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Thursday, August 12, 2010

The American dream

Listen up, America: you're bankrupt. You just haven't clued into this yet. The policies pursued by both Republicans and Democrats, aimed at keeping asset prices "stable" are precisely the reason why US home foreclosures are accelerating.

I know that it's passé to look at economics from a classical point of view, in a time where the economic consensus is that central banks should be printing lotsa-lotsa money until the economy has a "sustained recovery". But call me foolish for thinking that well, money actually matters.

The US government has actively been involved in propping up housing prices through direct supply-management, taking the form of different "relief" programs, ranging from providing direct mortgage payment assistance, having the US government just buyout the mortgage, to buying up idle supply on the market. You see, because according to the powers that be -- Bennie Bernanke, Timmy Geithner and Blackberry Barrack -- the absolute worst thing that could happen is, wait for it ... housing prices falling significantly. Because by god, that would lead to the world's most horrible economic, sabre-toothed, fire-breathing, baby-eating, skull-screwing economic disaster: price deflation.

You know, that thing where prices actually fall and your savings become worth more. Where, you're actually rewarded for your prudence while others are punished for their callousness. And most importantly, a funny thing happens -- and it's really quite incredible: housing becomes more affordable without the assistance of government subsidies.

But let's say times are really tough; you're just not making as much money as you were last year, and you just can't afford a house right now. So you might have to do the most embarrassing thing in the world: rent. Even worse, you might not be able to afford a three-bedroom rental. Your budget is only looking like it can afford a two-bedroom if you want to be reasonably close to work and still afford the car payments.

So what are you going to do? You're going to demand the government subsidize your mortgage so you can "stay in your home" and avoid the absolutely humiliating outcome of having to give up your f***ing American-dream backyard. No, you're going to demand all those other people, who saved for a rainy day, instead of getting in way over their head with a giant stucco-finished, two-garage, monotonous piece of shit house in the suburbs of Atlanta help you pay the bills.

F*** you. No really, I mean that.

Full disclosure: in 2004-2005, I was on the verge of bankruptcy due to some unfortunate circumstances. And you know what I did, after having lived the luxury of living in a beautiful modern, luxurious apartments in Charlotte, Tyson's Corner, and Toronto? I cut my losses and moved into an $850/month piece of shit near Bloor and Dundas St in the West end and got myself back onto my feet. So yeah, f*** you.

I don't mean to completely take this all out on you, Mr. Homeowner who's in over you head. It's not like the powers that be aren't doing their darndest to keep this whole charade playing out like a sad, slow-moving, melodrama starring Susan Sarandon (but actually far more boring). But I just want you to know how the world truly is -- beneath the covers of the debt-bubble-economy -- and how it should be. You know, a world where prices reflected demand, central banks didn't fart out money at velocities that exceed the limits of physics, and Paul Krugman was appreciated for his true calling: being a mostly generic, partisan hack.

Posted by Mike Brock on August 12, 2010 | Permalink

Comments

What a beautiful rant! A thing of exceptional beauty. God bless you.

Posted by: Agha Ali Arkhan | 2010-08-12 1:23:13 PM

Mike, excellent post and spot on. The writing has been on the wall for some time that the days of being the world's super power are quickly coming to an end, but many refuse to read it. I do not rejoice in the least in this, although they have brought it on themselves. Of course I do not mean every single American citizen but rather their politicians, courts, educational system and big unions.

Posted by: Alain | 2010-08-12 1:27:51 PM

The Americans voted for it Alain. Try to remove their subsidies and entitlements and see what happens. They want tax cuts, but not spending cuts. So, yes, in general Americans only have themselves to blame.

