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Source link: http://archive.mises.org/7780/depression-risk-might-force-u-s-to-buy-assets/

Depression risk might force U.S. to buy assets

February 14, 2008 by

As the credit bubble unravels, will the bad debts be written off, resulting in a debt-deflation spiral? Or will central banks do everything within their power, including the use of “unconventional methods” to prevent asset prices from falling? I suggest the latter outcome. The benefits to a deflation are deferred and dispersed, and require a considerable amount of pain first; while the benefits of bailing out financial institutions are immediate and concentrated. With 70% of Americans owning homes, public opinion generally favors rising, or at least not-falling home prices. It’s hard to see any political figure making a case for letting the system wash out and find its own leve.

Reuters reports :

    Fear that a hobbled banking sector may set off another Great Depression could force the U.S. government and Federal Reserve to take the unprecedented step of buying a broad range of assets, including stocks, according to one of the most bearish market analysts.

    That extreme scenario, which would aim to stave off deflation and stabilize the economy, is evolving as the base case for Bernard Connolly, global strategist at Banque AIG in London.

and
    “Avoiding a depression is, unfortunately, going to have to involve either a large, quasi-permanent increase in the budget deficit — preferably tax cuts — or restoring overvaluation of equity prices,” Connolly said on Monday.

    “If conventional monetary policy is not enough to produce that result, the government may have to buy equities, financed by the Fed,” Connolly said.

    Legal changes would be needed to give the Federal Reserve and the U.S. government the authority to buy stocks. Currently the Federal Reserve can buy only debt issued by the Treasury, as well as U.S. agency debentures and mortgage-backed securities.

    While Connolly already sees some parallels with the 1930s, he expects that a more pro-active central bank and government will probably help avert a repeat of that scenario today.

    The build up of a credit bubble in recent years was similar to the late 1920s run-up to the Great Depression, he said.

.and the Wall Street Journal writes, Worried bankers seek to shift risk to Uncle Sam:
    WASHINGTON — The banking industry, struggling to contain the fallout from the mortgage debacle, is urgently shopping proposals to Congress and the Bush administration that could shift some of the risk for troubled loans to the federal government.
.

{ 9 comments }

Taylor February 14, 2008 at 10:13 pm

G-Men on the boards of major US corporations?

Hahaha! Well, just more baby steps towards outright totalitarian fascism, not that the system isn’t already incredibly fascistic as it is.

George Reisman talked about how dangerous it would be to have the government buying up large tracts of major US corporations when he was criticizing some Social Security reform plans which would have the government invest SS money into the stock market to earn a higher return on the money.

I wonder how long it will take people to realize that THEY’RE paying for the higher asset/stock prices that the Fed is “financing” with THEIR tax money?!

TLWP Sam February 14, 2008 at 11:18 pm

Was the 1987 stock market crash one real-world test of the modern economy? If the 1987 crash didn’t do much was it because the costs were socialised with cash injections from the Government? If so, then depressions are associated with the gold standard because under a gold standard the costs can’t be socialised through inflation. Therefore is it unsurprising that many economic conservatives see downturns as ‘economic hangovers’ and it’s good if those who didn’t get involved in the bubble and prepare for the bust don’t get burnt?

Dennis February 15, 2008 at 8:42 am

Robert,

I seem to recall reading years ago that back in the very late 1970s or in 1980, Congress gave the Fed authority to purchase a wide variety of assets. As is often the case, the law had some type of Orwellian title, which I do not recall.

Maybe I am mistaken, or the law was subsequently repealed or modified. Can you or anyone else help clarify this issue?

Jake February 15, 2008 at 10:37 am

Ha Ha…Interesting. I commented on the same two articles on my blog. Glad to see I’m on the same wavelength as the clever people at Mises. :-)

I’m still a novice armchair Austrian Economist. Maybe someone can critisize what I wrote to see if I’m on track to become a fully fledged Austrian Economist?

http://freethemarketman.blogspot.com/2008/02/whore-of-world.html

http://freethemarketman.blogspot.com/2008/02/how-to-socialise-risk.html

eric lansing February 15, 2008 at 11:44 am

didn’t Japan try this to no avail?

and if the US tried this, they better hope that Americans and the rest of the world continue to use dollars to settle transactions.

billwald February 15, 2008 at 11:44 am

The government has the most computer power in the world and is planning to build the biggest machine in the world for spying on us. If it was reconfigured for technical trading the Fed could end up owning the whole world.

Dennis February 15, 2008 at 8:05 pm

I think I found the answer to my question.

According to Jerome F. Smith on page 37 of his 1980 book, The Coming Currency Collapse: “Under the Monetary Control act of 1980 the Fed is empowered to reduce reserve requirements still further and, for the first time, is further empowered to purchase and monetize debt securities issued by private corporations, banks, municipalities, states, etc.”

However, I do not know if this law was subsequently repealed or modified.

Daltica February 16, 2008 at 10:46 pm

This is exactly what the Contrarian Investors’ Journal says in Recipe for hyperinflation. The more the Fed tries to fight deflation, the more likely hyperinflation will be the outcome!

Dennis April 16, 2008 at 6:20 pm

In reference to my above two comments, I am currently re-reading Rothbard’s “The Case Against the Fed” (copyright 1994) and on page 132 he states:

“Over the years, all early restraints on Fed activities or its issuing of credit have been lifted; indeed, since 1980, the Federal Reserve has enjoyed the absolute power to do literally anything it wants: to buy not only U.S. government securities but any asset whatever, and to buy as many assets and to inflate credit as much as it pleases. There are no restraints left on the Federal Reserve.”

Given the 1980 date cited by Rothbard, I am assuming he is referring to the Monetary Control Act of 1980.

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