Mr. Murphy,
I would think that you would know better than make this statement. “People didn’t seriously consider the testimony of the tobacco company CEOs about the nonexistent dangers of smoking, because everyone knew those executives stood to lose billions from the settlement.” It was not the tobacco companies that lost billions because of the settlement it is the consumer that altimately pays the bill. Before the settlement a carton of cigarettes was $17 it is currently $48.

Great article, but I’d consider clarifying the following parenthetical for non-regular readers:

“Perhaps the big banks have to set up subsidiaries owned by minorities and women who get preferential treatment in the bidding process. But whatever the ruse, they will find a way to justify the low prices.”

To someone stumbling in here seeking answers, the above sentence could cause them to dismiss the entire article as cold-hearted at best and racist at worst, which would be a huge shame.

There’s an excellent and larger point to be made there, but without the proper context it sounds unduly harsh. I’d consider either expanding on this point to briefly explain the perverse effects of government programs sold as well-intentioned to the American people and congress, or dropping the parenthetical entirely.

I’m guessing that the spike in traffic to LewRockwell.com is being mirrored here, and as such you’re probably receiving new viewers that aren’t familiar with the nuances of these arguments. It might be wise to be attentive to the idea that these new readers don’t take for granted the fact that programs designed to help the underprivileged are often counterproductive and subversive, and that you’re not actually deriding ownership by minorities and women.

Tim,

Give Mr. Murphy a break.

He and Mr. Landsburg probably watched too many Christmas Season re-runs of “It’s A Wonderful Life” when they were young and impressionable. He overlooked the Landsburg error.

Mr. Murphy should have quoted — or written himself — about OTA rather than OPM.

I cringe each December when the gullible, again, are fed the OPM lie. Did the FED fund that movie?

It just ain’t so in a Fractional Banking environment.

Alex: “That is, people and financial intermediaries have reduced the amount of risk they are willing to take on to such a degree that normal businesses are having trouble financing their current assets.”

The problem is two-fold. 1) With housing prices falling, the value of mortgage-backed assets of banks have fallen as well. Those losses come out of banks’s reserves, which reduces their ability to expand the supply of fiduciary (counterfeit) money through fresh lowns. 2) When businesses default on loans, the bank can’t turn around and reloan the payments. Those losses also come out of reserves. If reserve requirements are 5% and reserves have fallen below that level, banks can’t loan any new money.

A good analogy of the fractional reserve banking system is a rubber band. Increased savings makes the rubber band larger, but fiduciary money only stretches the rubber band and makes it appear larger. However, a couple of defaults will cause the rubber band to snap back sharply and the supply of loanable funds shrinks.

Ever since the beginning of the banking school with John Law and the Mississippi bubble in Paris of 1720, businessmen and politicians have blamed financial distress on a shortage of money, or liquidity today. There is some truth to that because the money supply shrinks quickly when businesses default on loans. But they shouldn’t have had those loans in the first place. Loans should come from the savings of others, not from creating money out of thin air. The money shortage is caused by the disappearance of the counterfeit money, and the destruction of some savings through malinvestment.

As Milton Friedman believed, most people today think that the bubble is normal and the recession is abnormal. As a result, they believe that every businessman has a God-given right to loans anytime they want and at the interest rate they want. But no one has a right to a loan. The owners of savings have the right to loan money at interest they see fit. Businessmen have the privilege, not the right, of borrowing that money. If savings have fallen because businesses wasted the money in bad investments, the remaining savers will demand higher interest rates for their savings in exchange for the greater demand and risk.

Credit has not dried up. It has only become more expensive because savings have been wasted on bad investments and because the fiduciary (counterfeit) money has evaporated. Banks and businesses with good credit can borrow all the money they want if they’re willing to pay the higher interest rates. If businesses must have cheap credit to survive, those businesses are poorly managed and should fail. Pumping more fake money into the economy will do nothing but keep alive failed businesses and increase prices.

Mr. Murphy

It has been a while since this summer at Mises and I have found myself at a university studying public policy where the closest thing to an Austrian is a neo-con. When arguing against some of these people concerning this bailout what are some points that I should make to them without referring them to read Man, Economy, and State? Also, how much should I be willing to listen to “market failures” as justification for government intervention?

Great article by the way.

Babel

Erik,

The problem is not that the Fed is a pseudo-private organization. The problem is that it is a government mandated monopoly. If the currency were “re-established as a Federal Government activity”, i.e. made a true government monopoly, things would be the same or worse. The plundering will only stop when we have a true market-based money and a free, not cartelized, banking industry. Only then will power of money creation not be concentrated in the hands of a few who will certainly use it for their own ends.