Posted by: Charles | 2010-08-12 2:16:46 PM

Thanks for the complements. It felt really good to put my feelings into rant form. I'm pretty stressed out these days, so I figure I'd turn my limited contributions here for the time being into my digital punching bag. =)

Posted by: Mike Brock | 2010-08-12 4:02:09 PM

Two things I like to remember:

1. The problem with Socialism is that eventually you run out of other people's money.

2. Democracy only works until people figure out that they can vote themselves entitlements.

Posted by: Don from BC | 2010-08-12 4:02:38 PM

How about you stick to political ranting, Mike? Sure there's a lot of problems with Krugman's arguments. But I think it's safe to say that a Nobel Prize-winning economist doesn't need to take criticism from a guy who's entire education in economics amounts to reading Mises.org and pretending like that represents real economic thought.

I'm not a Keynesian. But I'll take Keynes over Mises' crazy anti-government religion masked as an "economic school" any day.

Posted by: A Real Economist | 2010-08-12 4:25:23 PM

Uh-oh. I've been out-credentialed! How dare I make such criticisms of a Nobel Prize-winning economist! The nerve! We should leave such matters to you experts.

Posted by: Mike Brock | 2010-08-12 4:35:49 PM

"I'm not a Keynesian".

In my experience, those are typically the words of a Monetarist. A distinction without a difference.

Both Keynesianism and Monetarism are meant to serve the purpose of imposing wage and price controls. What Keynesianism attempts to do by fiscal means, Monetarism attempts to do by means of expanding (and more rarely, contracting, the supply of private, rented, money: credit issued by chartered banks).

The big joke: Monetarism was Milton Friedman's 'second best' proposal for monetary reform. His first, best proposal was for an inelastic money supply: a 100% reserve, of the nature promoted by his teacher, Irving Fisher...a proposal that Wall Street opposed, because it ends a bank's freedom to manufacture the credit it issues...thereby making it necessary for banks to encourage saving/deposits...by offering market rates of interest to potential depositors.

In other words: those who condemn Austrians as anarchists for favoring narrow banking actually give props to narrow banking when they naively praise Friedman.

Posted by: Paul McKeever | 2010-08-12 5:09:55 PM

Paul,

If you want to have a debate about the merits of any particular economic theory, then by all means let us go at it.

But if we want to talk about this sloppy piece of writing by Mike Brock, which is what I thought this comment thread is supposed to be about, then I don't really see the point of your comments.

This post amounts to nothing more than saying "fuck you" to people losing their homes, espousing ridiculously simplistic economic concepts without taking into account a myriad of other legitimate economic factors at play, and then ending it all with an unqualified insult to Paul Krugman and his alleged partisanship.

If Mike Brock is looking to be the Canadian-libertarian Bill O'Reilly, then he's doing a very good job building his reputation as a clueless loudmouth.

Posted by: A Real Economist | 2010-08-12 5:28:04 PM

Mike,

Bravo sir.

Methinks the Real Economist may be of the same economic school as our PM.

No that isn't a compliment.

Posted by: Mike | 2010-08-12 6:58:15 PM

"This post amounts to nothing more than saying "fuck you" to people losing their homes...]"

yup; people who voted for entitlements and Keynesian pipedreams, instead of low taxes and radical government spending cuts.

...so, yeah, fuck you.

btw, i'm in the process of buying property at some pretty low prices.

good rant, Mike.

Posted by: Shel | 2010-08-12 7:02:55 PM

"espousing ridiculously simplistic economic concepts without taking into account a myriad of other legitimate economic factors at play,"

-In other words, he can't think of a real rebuttal.

Posted by: Cytotoxic | 2010-08-12 7:18:18 PM

These responses and this attitude is why libertarianism should be renamed to "blame-the-victimism".

Surely nobody really thinks the solution is to just allow for mass-bankruptcies and foreclosures? Do any of you Utopian visionaries actually appreciate what would happen if the government allowed this to occur?

You mock the use of monetary policy to smooth out demand curves, which is actually a real policy framework to address a real problem.

Your prescription of doing nothing and letting the "market work" is nothing more then having the fire department look on as the farmhouse burns while saying, "the sight of flames, and smell of smoke will cause the family to invent the means to escape unassisted".

Posted by: A Real Economist | 2010-08-12 7:25:29 PM

Umm.. okay... wow.

These responses and this attitude is why libertarianism should be renamed to "blame-the-victimism".

