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Source link: http://archive.mises.org/7053/the-party-is-over-again/

The Party is Over – Again

August 30, 2007 by

From the housing bubble to the latest brief upward explosion in the stock market, we are now faced with the hard reality that there is no place for this huge wad of cash to go. It is not the case that we have a “liquidity problem” because there is no money to lend; we have a “liquidity problem” because the outlets for borrowed money have shrunk drastically.
It now seems that the authorities have learned nothing from the financial disasters of four decades ago: they are determined to make the rest of us repeat them. FULL ARTICLE


Harry Valentine August 30, 2007 at 9:17 am

Its perhaps a forgone conclusion (to economists of the Austrian School) that the US housing market will undergo a meltdown. At the same time the US Gov’t will have spent at least US$0.5-billion on the incursion into Iraq. Perhaps a major economic upheaval may be unavoidable in the US within the next few years.

Anthony August 30, 2007 at 9:21 am

Good article, thanks for putting it up.

Person August 30, 2007 at 9:57 am

“We can forget about a 14,000-point Dow for a long while,”

Hm, can we quote you on this? What’s a “while”? Want to bet money on it? Have you bought puts on Dow ETFs?

Mark August 30, 2007 at 10:29 am

we have a “liquidity problem” because the outlets for borrowed money have shrunk drastically

Could you please be more specific what you mean by this.

Steve Farrell August 30, 2007 at 10:34 am

Thank you for the economic tour and insights.

David C August 30, 2007 at 10:47 am


“Hm, can we quote you on this? What’s a “while”? Want to bet money on it? Have you bought puts on Dow ETFs?”

Somebody has:


Eduardo August 30, 2007 at 11:12 am

The problem with this article, and all the similar ones, is that they equal things with money.
Mr. Anderson correctly points out the blame on the Fed and the fractional reserve system. Then concludes that the stock and housing markets are headed to a meltdown, that business will not be as usual.
IMHO that is not correct. We all agree that this system produces malinvestments, but not all investments are wrong.
People will always need transportation, housing, clothing, food, etc. When the dollar becomes worthless, it will mean that to pay for everything you will need lots of those pieces of paper, but the goods will still be needed and traded.
So, the stocks that represents for instance a motgage company will be worthless, but those of a food processing company will be worth lots of dollars, or whatever money people will prefer. The market, if let alone, will weed out the malinvestments, but the rest will continue producing and trading.
As for the housing market, as long as there is oversupply of houses built, they will tend to diminish in dollar value. But as long as the dollar continues in its path, it will mean that more dollars will be needed for the same house. depending on the magnitude of each, will the price of a house fall or rise.

In conclusion the meltdown will happen wherever a malinvestment was made, but not everywhere. The stock and housing markets encompass so many things that it is not wise to treat each of them as a unity.

David C August 30, 2007 at 11:28 am

“”we have a “liquidity problem” because the outlets for borrowed money have shrunk drastically”"

“Could you please be more specific what you mean by this.”

The Fed doesn’t just print up money, they print it up and loan it out. Eventually society becomes over saturated in debt, and cant afford to borrow any more even if they desperately want to. For the last 60 years, their print-it-up and loan-it-out philosophy always supplied plenty of fresh cash to people who wanted credit. While we had the occasional slow down and recession, it was never enough to clear the excessive debt out of the system to a prior point. There was always room in the economy for more credit. That constant credit, and the fact that the fed bails out failed banks that can’t pay of their lenders sent the market the message loud and clear that they could recklessly use debt and leverage to make profits. If one of your big lenders couldn’t pay you – no problem the fed gots it covered, if the economy slows down – no problem, in due time the Fed will start loaning out even more money and they could use that new credit to cover their prior losses.

This system appears to work until society can’t absorb any more debt. Then the Fed has a problem. In fact, this time they can’t even print money because printing money will drive up prices before it drives up pay – making it even harder for a maxed out society to pay down debts. (note, they appear poised to try even as I speak, God help us if they do – we will have a currency panic and a great depression at the same time)

Keep in mind that BoA alone has 8T in derivatives contracts, JP Morgan 40T, interest rate sensitive total 23T, and generic derivatives are over 400T. With the US GDP at 12T, the Fed can not bail them out without completely destroying the dollar. If I owe a million, and somebody owes me a million – in theory my net liabilities are zero, but in practice I am as liable as the weakest link in the chain. IMHO, people would be wise to take physical possession of all their money (and take possession of the stocks you want to keep) and put a good portion of it in gold because all freaking hell is about to break loose.

Paul Marks August 30, 2007 at 11:35 am

It is impossible to make some sort of scientific prediction about where the Dow will be by the end of the year – in part because we do not know how much funny money the Fed will throw (in various complex ways) at the financial system. That is what “inject liquidity” actually means.

These vast subsidies (for that is what they are) are the ultimate form of “corporate welfare”, directed at the circle of financial industry enterprises and (via them) favoured non financial industry enterprises and individuals.

