If what keeps the economy depressed is too many toxic assets on banks’ balance sheets, then it makes sense to do whatever is necessary to remove those assets from banks’ balance sheets. Equally, it also makes sense to nationalize banks and force them to lend. We suggest, however, that what matters when it comes to economic recovery is the state of real savings. Contrary to popular thinking, it is real savings that fund economic activity and not bank lending. FULL ARTICLE
Source link: http://archive.mises.org/9722/would-cleansing-banks-balance-sheets-kick-start-the-us-economy/
Would Cleansing Banks’ Balance Sheets Kick-start the US Economy?
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“It is extraordinary that various commentators who are currently blaming the banks for refusing to increase the pace of lending and thus delaying economic recovery, were the first to accuse the banks for causing the present economic crisis by not practicing prudent lending.â€
Excellent point! The same people who griped about the lack of affordable housing before the crisis now complain about the falling price of housing, which makes housing more affordable. The hypocrisy is deep and completely ignored by the mainstream media.
While the recent stimuli and rescues by the state will not create a lasting recovery, combined with increased savings it will result in a brief recovery because of the growing pile of idle resources. This would be a good time to borrow as much money as possible to buy a house or start a business, because interest rates are low and the unsustainable recovery will begin soon and cause them to increase. In addition, the vast amounts of state spending and fed money creation will spark price inflation and reduce the real debt by half in the near future.
This is a good time to get into the stock market, too, because it will benefit from massive monetary pumping as well. But watch the Austrian business cycle carefully so that you can get out before the next bust! The important signal will be when the mainstream media put record profits at the top of the hour’s news.
Quote from fundamentalist: “This is a good time to get into the stock market, too, because it will benefit from massive monetary pumping as well.”
I wonder if they were saying that in Japan in 1990 (or on Wall Street in 1930).
“It is extraordinary that various commentators who are currently blaming the banks for refusing to increase the pace of lending and thus delaying economic recovery, were the first to accuse the banks for causing the present economic crisis by not practicing prudent lending.”
It’s not extraordinary in a Pragmatist culture in which mental compartmentalization is rationalized, justified, taught in schools as a learning method and morally encouraged.
geoih: “I wonder if they were saying that in Japan in 1990 (or on Wall Street in 1930).”
I could be wrong. Forecasting is difficult, but especially so when attempting it with the future. The US is different from what it was in 1930. A major problem at that time was that people wanted gold as money and had little confidence in paper money, so there was a huge rush to hold gold and not a little bit of hoarding. And regime uncertainty was high. It’s high today, but not as high as then. As for Japan, I think the difference is that our economy is more flexible and can adjust more quickly. I’m betting that what little space is left for entrepreneurs will enable them to overcome the destructive efforts of the feds. Plus, I’m betting that the financial crisis isn’t nearly as bad as the feds claim and was really an issue of bailing out Paulson’s buddies at Goldman Sachs.
Perhaps the President or Fed Chair or SecTreas could answer why, if these assets are so terrible that the banks (who bought them voluntarily) shouldn’t hold them, why the American public should be forced to.
I have come to the following conclusion: to nationalize the bank is logical only if your goal was to eliminate individual liberty and responsibility. In other words, if you believe in the notion that individuals ought to have their life run by a group of people or Plato’s philosopher-kings.
But something tells me that those advocating such action have not fully grasp such implications. I would even speculate that this is the major reason behind interventionism or pragmatism: the lack of philosophical basis (e.g.: individuals versus state, private gains and socialized losses). So ultimately, it boils down to a choice among different ideas, not whether some aspects of one idea can be combined with some aspects of an idea that has a different goal. I could be wrong, but it seems to me that as long as people fail to recognize such conflict, we can expect more of the same. This is probably what Bastiat, Mises, and Rothbard understood (Although it could be argued that Rothbard was more consistent than Mises when it comes to political organization).
As a regular reader of Shostak and Mises.org, there’s not a lot of new insight here. But, there is a gem in the article, not really new information, but something said in a new way:
In the case of fully backed credit, the borrower secures goods that were produced and saved for him. This, however, is not the case with unbacked credit. No goods were produced and saved here.
As a result of the unbacked credit, an additional demand for various goods emerges. This leads to an attempt at expanding the infrastructure of the economy. This attempt is bound to fail since the flow of real savings is not large enough to support the expansion of the infrastructure.
The attempt to expand the infrastructure leads to the diversion of real savings from various activities that make the present flow of real savings possible.
Consequently the flow of real savings comes under pressure and the rate of real economic growth follows suit. (Remember that real savings fund economic activity — not money.)
It all boils down to the same fundamentals. Llewellyn Rockwell, in my favorite quotation of the many I’ve read in these articles, said …
“You cannot make a country rich by looting taxpayers and paying people to pound nails into siding at public schools! These activities amount to capital consumption. They are not sources of investment. You can say that they are stupid tasks or wonderful tasks, but it is not a matter of ideology as to whether such public projects will make us all wealthier. They will not. They drain the sources of wealth from society. They represent a cost, not a blessing.”