Eric,
Yes, in the passage you quoted Friedman sounds very Austrian. But Friedman specifically wrote about Austrian econ and criticized the Austrian Business Cycle. I saw an article about it on this site, I just can’t remember which one. Roger Garrison talks about Friedman’s views in his text. Friedman used the analogy of a string to describe how he saw cycles. He saw economic growth as a straight string with depressions as dips in the string as if someone had plucked the string down. In other words, no bubbles exist. All growth is good and normal. Only “plucking” the economy from its normal growth pattern exists. The cause of that plucking might be that workers realized they had been fooled by higher nominal wages while real wages fell, so they asked for more money. Friedman saw the solution to such plucking as more monetary pumping.

The essence of the ABCT is not price inflation as it was with Friedman, but capital distortions. Monetary pumping distorts the natural relationship between the production of capital goods and consumer goods. That distortion will cause a depression even if the Federal Reserve does nothing.

It is entirely possible that the central bank is drying up credit to help force the bailout bill through Congress. They have done this before. That is one major problem with a central bank. There may be no competitors able to step in and fill that credit void, for a slightly higher fee, perhaps.

On the matter of money supply; if the rate of increase exceeds the honest rate of growth in the economy will there not be financial and economic distortions as a direct consequence and for certain?

On a different topic: the Baltic Dry Cargo Index, there has been a roll-back in the value from May of 70%.
How important is this index as a leading signal to a slowing of international commerce?

Eric: “I don’t see the things that he gets accused of saying, especially, here at mises.org.”

Friedman was one of the greatest champions of liberty in the 20th century, even if Austrians disagree with his economics. I would imagine that most of the criticisms of Friedman come from the anarchists who also criticize Mises and Hayek for not being anarchist. Rothbard was a brilliant economist and historian, but he did a great disservice to the cause of liberty by with his ethical system.

Eric: “But I also read Milton’s writings about the time that Mises stormed out of a conference after calling everyone there socialists, including Milton.”

As his wife would tell people, Mises had a bit of a temper. I believe Hayek was in the meeting, too. Mises was complaining about them giving in to inteventionist policies.

Eric: “There was a lot to like about Milton, even if he was not perfect.”

Exactly. And he moved economics much closer to Austrian econ than any other mainstream economist. Without Friedman, no one but Austrians would be talking about the money supply. Friedman made it a common topic of conversation.

Paul S. Nofs: “It is entirely possible that the central bank is drying up credit to help force the bailout bill through Congress.”

Another way to look at it is that the Fed can’t pump money into the economy without the cooperation of businessmen. Businessmen must borrow the money that the Fed is offering. Greenspan used to call the Fed’s dilemna “pushing on a string.” Bernanke may be thinking that Congress can do what the Fed can’t.

erik andersen: “On the matter of money supply; if the rate of increase exceeds the honest rate of growth in the economy will there not be financial and economic distortions as a direct consequence and for certain?”

It’s not just growth in the money supply exceeding the growth in the economy. It’s growth in the money supply beyond the growth in savings that causes the distortions. The whole point of the $700 billion bail out is to increase the money supply. Supposedly, banks will be able to sell stock and raise more capital if they don’t have these bad loans (or bad securities) on their books. The theory is that once they raise capital they will be able to loan money again, and those new loans will increase the money supply far beyond the level of savings. That sets in motion the business cycle. However, by the time this thing gets implemented, the economy will already be in a depression and few businessmen will want to borrow. Nothing good is going to happen until mortgage defaults slow to normal levels and housing prices quit falling. Congress can do nothing about either one, in spite of their hubris.

Fundamentalist:

In reply to my post, your statement to me: “Loans should come from the savings of others, not from creating money out of thin air.” got me scribbling. I have participated in the discussions before concerned the alleged fraud of fractional reserve banking, and, as you probably know from my past posts, I like numerical examples. I have always believed that if someone cannot give a simple numerical example to demonstrate an economic argument, especially with regard to the nature of banking, then we should be suspicious of the argument. Anyway, as I say, I started scribbling some numerical examples and came up with some stuff that supports your (the Austrian) position on fractional reserve banking.

I began to write the examples in a post and realized that it was too long for most readers to bother going through (especially since they have already bought the notions), but I would like to send the material to you for your comment. My e-mail address is macmilla@cogeco.ca. If you would like me to send the examples for you to look over, e-mail me. In any case, thanks for your catalytic remarks.

Rob MacKay asked:

“Is there any belief that things will turn around?