No, I'm not blaming the victim. I'm blaming something -- which should be quite a regular concept to you as a 'real' economist -- known as: the nature and reality of risk.

I do not deny that these people -- in fact, most people -- are victims here. But the truth is, that we all play a part in being victimizers. Especially if you're middle-to-upper-class.

We benefit from easy access to credit, which has the effect of not just contributing to, but being the primary cause of, price inflation due to the effects of currency debasement.

That said, one can hardly avoid blaming some of the victims for contributing to the problems; buying a a $500,000 home on a $55,000 income with no money down, should give one pause, no matter how low interest rates are.

Your solution, it seems, to plugging the hole in the problem, which is itself an economic imbalance brought about by the excess creation of money and credit, is to just do more of the same. Faster, more aggressively, and without limit.

The problem with your stupid fucking theory, is that it hinges on there being this miraculous economic recovery that will ultimately pay for and offset the debt incurred as a result of monetary and fiscal actions taken to "smooth the demand curve". When has this worked? When?

The economic miracle of monetarism that was in play after the collapse of the NASDAQ bubble was no miracle at all. It just transferred all that debt and risk into another asset class: mortgage-backed securities.

Such brilliant fucking monetary policy. Just blow a bigger bubble every time the former bubble collapses. Wash. Rinse. Repeat.

You expect me to just defer to your brilliant economic analysis, as you're a "real" economist, and I'm just some "loud-mouthed" fool who doesn't know what I'm talking about. But what is it exactly that provides the substantive evidence that you know what you're talking about?

Oh, I know. Your theories were so perfect and successful until financial institutions started securitizing sub-prime mortgages. THAT was the weakness you overlooked. If only you had plugged that regulatory oversight, the rest of the plan would have played out perfectly, and we'd be sipping margaritas in eternal Pax Americana.

Or maybe, if monetary policy wasn't such ,that it effectively wiped out the traditional bond market, financial instituions wouldn't have been left scraping the bottom of the barrel? No, there's nothing to see there -- "That's not true! It was just plain and simple greed! Our theories were perfect! The theories were so tight. We'd entered a 'new economic paradigm'! We just weren't paying attention to Dick Fuld. Yes... yes! Next time it will work out perfectly... if only we can print enough money."

You talk about us being utopian... Jesus-H-Christ... look in the mirror!

Espousing the values of hard work, savings and investment. So utopian of us. We haven't clued in to the miracles of your magical money-creation machine.

Posted by: Mike Brock | 2010-08-12 7:43:52 PM

The problem is that too many Americans have forgotten the concept of living within your means. We run our credit cards up and only pay the minimum monthly requirement. We know that big government is an anchor on the economy(the polls show that overwhelming Americans prefer small government with low taxes versus big government with higher taxes). However, too many of us have let ourselves be bought off with entitlement programs and earmarks. This happened because everyone thought the good times would last forever! It's like the fools I would talk to in 2008 who act as if Obama was Jesus Christ! I would point out his positions and how his economic plans had failed each time a government had implemented their basic outline. I pointed out to them how government run healthcare had been a costly ineffective boondoogle in every country it had been tried! The problem was that 53% of the public bought the marketing campaign. Other people I talked to seemed to actually think that electing Obama would end the racial tensions of black americans and no longer make them mad at white population. This was also an obvious pipedream. I don't make a lot of money but I am that rarest of Americans who has no private debt. I reduced my credit cards to one. I pay the balance off everytime and carefully budget. This allows to pay my bills, have a place to live, go to school at night, and still once in a while take a trip. I don't buy the latest phone or the biggest television if I don't have the money up front for it! My hope lies in the fact that I am beginning to see more Americans do the same. The solution to America's debt bubble is the same whether you are running a household or a government department cut spending! The government promises everything but botches most of it anyway. Get rid of the department of education! The department was created in 1979. This means somehow America survived without a federal department of education for the first 200 years. So is it really necessary? The same goes with the Department of Energy which was only created in the 1970's. Fannie Mae and Freddie showed be knocked down. The Commerce Department could probably be shut down. Social security and medicare are probably tot dangerous to touch politically. However, congressman Paul Ryan of Wisconsin has a good plan that would reduce some of the benefits and expenses and actually allow the programs to be financial solvent. The two things that the American government does best are defense and the police(FBI, federal marshals, state and local police). Every else should be looked at for possible privatization, downsizing, or elimination.