Too many, with whom I argue, attempt to inject ideology. It has little or no place in passing tests of logic. Arguments can be based on only two things, … Facts and Logic. All other intellectual intercourse is BS!
Hey, come on youse guys, don’t you know that saving (hoarding) is the problem? That what is needed is an increase in the marginal propensity to consume by reducing people’s liquidity preference, which Obama is doing by restoring confidence (aka Faith)? If people can only be induced to start spending again the price of homes will stabilize, the stock market will recover, and all will be well in America. Say’s Law has been repealed; Keynes’ Law of gpvenmemt-assisted consumer spending, which when aided by strong government investment spells economic well being. Consumption generates employment, which in turn creates spending, which calls forth production, while government investment rebuilds the infrastructure thereby creating more jobs. Of course sufficient money must be created by the Fed and the fractional-reserve banking system in tandem with vigorous fiscal stimulus to sustain recovery and the subsequent growth that comes about through the well-known multiplier effect. This is all made self evident by the mathematical equation: S+IxO+P/R=C, wherein S is spending, I is government investing, O is president Obama, P is Nancy Pelosi, R is Harry Reid, and C is Cockaigne.
Dr Shostak has provided a lucid explanation as to the folly of “cleansing the banks”. Political interference in the economy resulted in vast sums of “money” having been loaned to high-risk borrowers whohad little collateral and little if any means by which to pay back these loans. Political interference in the money system that forces banks to lend money to high-risk borrowers will only worsen an already bad situation.
Great article from Mr.Shostak as always.
I could be wrong but i actually think the plan is not even going to work. The basis of an exchange is that it must be considered beneficial from both parties.
Is it beneficial to would be buyers of these assets, to borrow from the treasury, to buy toxic garbage at 80 cents on a dollar, and destroy their balance sheets?
Even worse, at 80 cents these assets offer little return, even if you assume the best case scenario possible, it will take years and perhaps a decade, for investors to sell these assets back to the market at an insignificant higher value.
And, will the banks sell for lower than 80 cents say 40 or 50 cents, when doing so will probably bankrupt them? The answer is no. Currently there is huge demand for these assets at 20 cents at a maximum 30 cents, but banks refuse to sell, because they would go bankrupt if they did.
I think that even with free money from the government, investors will not buy at the price that treasury and the fed imagines, the only solution to this is bankruptcy, or for the government to buy the garbage from the banks at inflated prices, ahem.. ahem.. excuse me, i meant invest for the taxpayer.
Forgive me for being simple-minded, but that is how I am. How is this plan any different from “paying” a credit card balance by charging said balance to a different credit card?
Money can enhance real savings. If baker A can produce 10 loaves of bread a day and baker B can only produce 8 loaves a day with the same equipment, we can conclude that baker A is more productive. Now if credit is available to baker A to buy baker B at a rate of 1 loaf of bread a day. Baker A could buy out B and society is better off by 1 loaf of bread a day.
The problem is when money is made available to Baker B to expand his business to produce 16 loaves a day. Because he inefficent, he waste resources to increase the supply of bread and drives the price down. Net revenue falls for all bakers as the supply of bread increase and the value of all bakeries fall. And now the banks are stuck with toxic bakeries.
Now the banks, forced by mark to market rules, need to cover margins and the amount of money they can lend drops drastically. Bakeries start to fail and the problem gets worse. The efficient baker A could take over some of these bakeries, but because the market turned down, he can’t get the money to do so.
So what does society do? Do we help Baker A get the funds to provide us bread. Or do we wait for Fiat to buy in and provide us nothing but Italian bread? For me a productive A is better than a cheap Italian variety.
@Ned Netterville,
I love your equation. However, you forgot factor “F”.(you naughty) It is the Barnie Frank exponent.
Humans are immoral and have spent their entire lives by justifying or hopelessly curtailing their immoralities. Religion is sustained primary because of this.
The just man does not exist, but he uses foolish insolent talk to appear just while stealing and looting the wealth of the people. Wealth generators are the common people with real solutions to real life problems. Their wealth immediately stolen by the human immoral and is propelled by the parasitic state. Therefore, cleansing human is impossible, much less bankers.
greg, since, presumably, baker A’s credit is good, he will likely be one of those still getting loans(despite the “credit crunch” rhetoric, remember that banks are just more cautious – they still lend, lest they go bankrupt), which he can use to buy baker B. If he’s made a wise choice, even a high interest rate of, say, three loaves per day would be sustainable. This is the essence of downturns: those who malinvested lose their shirts(a number at once, of course, else it wouldn’t be a downturn) while those who did not survive to make lemonade. Boring growth is sustainable growth – if you insist on riding bubble, make sure you’re ready to get out of Dodge at a moment’s notice.
As a matter of fact, a local credit union happens to be advertising the fact that it’s as healthy as ever – the market in action.
thesprot
“Is it beneficial to would be buyers of these assets, to borrow from the treasury, to buy toxic garbage at 80 cents on a dollar, and destroy their balance sheets?