As F.A. Hayek was fond of pointing out, the money supply is not like gushing water rushing everywhere at once (which is how the Chicago School tend to see it) with say a ten per cent increase in the money supply meaning that everyone finds that they magically have ten per cent more Dollars in their wallet, but more like “treacle” that piles up in mounds in certain places.

Typical places for these mounds for the new credit money are the stock market and the real estate market.

Distortion of the capital structure (malinvestments), and lots of important politically connected people with sticky, sweet smelling fingers.

Borrowing should be 100% financed from real savings (i.e. income that people have chosen not to consume), not (government backed) book keeping tricks pretended to be “savings”. But that is not the “modern” way.

Every credit money expansion boom leads to a bust.

Or does it?

What is being tested now is the “mainstream” thesis – i.e. the idea that when the bust eventually comes the government (via the Fed) can “save the economy” by pumping in (via various complex methods) yet more credit-money.

The “mainstream” thesis is going to be tested to destruction (which will please “mainstream” economists who believe the subject to be an empirical rather than a one based on reason). The economy is not going to be allowed to have a bust – more and more money is going to be thrown at the financial system to prevent it.

And some will see what happens to the economy over the longer term (for “in the long run we are all dead” does not apply to most people if the “long run” is a couple of years).

In case anyone thinks that things are better in Britain or the Euro Zone – forget it, the money supply credit bubble growth in both Britain and the Euro Zone is worse than that of the United States (and has been for years).

Daniel M. Ryan August 30, 2007 at 3:31 pm

Here’s a short P.J. O’Rourke-esque summary of Say’s Law for your consideration:

- If production is for use, then the resultant supply of X implies a demand for X.
- If production is for exchange, then the resultant supply of X implies a demand for Y (or Z, or whatever the fella get get for the X.)

To sum up: Say’s Law says no-one produces just for the hell of it.

banker August 31, 2007 at 12:29 am

A good metric for credit conditions would be looking at real estate prices in Manhattan. That and the bonuses being paid out. When layoffs hit Wall Street, then we will know for sure that we are in a full fledge credit implosion/recession.

Can’t make money if you can’t loan money, right?

moon cake August 31, 2007 at 1:41 am

Thank you for the economic tour and insights.

JIMB August 31, 2007 at 10:17 am

Chinese don’t hold dollars, they hold dollar debt, and their central bank buys additional dollar debt with dollars they receive from Chinese exporters to the U.S. and they buy additional dollar debt with freshly printed Yuan to fix the price of the Yuan to the dollar. That keeps the Chinese export machine running. That will work only if our Fed doesn’t run money policy that outstrips the gains from Chinese labor and talent, because then the “derived demand” for resources from Chinese production will push prices up (such as oil, etc). It has the side effect of hammering labor for a period of time – but that will structurally reverse (painfully for investors) as those gains come to a close at some unknown point in the future and inflation can’t be stopped without far higher interest rates.

This is also not a liquidity crisis as much as a net worth crisis (maybe 10% is a liquidity crisis). A liquidity crisis is when good assets are marked down because cash is hard to find. This has more to do with the collapse of structured mortgage finance (lower rated tranches – essential to getting the higher rated tranches done – are finally seen for what they are) and also the inability to know what obligations (since they are off balance sheet) say Countrywide has for repurchase obligations (to make their past structured finance vehicles whole) plus the deterioration of their loan performance they have on portfolio from mispriced loans.

No amount of new liquidity will repair a fundamentally unsound asset once investors decide they don’t want it. The money will flow elsewhere. Hence the recent “Bush bailout” to force you to pay for bad loans.

Eric September 2, 2007 at 1:43 pm

Good article.

My question is this. What is the actual level of “price” inflation? From what I can tell, just by the grocery store prices and the few other items I purchase (gas for my car, electricity, etc.) there hasn’t been nearly as much price inflation as I would have expected given the amount of money inflation that has occurred – or so it seems.

So, let’s see, mitigating factors can be, a) Someone is holding onto the new money being created (like hording it under their mattresses) or b) the dilluted money is able to purchase the growing supply of new stuff there is to buy in near equal proportion.

Have I left out anything? Will we see a repeat of 17% mortgage rates that I remember in the late 70s when I was getting cost of living raises of 10-15% a year?

IMHO September 4, 2007 at 4:10 pm

Thanks for a very good article. I appreciate your explaining about Keynes. It gave me some insight as to why they redistribute wealth to the poor.

david December 25, 2007 at 12:15 pm

It seems the party is not over, it has gone into overtime, including the recent Santa Claus rally. The fed has brought more punch and we are in an after party, and if people are beginning to feel hung over, need not worry, the fed can pull out all the stimulants to let you keep dancing and partying well after dawn.

Netbook manufacturer June 17, 2009 at 11:04 pm

nice,like it

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