Posted by: Ted | 2010-08-12 7:57:15 PM

Ouch. Can't wait to see Real Economist's response to Mike Brock.

AMAZING discussion by the way.

Posted by: Serle Epstein | 2010-08-12 8:02:48 PM

'Every gun that is made, every warship launched, every rocket fired, signifies in the final sense a theft from those who hunger and are not fed, those who are cold and are not clothed.'

Dwight D Eisenhower.

USA! USA!

So many Wars, so little Time.

Posted by: jeff franklin | 2010-08-12 9:19:54 PM

I don't think the situation is as dire as you make out, Mike. In the 1960s we heard predictions that even the developed world would be starving by now. Indeed, certain data indicated that was the way it was headed, and the 1970s was one damned disillusioning decade. But people found a way to solve the problems, and Americans are no closer to starving now than they were in 1965.

I agree credit has been made too easy to get. I'm not overly disciplined financially, but I allow myself only one credit card, and we own about 15% equity in our house (which isn't bad considering we bought it not even a year ago), and we're putting $300 a month directly on the principal in addition to the mortgage payment. But when the Vancouver housing market was red-hot a couple years ago, and every house the subject of a bidding war that could see a dozen offers made in the space of a day, realtors told stories of young couples adding up their entire monthly salary, subtracting a hundred bucks for groceries, and offering that as the mortgage payment. It was insane.

Housing prices are not falling into the basement. They're merely falling into line as part of a long-overdue correction. Because the correction took so long, and the bubble got so big, everyone got their hair ruffled when it finally burst. The fact is we were due for a recession; they generally come once every eleven years or so, usually around the beginning of a decade. I remember all the doomsaying that accompanied the recession of '81, '91, and '99. And every single one was the worst since the Great Depression.

By the way. Investors create bubbles, not Uncle Sam.

Posted by: Shane Matthews | 2010-08-12 9:20:47 PM

Governments who subsidize real estate investment on mammoth scales by creating artificially low interest rates carry more of the responsibility than those who took the money and leveraged it.

If interest rates are below CPI, then the only rational thing to do, in order to maintain wealth, is to borrow and leverage.

But the problem is, the rational decisions were significantly distorted by the fact that interest rates, as a result of central banks, are decoupled from capital availability. Thus, low interest rates, rather than being indicative of excess saved capital, are merely creations of a printing press.

Blaming investors for turning into speculators in such a market is something I can hardly blame them for. The government's monetary policy ensures such speculative asset prices are natural. Because if the amount of money you can leverage is unbound by real capital, then prices can rise precipitously with no connection to underlying capital conditions. And this, is fundamentally why Uncle Sam is to blame, Shane.

Posted by: Mike Brock | 2010-08-12 9:39:04 PM

Good Rant, Mike. Anyone hiding behind the moniker, Real Economist offering nothing but sound bites is a troll. Too bad he couldn't bring up some actual arguments for you as you are on a roll.

Posted by: John Chittick | 2010-08-12 9:57:00 PM

Governments who subsidize real estate investment on mammoth scales by creating artificially low interest rates carry more of the responsibility than those who took the money and leveraged it.

No, they don’t. It is a fundamental tenet of libertarian philosophy (and also the plain truth) that each buyer is ultimately responsible for his own actions. Even if one accepts the simplistic assertion that it was the government that offered the brass ring with the lead core, it was the buyer who accepted it.

If interest rates are below CPI, then the only rational thing to do, in order to maintain wealth, is to borrow and leverage.