Even worse, at 80 cents these assets offer little return, even if you assume the best case scenario possible, it will take years and perhaps a decade, for investors to sell these assets back to the market at an insignificant higher value.
And, will the banks sell for lower than 80 cents say 40 or 50 cents, when doing so will probably bankrupt them? The answer is no. Currently there is huge demand for these assets at 20 cents at a maximum 30 cents, but banks refuse to sell, because they would go bankrupt if they did.”
I think it is beneficial if the major banks all agree to buy and sell from/to each other. Goldman and Citi can agree to buy each other’s junk at 80 cents, getting the government to pay 75 cents of this. They will each be out a nickel and get back 80 cents in return — giving them liquidity — and there will be a robust market at 80 cents giving them good reason to “mark” to this price, giving them solvency.
It may not last forever (obviously) but a trillion dollars of government money (I use the term loosely) will go a long way to extend the inevitable.
danny.
You are absolutely correct, it makes sense now. There was a story a couple of days ago, i think in FT that City and BOfA where aggressively buying such assets in the market. I was struggling to understand from whom are they buying these assets from, but now it is clear.
Talk about a government run ponzi scheme.
We all know the good old story about “Real Savings”…
I believe there is no need to repeat the same truism over, and over, and over again…
Albright, I get it! We need more real savings for God’s sakes…
Now, how does author expect the ordinary Americans to have this by now proverbial “real savings”, if all the jobs are going overseas, and whatever local employers are left, going bust?!
Why not talk about the real problems – the enormous trade imbalance? Why not talk about the corporations who care not who toils for them as long as they can produce crap dirt cheap in one place and sell for big buck to the others… Whiy not tell everyone that corporations are purely legal entities under unrestrcited free market, and are fair game?
Now, what IS the solution Mr. Shostak? We all know the problem well by now…
Oh, I know the answer – let us go back to fundamentals – the real money and real savings, and let us save more and eat less and work harder, and yes, the golden solution to all problems – buy gold and keep it under your mattress, since the economy is all about savings and accumulation of capital… And yes, if you are unemployed – it’s purely your choice – it is voluntary for God’s sakes (after all you could volunteer at your nearest soup kitchen to help feed the bums, or help those old people or school kids)!!! So much for Capitalism… It all looks to me the old game between the haves and have-nots, and there is nothing free about it…
Wake up, time to go!
pbergn: “Now, how does author expect the ordinary Americans to have this by now proverbial “real savings”, if all the jobs are going overseas, and whatever local employers are left, going bust?!”
Not all jobs are going overseas and not all companies are going bankrupt. Even with an unemployment rate of 25%, as it was in the Great D, 75% of people have jobs. With prices falling, they are able to save more. They save by consuming less.
Businesses go overseas largely because of our high taxes and regulations on business, and because of our borrowing from overseas. Borrowing money from foreigners requires a trade deficit in order for foreigners to have the dollars necessary to loan to us.
No, we don’t live in a free market. We would be much better off if we did. Get the 800 pound state off the backs of business and we will all do better.
What bugs me is how the media reports on “economic indicators”, like how much people are spending for eating out, travelling, etc. They totally ignore savings and capital.
TO: fundamentalist
Fundamentalist,
Then how do you explain the lack of real savings?Are you accusing the Western World in overspending, and indulging in too many earthly pleasures, such as leasing a decent car or taking one’s spouse to a decent place to eat?
There is nothing fancy about American Dream…
So, if regular people cannot even afford that, then what are we talking about? What is the pursuit of happiness, then?
I don’t understand your logic, fundamentalist:
If there are jobs, and they are paying adequate compensation, then why on earth the standard of living in America is going down?!
My take on this is that either the prices of everything are over-inflated, or there are not enough earning opportunities for the populace, ’cause you would agree, as I assume, that having a car, owning or renting a house, and having decent pair of clothes is not strictly speaking leading a luxurious way of life… This is the minimum that one requires to call his or her existence as “living”…
Are you implying that common people are indulging in hedonism, and are too lazy to work? So, good Chinese are extending us their helping hand, without which we all would be living in poverty, since we are all so lazy and non-productive…
Honestly, I don’t understand what is going on – no Economic Theory seems to hold any water nowadays…
I appreciate your input, though…
“So, good Chinese are extending us their helping hand, without which we all would be living in poverty, since we are all so lazy and non-productive…”
Yeah, the Chinese, the Arabs, the Japanese, and the rest of the world has been extending “foreign aid” to the Western world for decades now.
It is sad that the West has departed from its Western values, losing its moral and economic authority, and in a state of decline.
If it makes sense that my house is warm because the furnace is working, then it must also make sense that the furnace works because the house is warm.
All I need to do is warm the house by burning the furniture in the fireplace to stimulate the furnace into working again.
Having shown that I have mastered Keynesian econ,
I await multiple high-paying job offers.
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