inflating the money supply, as a means to supposedly control interest rates and stimulate (or “cool down”) the economy, is such an inherently unstable process that even the idea of doing it should be ridiculed by everyone. Instead, it is condoned and there is an entire “professional” class of policy punks that get away with this harmful nonsense.

M E Hoffer June 30, 2006 at 12:48 am

From a Financial sense, banker gets the effects correct.

But, Inflation is not practiced for solely Financial gain. It is the ultimate lever of Economic [remember, Economics came from Political Economy] control.

Chris Donabedian June 30, 2006 at 1:25 am

I am an Austrian and oppose the existence, let alone the monetary expansion of the Fed. But there is nothing inherently wrong with financing a car, and consumer debt is not an inherently evil thing. The basic economic concept of opportunity cost indicates that any given consumer might be much better off in fact leasing or financing a purchase with debt, and using his cash otherwise, as you have noted. If that consumer happens to be an astute investor, he could invest the cash and perhaps do better. He might launch a business with his cash and use the car as his company car. “Securitization” is also certainly not an inherently negative concept. Indeed, if the Fed did not exist at all and we had a pure gold standard, more than likley there would be even MORE of these types of securities traded (different, but probably more types). Cars are depreciating rocks. For some it makes perfect sense to use a short-term lease, and leave the later year, unpleasant phase of constant repairs and car problems to those who are most eager to buy at that stage. Productive entities make a decision as to where they should allocate their capital most efficiently, and quite often it is more efficient to lease a car (or a machine, or whatever) and use the cash otherwise, such as for a longer-term, higher return asset purchase, oro to acquire another company. Even in a totally free economy, there will be those who wish to lend at any given time, and those who wish to borrow. Please continue to attack the Fed and its inflation, but do not make the fallacy of attacking or snearing at things like “securitization” as if it was categorically a bad thing.

Fabio Gallazzi June 30, 2006 at 5:08 am

“Securization” is a a way to delay a Ponzi’s Scheme outcome. We now have unreal profits based on a desappeared purchasing power…

banker June 30, 2006 at 8:14 am

Why bother saving if you can only get a paltry 1% return on a money market account? Can you imagine the horrendous risk someone has to take on just to get a decent return above 5%? And policy pundits are complaining about the low savings rate and how government should fix it.

What should throw people off is how there is an investment boom in capital markets (esp real estate) while no one is saving money. Price goes down (interest), demand for capital goes up (people buying houses, etc), yet savings is low? Something is amiss hear and probably has something to do with the oracles of oracles, Mr. Greenspan.

Vince Daliessio June 30, 2006 at 8:40 am

Jim B said;

“Enrich? A tax repeal is returning what is rightfully yours, not creating new wealth. Talk about Orwellian … And the “richest 2/10″ is basically everyone right now. Properties and land and businesses are many times far, far in excess of the limits even for medium income-earners.”

I should have put “enrich” in quotes. I don’t think the government should tax anything except the profits and salaries of its vendors. Ha!

Vince Daliessio June 30, 2006 at 8:47 am

billwald sez (quoting me);

“”(inflation) is a theft from the poorest by the wealthiest.”

No, it is theft by the middle class who can pay off loans with cheaper money. The wealthy don’t have outstanding loans only the pseudo wealthy.

Inflation hurts the coupon clipping wealthy.”

You are arguing without facts, Bill. I presented my facts – my poor (non-welfare-consuming) family was harmed greatly by Nixonian / Burnsian inflation. We had no debt because we couldn’t get anyone to lend us money. Inflation destroyed both the value of our savings AND our necessity purchasing power. You counter that it harms the “coupon-clipping wealthy”. Obviously it harms everyone except mass debtors and the people who profit (bankers).

Mark Brabson June 30, 2006 at 4:33 pm

As Rothbard so succinctly put it, inflation harms everyone, EXCEPT the first receivers of the new money. It harms most the very last receivers of said new money.

First new receivers, government and banks, both of which benefit greatly.

Last new receivers, tend to be the non welfare poor and lower class in general, so obviously they are harmed the most.