That depends on what you mean by “rational.” To an aggressive entrepreneur, it is perfectly rational to take a big risk with a big potential payoff, whereas to a cautious investor, it is more rational to take the prudent course. What is rational depends on your objective, which itself may or may not be rational, sensible, or even sane.

To a degree this is fine. The entire banking system as it currently stands is based on borrowing money and charging interest on the amount borrowed. If no one is borrowing, usually no one is buying, and if no one is buying, your economy craters. Tinkering with the rates encourages investment. The line of prudence is crossed not when rates are lowered (within reason), but when moneylenders take too many risks.

Blaming investors for turning into speculators in such a market is something I can hardly blame them for. The government's monetary policy ensures such speculative asset prices are natural.

Lots of things are natural, Mike; that doesn’t make them prudent. Greed is natural, and every economic bubble in history has been driven by it. This is a curious viewpoint, in that even though it is the private investors and lenders that are actually creating the problem, you instead blame the government that lets them get away with it. I thought libertarians favoured less government regulation, not more.

If the amount of money you can leverage is unbound by real capital, then prices can rise precipitously with no connection to underlying capital conditions. And this, is fundamentally why Uncle Sam is to blame, Shane.

But is Uncle Sam forcing people to leverage this unbound money? No. This conclusion therefore makes no sense at all. It’s also inconsistent with libertarian positions on other matters. When it comes to drugs, libertarians blame the government for creating rules for people to break. When it comes to the economy, libertarians blame the government for not making rules that people will, in this one matter only, always magically obey. In both cases the private individual is excused from all responsibility and the blame laid squarely at the gates of 1600 Pennsylvania Avenue.

Observation, Mike: I don’t think anything any government did could please you. Seconders?

Posted by: Shane Matthews | 2010-08-12 10:05:59 PM

Shane, you're missing a lot of the subtleties in this broader economic argument.

We are not just talking about institututional investors or hedge funds. We are talking about the entire economy. From the consumer, to the top.

The same argument I'm making about it only being rational to borrow and leverage at higher and higher risk, can be demonstrated to be occurring with your average Joe.

For instance, because of the fact that the government is inflating the money supply, to fund all these loans, causing prices to rise, people are left with two rational options: invest or exchange your money for real goods. And possibly leverage at low interest rates to obtain those goods.

Why? Well, because the third option, saving, is a pretty shitty deal. Put a $100 bill under your mattress and then take it out in twenty years and tell me what you can buy with it.

We've come to accept this currency devaluation as a fact of nature. But people educated in economics, and even as our "real" economist knows, this is a result of government monetary policy. Governments aim to maintain an inflation rate of 2% a year. They call this "price stability".

But what it is, described differently, and this is no exaggeration or miscontrual of the reality is: the intentional devaluation of the currency to provide a continual supply of large amounts of short-term credit.

That's what it boils down to. So, in order for your savings not to depreciate, you need to put them into instruments that will maintain their buying power or increase them.

Neither cash or a savings account fit the bill. So poor people are fucked.

The big institutions, like insurance companies can't rely on treasury paper anymore. The yields are shit. But they don't want to dabble in a volatile stock market, either.

Where do they go? To asset-backed bonds. Where can we find a lot of those? Mortgages. And that's exactly what they did.

And when they ran out of bonds to buy for their long-term investments, they started looking around again.

Suddenly you had mutual funds and insurance companies waving cash around looking to buy bonds at decent rates -- like they used to get from treasury paper -- and there were no sellers.

So, the market did something that markets do. It matched demand to some supply. That new supply was "sub-prime".

But notice in this narrative, it is the government's printing of money that has more or less wiped out the traditional safe, reliable bond market.

Some call this "greed". Others, like myself call it market distortions brought about by government; situations that would not exist absent the government manipulations.

The rest is, of course, history.

The government central-planning of the market through currency manipulation changed the game fundamentally. Forced businesses to look for safe replacements for maintaining their wealth. When they ran out of safe places to put it, they started lowering their standards.

The government encouraged this behavior, too. You can find many-a-politician and Federal Reserve commentary praising the sub-prime and derivatives market at the time.

