The Brothers Austrian

A great article posted in WSJ by Bob Gelfond, brought to me by Cafe Hayek briefly lays suggests that the governments influence over the money supply can have a disastrous role. The problem is that he failed to incorporate some very important terminology from Austrian Business Cycle Thoery: malinvestment.

Us Austrians need to point people to fact that malinvestment is the single most destructive product of fiat currencies.

Recently I went to a panel discussion that included UBS’s Art Cashin. He described how Y2K’s money expansion helped lead to a bubble: the run up in tech stocks at the turn of the century and later a housing boom. As we know such investments  cost many investors dearly. What Cashin was describing was a classic case of malinvestment, however he, as well as the other panelists, coined such scenario’s as bubbles.  I wish we could somehow get prominant speakers to use ABCT terminology such as malinvestment instead of terms like “bubbles” to draw people into reading more Von Mises literature. The literature so compelling I feel it would be hard not to grow are ranks exponentially in the near future.

Wendall Wilkie Federal Reserve Bob Gelfound, Cafe Hayek, money supply

In 1819 the Second Bank of the United States was a lightning rod issue in many states.  The bank was in shambles, as was the American economy.  Take a look at the following argument from McCulloch v. Maryland, we get the following oral argument from Walter Jones.  The Constitution did

not imply the power of establishing a great banking corporation, branching out into every district of the country, and inundating it with a flood of paper money.  To derive such tremendous authority from implication would be to change the subordinate into fundamental powers; to make the implied powers greater than those which are expressly granted; and to change the whole scheme and theory of government.

Of course this logic was rejected, sound familiar though?   Some may not understand the tremendous power grab Supreme Court Justice John Marshall took on behalf of the federal government when repudiating the above sentiment.  His sweeping opinion codified the implied powers clause as a broad offering of power to the federal government.  A tragic, if inevitable, day in American history.

Teacherman Federal Reserve, History bank of the united states, john marshall, mcculloch v maryland, walter jones

From 1987 up until the end of Greenspan’s rein in 2006, there was a period of easy money and what Barry Ritholtz called “ultra easy money” which was created by Greenspan flooding the market with easy cash.

Ritholtz points out that yet another ingredient to the crisis pie might have been that there were too few banks and too many giants. You had super mergers in which smaller banks were snatched by the larger banks. One argument is that banking should be done on smaller scale. A scale where the bank manager as a more personal relationship with person he is lending to.

The principal of banking has always been the same throughout history, borrow money cheaply (deposits) and lend it out to someone who will pay as much interest as possible. What we saw develop through the use of technology was a man (or computer software) lend money to man in on Long Island to buy his house without personally verifying the financial standing of the borrower.

Sweet plan, right? The lender is now executive somewhere else and the taxpayer is left holding the ball, the proverbial “Moral Hazard” at its best.

The easy money policy that allowed for super mergers to occur is another example of how Federal Reserve policies often limits competition and encourages malinvestment.

Wendall Wilkie Federal Reserve, Real Estate banking, barry ritholz, Federal Reserve, greenspan, moral hazard, taxpayer

Will U.K. lose there AAA rating? Will the U.S. lose its AAA rating? Will the FED take a hint from the market? Will Obama and his Dems and the spend happy Republican pals get the point? Not likely.

Is this the start of what Teacherman was talking about?

Wendall Wilkie Federal Reserve aaa rating, fed, obama

Jack Welsh’s on the Economy: Past the Point of No Return title describes how I have thought about monetary policy after I picked up on the Austrian Business Cycle Theory (his piece is a must read). We have gotten so out of control with credit expansion, by every measure, that I fear the consequences of unwinding it. Again, think of the last pargraph of chapter 23 of Hazlitt’s Economics in One Lesson.

“Like every other tax, inflation acts to determine the individual and business policies we are all forced to follow. It discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.”

Wendall Wilkie Federal Reserve business cycle, credit, economics in one lesson, Hazlitt, monetary policy

My brother has posted a few times lambasting the higher education system, especially at the elite level, for propagating a broken economic system.  Worse, their temerity leads them to believe that they can diagnose and fix macroeconomic systems.