M E Hoffer June 30, 2006 at 5:03 pm


That may be true from the short-run Financial perspective, though, could you give an example of a political organization that has endured its experiment with Fiat Currency?

The appeal, and thereby, the Danger of the Fiat regimes, is that there are indeed those, pretended, able to outrun the consequences. I imagine that the Warden of Sing Sing is comparatively better off than the inmates, but he still works at a Jail, no?

Has there been a Fiat regime that has not led to the utter rot and decay of its Host?

I wonder, funny enough, how many will remember, over the weekend( into Tuesday ) that one of the prime reasons the colonists told King George to take his Lobsterbacks, and his great need of revenue to satisfy the Bank of England, to Blow, was that they wanted the power to issue their own currency(again). Imagine!~ Willing to Die, to be free of the perversity of Fiat! They knew well, the simple political triangulation of Patrick Henry: “Liberty or Death.” Noone escapes the penitentiary that is the Fraud of Fiat.

Mark Brabson June 30, 2006 at 8:32 pm

M E Hoffer,

The effect of inflation as described is the short run effect, I agree with you on that.

I fully agree that fiat money cannot be successful over the long term and that the fiat system will eventually collapse at some point. All previously attempted fiat systems over the years have ultimately collapsed.

The only solution is commodity money, preferably gold. Of course, along with that would necessarily require that abolition of central banking and a 100% reserve requirement.

I have pondered the issue for a couple of days from the other blog thread and I think that it would be a good step to dispense with the term “Dollar” altogether. When the switch over to commodity money occurs, gold coin should be labelled only with its weight in gold, for example, one ounce. Likewise, banknotes should read thusly..

“This Certifies that the Bank of Central Florida has on deposit Ten ounces of gold coin, Redeemable on Demand.” or whatever the case may be.

I believe at one time the dollar represented 1/20 of a gold ounce, but the dollar is too long gone to attempt to tie to any reasonable amount of gold. Best to simply dispense with the unit altogether.

As for the problem of foreign currency. Simply refuse to accept foreign fiat money and demand all foreign payment in gold bullion or coin. The simple refusal of the U.S. to accept foreign fiat money will accelerate the collapse of the international fiat system.

M E Hoffer June 30, 2006 at 9:11 pm


For sure, Central Banks and fractional reserve banking can join Fiat Currency in the ashbin of history.

The rest of what you lay out seems eminently rational to me.

The sure trick, of waking our fellow travelers from their slumber, steadfastly remains.

Mark Brabson July 2, 2006 at 9:00 pm

It is a difficult concept to impress on people, unfortunately. Of course, most people are totally apathetic to the subject. Then there are those that are interested, but have been taught in the government school system so they have a totally flawed understanding of economics and little or no concept of central banking versus 100% banking. Trying to convince someone in the breakroom at work or over a coffee table has little chance of success. If you can convince them to sit down and read one of Rothbard’s works, then it is a completely different story. An therein lies the problem. It is very difficult to verbalize in a short period of time the complexities of the whole monetary/banking system. Rothbard did an incredibly good job of laying out in his many volumes, but trying to get most people to read even a small book is almost impossible these days. So, how do we convey our message???

Paul Edwards July 2, 2006 at 10:14 pm

“As Rothbard so succinctly put it, inflation harms everyone, EXCEPT the first receivers of the new money. It harms most the very last receivers of said new money.”

I think another very interesting recipient of benefit from inflation is the exporter. As it turns out, the forex markets anticipate a domestic inflation and discount the currency quickly. The domestic markets react to inflation much slower. The result is, while exported goods become more attractively priced to foreigners, and hence sales increase, and profits increase, domestic prices adjust slower and so there is a net benefit to exporters. Cool huh?

M E Hoffer July 3, 2006 at 3:43 am


try pictures, for starters: http://www.itulip.com/realdow.htm




And, with this book: http://mises.org/store/Whatever-Happened-to-Penny-Candy-with-Study-Guide-P303C0.aspx

you may be able to appeal to their sense, if any, of responsibilty to their kinder.

And, Paul, is correct, of course, that anything by Rothbard will lay bare, in concrete terms, the wonderful Wally-world of willy-nilly Fiat.

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