And the risks of such activities were sort of downplayed by the government's seeming willingess to bailout the industry. Such as when it got involved with LTCM.

When I say "rational" Shane, I mean decisions within a persons apparent self-interest based on all available information to them at the time.

For instance, if you offered me a billion dollar loan that I only have to make $1 payments a month to, for the rest of my life, you might say it's irrational to take a loan that I can never pay back. Because, when I die, my creditor will be saddled with the losses. But I'd say, despite the externalities it may impose on others by accepting this, it's certainly a good deal for me.

So the government creates these same sorts of propositions to the industry at large by giving them almost-free money to leverage.

And you're blaming them for accepting. Not blaming the government for having the idiocy to offer.

Posted by: Mike Brock | 2010-08-12 10:43:23 PM

But is Uncle Sam forcing people to leverage this unbound money?
Posted by: Shane Matthews | 2010-08-12 10:05:59 PM

Most people vote with their wallets and travel the path of least resistance.
Government did make that path very easy to take so should get some blame. Canada kept more checks in place and largely avoided the need to foreclose due to feel good policies and political interference. I can't blame the poor suckers at the bottom that do'nt read or do'nt understand the fine print but are led to believe they can truly live the "American dream" while working at Walmart or McDonalds.
That only leaves the Government for making it possible. The poor have their dreams.... and a lot of voting power.

Posted by: peterj | 2010-08-12 10:51:26 PM

What your argument boils down to, Mike, is this:

Creditor makes insane offer, for own self-interest.

Borrower accepts insane offer, for own self-interest.

Only creditor is to blame.

Sorry, don't buy it. Blaming only one side of a two-party exchange with each party acting in its own self-interest just doesn’t wash. The sound of one hand clapping is no sound at all.

Posted by: Shane Matthews | 2010-08-12 11:17:20 PM

Shane,

I'm not saying that only one party is to blame. But the government, who is using it's power over the supply of money is manipulating our economy by providing artificial incentives to borrow.

Since only government has the legal authority to pull money out of it's ass, shouldn't it's responsibility be commensurate with that power?

And the exercise of that power has real negative externalities to the actual transactions; such as consumer price inflation, increases in the gap between the rich and poor, lower capital investment and higher consumption, leading towards destruction of manufacturing, trade deficits, etc.

Given this, treating the government like an equal party seems absurd. They're not an equal party. Not in any objective sense.

Posted by: Mike Brock | 2010-08-12 11:33:37 PM

The correlation between the per capita illegal immigrant population and the foreclosure rate by state is .68. (high)

Like the identity theft problem (but much more consequential), the mortgage meltdown and ensuing economic recession are inextricably linked to the lack of immigration enforcement in the U.S.

Posted by: Jim | 2010-08-13 1:19:38 AM

Mike,

Shane has never read one single book written by an Austrian economist. He doesn't understand the argument and doesn't want to.

Jim,

Yeah. That's right. Let's just end all "illegal" immigration and we'll never have a financial crisis ever again.

This is actually pretty simply. An interest rate is a kind of price. It coordinates present consumption versus future consumption. When people are saving and investing, this naturally drives down the interest rate. Entrepreneurs will begin production processes which are further away from consumption to one day be able to produce more consumer goods and services. That's how the economy grows.

When banks lend out deposits or the central bank creates money out of thin air and banks lend it, this artificially reduces the interest rate and entrepreneurs mistakenly begin production processes which are further away from consumption. Anyone with the slightest knowledge of financial theory will immediately understand what I am talking about. When you lower the discount rate in an NPV model, the long term projects suddenly turn positive. This creates all kinds of distortions in production and price increases. Capital goods will rise first and consumer goods later. Eventually though, these entrepreneurs will complete their production process and find no one has saved to purchase their products. A natural correction process will ensue. Interest rates will rise and entrepreneurs will immediately realize that their projects are unprofitable. They will cancel their projects and return to those justified by higher interest rates. At this point, a painful adjustment takes place as entrepreneurs are transferring production from one type of project to another. This is why you get unemployment during recessions.