The seminal work underpinning my brother’s revulsion is The Pretense of Knowledge, by Friedrich A. Hayek.  This is the name given to a speech by Hayek in 1974 in a lecture to the memory of Alfred Nobel.  In it, Hayek explains the limits of human knowledge, especially in relation to the infinite variables of a macroeconomic system.  As he says, “Unlike the position that exists in the physical sciences, in economics and other disciplines that deal with essentially complex phenomena, the aspects of the events to be accounted for about which we can get quantitative data are necessarily limited and may not include the important ones.”  Nevertheless, political economists tend to use rigid formulas, in a manner like the physical sciences, to analyze highly fluid macroeconomic settings.  Hayek notes, “Yet the confidence in the unlimited power of science is only too often based on a false belief that the scientific method consists in the application of a ready-made technique, or in imitating the form rather than the substance of scientific procedure, as if one needed only to follow some cooking recipes to solve all social problems.”

The inane pretense of the Federal Reserve and the Obama (and Bush, etc) administration that they have the knowledge to manipulate the monetary system without consequence is absurd. 

But when it doesn’t work, we can just blame the ‘free market’ — right?  Talk about moral hazard…

Teacherman Federal Reserve, Interventionism, Politics Federal Reserve, hayek, macroeconomic, monetary system, pretense of knowledge, sciece

I posted last week about the growing unease of the Chinese Central Bank toward its US investments.  Now China (along with Russia) has manifested its unease with a call for a new global currency, led by the International Monetary Fund.  As scary as this notion is, I wanted to highlight the growing unease with the US dollar.  While it appears unlikely that China is willing to take an investment hit in order the skewer the US, it is clearly setting up for a dramatic shift away from supporting the issuance of dollar debt.

How China Sees the World (Economist.com)

China understands that the only way for the US to service its debt is through monetization.  It’s unlikely that they ever imagined a US recession would lead to this type of monetary expansion:

As the US dollar currency in circulation approaches $1 trillion, China is finally trying to find a new safe haven for cash.

Is it likely that we will see another Bretton Woods soon?  I don’t think as it stands now.  But maybe, just maybe, China is setting the framework for a future day when it dumps its treasuries and punishes the US.  This certainly would be painful for Beijing, but what is this investment actually worth anyway?  It may be the perfect catalyst for a Shanghai version of Bretton Woods in 2010.  Could a new currency order with China leading the way be worth its investment loss?

Teacherman Federal Reserve, Inflation bretton woods, china, debt, dollar, global currency

“The chains of habit are too weak to be felt until they are too strong to be broken.”
–Samuel Johnson

U.S. consumption has driven global growth for years. South Pacific countries sold us their spare capacity which drove and modernized their economies at a seemingly unrealistic pace. Foreigners have been building dollar reserves for decades. Many of those countries have rightly realized that perhaps they should use those dollars to buy U.S. assets rather than hold treasuries. It is one thing to exploit foreign labor, but now foreigners have put their surpluses (their money/capital) to work buying up U.S. assets, thus exploiting us. Touché. Now, profits generated from the selling to the U.S. consumer go oversees rather than staying here.

The consumer was being squeezed on all sides entering into 2008. Higher fuel prices, falling housing prices, stagnant wages, higher unemployment, and rising food costs.

Household debt as a percentage of GDP is almost 100% as the below chart illustrates.

Pundits argued that rising household net worth would allow spending to continue forever and ever as net worth continued it climb in 2004, 2005 and 2006. Now household net worth is falling at an unprecedented rate. In 2008 household net worth declined an astounding to $11.2 trillion to $51.5 trillion (Random Factoid $trillion in household net worth vs. 600 trillion in outstanding derivatives in the U.S.).  In 2007, residential mortgages outstanding, in percentage terms   were equivalent to 78% of US GDP. In 2006 residential mortgages made up an outstanding 36% of total U.S. debt outstanding. When this crisis started in 2007 Gary Shilling said that we would need vacant supply to fall below 600k homes now he estimates that there currently are 2.1 million in excess supply. Shilling estimates that housing prices could fall anther 20% (ughh what’s that going to do to household net worth?).

A sad fact now apparent to most of us, the U.S. consumer is tapped and they are not coming back for years … not months. I am now realizing why the Fed has chosen to monetize this debt, clearly the people who have burrowed(or should I say lent…ah what the hell…both) can’t afford for the Fed not to.

