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Source link: http://archive.mises.org/6987/moral-hazard-yes-weimar-not-yet/

Moral Hazard? Yes. Weimar? Not yet.

August 15, 2007 by

A little clarification of the confusion surrounding the recent massive central bank intervention in the markets might be in order.

Yes, multi-billion cash injections have been taking place: no, this does not mean a return to the 1920s – not yet, anyway – since the bulk of these extra funds have already been withdrawn in the subsequent money operations undertaken as the original loans (strictly, repurchase agreements) have expired.

Of course, the CBs now face the nice problem of weaning a (rightly) fearful and vastly overstretched market off the dripfeed on a more permanent basis and, granted, this has greatly reduced the possibility of a more restrictive policy being implemented in the near future, but that is still not to say that we can take the sum of announced liquidity injections and immediately construct some scary multiple of new M2 or M3 which will be the enduring result of their recent actions.

They are therefore attempting to stop a bank run (strictly, a NON-bank run) at present, not running the printing presses in any sustained fashion.


Person August 15, 2007 at 10:49 am

Isn’t their latest injection the same way they normally add money to the system? How does it differ from “normal” “running the printing presses in [a] sustained fashion”?

corrigan August 15, 2007 at 4:08 pm

Exactly because it isn’t being sustained – at least not in the huge size which is being uncritically bandied about

MikeM August 15, 2007 at 7:22 pm


So what they are doing now would be akin to loaning enough money to a bank so that it could survive a bank run? Then once the panic has subsided, and all of the bank’s customers got the money they demanded, they would feel confident that everything was OK and deposit their money again. At this time, the bank could repay the temporary loan and the money would be removed from the economy. Is it basically a way to temporarily mask the underlying insolvency of the system?



Only size matters. August 15, 2007 at 9:15 pm

The only thing saving the economy at large is simply the vast size of the economy. The CBs can screw them up that bad on a small issue of too risky lending.

olmedo August 16, 2007 at 5:24 pm

when central banks open these humongous “repos” at artificial rates they are doing nothing more than to subsidized the interest rates below their real values and therefore, creating money not with the printing presses but with the banking system loaning mechanism.

it is the same as stablishing a shop right beside yours where they sale groceries at below market prices so that you cant keep them higher, the only problem is that government can not print milk and vegetables as easily as “repos”.

for any practical porpuses, it is just the same as printing money


ronmck August 18, 2007 at 11:51 pm


You were right while the Fed was just buying three day repos.

Does the reduction in the discount rate change the situation. Commentators are now saying that the Fed is creating high-powered money.

We really need a good Austraian analysis of the current crisis and the Fed’s ressponse. Are you up for it?


corrigan August 19, 2007 at 1:53 am

Well, clearly, the ball game has changed as the panic has spread. ——————————– Cutting the new-style discount rate (effectively a ‘proper’ European-style Lombard rate) and allowing for loans of up to 30 days is a significant step towards a process of monetizing falling asset prices and attempting to shore up the system ————- One of the main problems they face, however, is that the most exposed sectors will be found among the non-bank actors – hedge funds and specialized lenders which rely upon access to wholesale finance. —————— Many of these have been funding one another, essentially, in a credit spiral which is now unwinding. ————- The major banks will only be hit by this to the extend that their own (theoretically over-collateralized) loans and agreed back-up credit facilities to such actors also begin to go sour, though some of their ostensible risk reduction has come through buying protection from these very same institutions least likely to survive the turbulence. ————————————-
Real estate exposure of US regional banks and Savings & Loans could be another matter, especially if commercial real estate gets dragged into the vortex. ——————————–
Don’t get me wrong, I have been warning clients in writing, in conference presentations, and face-to-face with increasing stridency this past year-and-a-half that the credit bubble was responsible for all other asset classes rising so rapidly that it was distorting real-world economic activity and that it would be very ugly when it burst—————– I also fully expect the central banks to degenerate to taking ‘unconventional measures’ if need be – i.e. monetizing anything they can identify, tangible or otherwise, and so they will be disturbing the Ghost of ole man Gutenberg. ——————- My point last week was the dual one that they hadn’t then started on that in earnest and that old-style banking fractional reserve multiplication arguments are not, in my opinion, of much relevance to the way the modern financial system generates inflation.

RogerM August 19, 2007 at 10:11 am

corrigan: “…old-style banking fractional reserve multiplication arguments are not, in my opinion, of much relevance…”

That’s a very good point. I’ve been reading a lot of economic history lately and it seems to me that we’re closer to the way finance worked in the middle ages when gold was money. Back then, bills of exchange worked like money and expanded the effective money supply dramatically, up to 15 times the amount of gold in circulation. Bills of exchange we nothing but businessmen loaning each other money. Several disastrous financial/economic collapses happened in the 18th century as a result of the pyramid of bills of exchange.

Today, the Fed controls banks, but bank lending is roughly one third the total lending market. That may be why the Fed couldn’t control the money supply in the 1980′s. Large lenders like GE Capital, hedge funds, and other large financial institutions can expand/contract credit at will. The Fed has some influence in determining the “risk free” rate on which other lenders “anchor” their rates, but little direct control.

Even Greenspan at times acknowledged the Fed’s impotence when he described lower interest rates as “pushing on a string.” The Fed has often lowered rates dramatically only to find itself feeding inflation without without helping the real economy. That happens when so many businessmen face bankruptcy that most begin to build cash reserves and pay off debt. At that point, banks could offer negative interest rates and no one would borrow. Then there is nothing left to do but wait for the bad news to slow down and confidence begin to rebuild, but not consumer ocnfidence, business/investor confidence.

ronmck August 20, 2007 at 2:13 am

“Pyramid of Bills of Exchange”. Makes sense.
Can you provide references to where this process is described. The textbook descriptions seem to be difficient.

RogerM August 20, 2007 at 7:21 pm

ronmck, I got my info from Fernand Braudel, the famous neo-Marxist historian. You have to ignore his conclusions, but his detail is fascinating. In the series “Civilization and Capitalism, 15th-186h Century”, vol 3, “The Perspective of the Word”, pages 243-248 has the material on bills of exchange and credit. Then pages 267-273 go into the financial crises of the 18th century. He even ties the crises to credit to some degree: “Beginning in the 1760s, the might Dutch system experienced several serious and incapacitating crises: crises which all resemble each other and appear to be connect with credit. The mass of commercial paper [that is, bills of exchange, RM], the total sum of ‘artivicial money’, seems to have enjoyed a degree of autonomy vis-a-vis the economy in general, but there were limits which could not be overstepped.” (p. 267)

Braudel hates capitalism, though he defines it as big business only, and he never mentions Mises or Hayek. But some facts are too obvious for even an old Marxist to escape.

ronmck August 21, 2007 at 1:16 am

Thanks Roger

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