Even though there was a glimmer of hope during the down vote on Monday I fear it was nothing more than a passing fancy brought about by the impending election. The Senate vote today and the inevitable house passage of a bailout/theft bill later in the week seems nearly certain.”

It seems we have been officially Europeanized. The politicians keep taking the vote until they get the “correct” result.

There is indeed a liquidity crisis in our financial system. I believe Mises would say there is an increasing demand to hold cash.

In the face of a massive two-day run on its cash reserves by its account holders, Washington Mutual had no choice but to, in effect, liquidate.

Banks are seeking to protect their cash reserves by cutting back on lending to forestall runs by nervous account holders. If possible bank runs are a non-issue today, why has the increase in FDIC insurance to $250,000 proved so popular in the new version of the bailout bill?

As Mr. Kern points out, bank assets are leveraged to the hilt. Bankers are well aware of their vulnerability to a run on their cash. Just as in years past, it is still the nerve of the account holder that decides a bank’s fate and, ultimately, the fate of the house of cards that is our financial system.

The most any government intervention can hope to achieve is to temporarily satisfy people’s demand for cash by means of cash infusion into the system, deposit guarantees and ever increasing credit expansion. As Mises taught, the eventual crackup boom is inevitable.

And Mr. Landsburg is naive to believe that, if fractional reserve banking ended, the amount of credit available to borrowers would not significantly decline. His naivete is to assume that all bank depositors under the current system would be willing internet lenders.

How many depositors in our current banking system would remain willing lenders if they really understood the way our fractional reserve banking system “safekeeps” their deposits?

Hope folks here are still following this thread. I wanted to pick up on some of the comments about Friedman. It seems to me one of the beliefs underlying his monetary theory is a healthy economy needs some amount of inflation so the money supply grows at a rate that keeps pace general economic growth. What the money growth rate should be is difficult, if not impossible, to determine, so he famously recommended adopting a monetary rule — the growth rate of a small percent. The flip side of this view is deflation is always a bad thing.

Friedman’s views have been hugely influential. Indeed, can’t we say that Bernanke is following the Friedman playbook in responding to the current financial crisis? To Friedman, the cause of the Great Depression was a massive monetary contraction at its outset, and the Fed failed to respond by putting new money into the banking system.

Let me put the following question to this blog: Does economic growth depend on increasing supplies of money to keep pace?

Here’s a more specific question: To what extent, if at all, was Friedman right in blaming the Great Depression on monetary contraction?

KC

KC: “Indeed, can’t we say that Bernanke is following the Friedman playbook in responding to the current financial crisis?”

Yes, Bernanke has stated publicly that Friedman was right and the Big D was the Fed’s fault because the Fed didn’t pump money into the economy. But Friedman and Bernanke are simply wrong. Read Rothbard’s account of the Big D. Both follow a wooden interpretation of the quantity theory of money. They think that the money supply can grow any time they want it to. It won’t. All the Feds can do is buy bonds and lower interest rates. For the money supply to grow, businesses need to participate with the Feds and by borrowing money to expand production. If business confidence is low because wages haven’t fallen sufficiently, businesses won’t borrow and the money supply won’t grow.

In addition, the main factor in shrinking the money supply in the Big D was bank failures. People had lost confidence in paper money and wanted gold, but there wasn’t enough to cover all of the paper money that had been printed. That’s why FDR made holding gold illegal, which was an illegal and immoral act but everyone let the criminal go because he was so likeable.

But even it the Feds could have made the money supply grow, it would not have helped. Real savings had been destroyed in the boom. Fake money cannot replace real savings. The same thing happened in the recent housing boom.

Robert Murphy writes: “Austrian economists tend to be libertarians in their political views…”

I wish to challenge this assumption. Imagine someone who understands perfectly well that economic value is subjective and ordinal, and who understands the true nature and origin of money, and who understands the workings and consequences of fiat money and central banking, but is simply not interested in what this knowledge has to say about the nature of government economic and monetary intervention from an ethical point of view. Consider, rather, that there are many incredibly smart people who only care about this knowledge for how it can be used to serve their own interests.

I am no longer willing to concede any benevolent intentions at all on the part of political authority. I don’t believe for a second that John Maynard Keynes didn’t know he was just making sh** up that just happened to confuse economic issue in a way that just happened to serve the interests of the parasitic classes.

And while I believe Milton Friedman, at least for the most part, honestly believed his own economic theories, I believe he was only allowed the attention he got because he was profoundly wrong on the one issue the plutocracy really cared about: the tokenization of money.