Now let me get this straight…the Fed is going to buy back these mortgages via Fannie and Freddie, an issue treasuries to do so? Now the Fed is going to buy back treasuries (monetizing: printing money) to keep rates down so lenders can then make more loans to people who are insolvent? Meanwhile oil is walking its way back up the ladder towards $100 (granted I believe will break $40 once more) because oil is finite and fiat dollars are not. Food costs are not slowing the way they should if an economy is truly productive, wages are declining, productivity(…well is there such thing as productivity in Never Never land?) is declining and the government is scaring the entrepreneur back into his/her shell with taxes.

Jefferson is rolling over in grave as we speak.

Wendall Wilkie Federal Reserve, Free trade, General, Real Estate consumer, dollar, foreign labor, trade, treasuries

Have you ever stopped to think about how much efficiently you could have learned something? Or what about when you realize everything you thought you knew was wrong? I am sure some very smart people were convinced the world was flat and were quite perturbed when learned the world was actually round. Well I would say I just realized everything that I had been taught/thought about the history of the U.S. was dead wrong.

At Syracuse University, as a history major, I was taught that it was Roosevelt’s quarterbacking in the 30’s that helped the U.S. recovery from the depression. I was essentially taught, like the rest of us, that fiat monetary system created by the Federal Reserve was necessary to provide the economy the “flexibility” to soften the blows that were supposedly considered a natural occurrence of the market (this is painful to think about). If you are reading the blog, you probably have had the experience that I had when I discovered the plethora of readings that come from what is known as the “Austrian” school of economic thought. My first reading was Economic Policy: Thoughts for today and Tomorrow. From there it all just snowballed for me. Hayek, Hazlitt, Rothbard. But honestly it really only took me about the first 25 pages of that first Von Mises book and I was hooked. Like I had discovered a new religion and that I was saved….and then I immediately felt as if I had been robbed.

I thought to myself, “How could I not have heard of this school thought…I was a double major.” One would think that if you majored in both political science and history that I would have come across this “Austrian” school of thought. This just did not make sense.

What I do realize is that history is written by the victors. America came out of the WWII the strongest nation which had seemingly won WWII (no one really won, everyone lost in my opinion). We had amassed an enormous amount of wealth throughout the 19th and early 20th century. Subsequently although Roosevelt was in charge during the majority of America’s most prolonged down turn he and his “brain trust” are viewed as saviors.

What’s my point? I honestly believe that Mr. Obama and Mr. Bernanke are two of America’s best and brightest, however their current “humanactions” are a mold/consequence  of their life experiences. Obama happened to attend a college that teaches its students to believe that they know better than the collective. They believe can smooth out market upheaval with their policies rather than recognizing its their policy  their school of thought that caused the problems.   What if Mr. Bernanke was scientist that could have cured cancer but he was instead taught that cancer can’t be cured but merely slowed down and then at very end of his life he realizes he could have cured cancer all along but he was taught it can only be slowed down.

This is my glass have full post. I will try not to succomb to the idea (at least not tonight) that this mess came about because politicians and other self interested individuals were/are trying retain their power through inflation and wealth redistribution.

Wendall Wilkie Entrepreneurship, Federal Reserve, Free trade, General, History, Real Estate austrian, education, Federal Reserve, hayek, Hazlitt, syracuse university

Picking up off a recent blog article that made some waves, this post is in support of H.R. 1207.  Ron Paul introduced the Federal Reserve Transparency Act of 2009 last week.  According to Paul, the bill is the first step to open up the Fed’s ‘opaque’ operations to the public.  As Rothbard put it in The Case Against the Fed,

By far the most secret and least accountable operation of the federal government is not, as one might expect, the CIA, DIA, or some other super-secret intelligence agency. The CIA and other intelligence operations are under control of the Congress. They are accountable: a Congressional committee supervises these operations, controls their budgets, and is informed of their covert activities. It is true that the committee hearings and activities are closed to the public; but at least the people’s representatives in Congress insure some accountability for these secret agencies. It is little known, however, that there is a federal agency that tops the others in secrecy by a country mile. The Federal Reserve System is accountable to no one; it has no budget; it is subject to no audit; and no Congressional  Committee knows of, or can truly supervise, its operations. The Federal Reserve, virtually in total control of the nation’s vital monetary system, is accountable to nobody—and this strange situation, if acknowledged at all, is invariably trumpeted as a virtue.

Teacherman Federal Reserve, Politics Federal Reserve, ron paul, rothbard, transparency