This explains why Austrians want an end to fractional reserve banking (a 100% reserve requirement) and central banks. Furthermore, fractional reserve banking is tantamount to fraud. Bankers have promised to return deposits on demand and instead lend it out. The free market is based on protection of property rights. Lending out deposits is a violation of depositor property rights and hence should be illegal. Anyone wanting to debate the theory I've just put forward is more than welcome to. Anyone wanting to emulate Shane Matthews and not address the arguments put forward will be ignored.

Posted by: Charles | 2010-08-13 6:07:56 AM

Shane has never read one single book written by an Austrian economist. He doesn't understand the argument and doesn't want to.

And where is your proof that the Austrian school of economics is the only one worth considering? For that matter, where does it say in any book about Austrian economics that only one party to a bad loan is morally culpable for it?

You hold up Austrian economics the way medieval Europeans held up ancient Rome: utopia, a passed-away ideal towards which society would ever strive in vain, but strive it must, for there was no greater glory. But Rome was far from perfect and the geopolitical realities that had supported it until the fifth century had changed. Social structure in medieval Europe was completely different and even the empires founded in Rome's name (such as the Holy Roman Empire) bore no resemblance to the ancient empire.

What this means to you is that the Austrian school of economics has not proven itself a workable concept; it is, like ancient Rome, an unattainable ideal in today's geopolitical climate. It has not been the world's model of economics for the entire 20th century, so all the theories Hayek et al put forward remain just that: theories. Theories I doubt would pan out unless they're a good deal more well-rounded than the views of the people I see promoting it on this board.

P.S. What argument have I not addressed?

Posted by: Shane Matthews | 2010-08-13 6:45:13 AM

I'm not saying that only one party is to blame. But the government, who is using it's power over the supply of money is manipulating our economy by providing artificial incentives to borrow.

As are the banks, who actually lend the money. Those toxic loans were not made by the government; they were made by creditors who pursued the insane practice of lending money to people they knew would likely default. There are even reports of cases where the banks have encouraged potential homebuyers to lie on their application forms in order to qualify.

Since only government has the legal authority to pull money out of it's ass, shouldn't it's responsibility be commensurate with that power?

The entire financial system is a giant house of cards, Mike, and banks make their living by taking people’s money and loaning it to others on the assumption that they won’t need it back right away. And since the borrower or depositer has the right to say no to the transaction at any point, shouldn’t his responsibility be commensurate with that power? Even conceding the point the government provides tainted water, it can’t make the horses drink. And let’s not forget that the people who vote in these governments expect them to behave this way and would react harshly if they didn’t.

Except that currency and trade are now pretty much globalized, and while one government’s policies can make things difficult for its own people, the true value of any venture’s assets are determined by the overall value of world currencies. That is why it costs a thousand Russian rubles to buy the same steak dinner we get for thirty bucks. The world economy didn’t tank because American creditors extended overly easy credit. The entire world housing market was insanely overheated, and most Western countries were doing the same things the Americans were doing. The bubble broke in America first, but there were bubbles everywhere. Iceland, for example, is now so impoverished that its government can do little but tell the people to "go fish." Literally.

Given this, treating the government like an equal party seems absurd. They're not an equal party. Not in any objective sense.

Given the fact that the government serves at the discretion of the people and that people over the decades have come to demand this type of involvement from their governments, it is absurd to expect that governments would behave otherwise, or that it can be justified in laying the blame on anyone except those same people—the same ones who sign mortgage agreements without reading them and saunter around with a wheelbarrow full of credit cards.

Sorry, Mike. Even in a central-banking model, the ultimate power lies with the consumer. I’ve been invited to go deeper in debt, but barring urgent necessity, I won’t. If more people showed the same prudence we’d have fewer bubbles and fewer recessions.

Posted by: Shane Matthews | 2010-08-13 7:04:40 AM

Anyone wanting to emulate Shane Matthews and not address the arguments put forward will be ignored.

First, getting personal is the mark of the amateur. And secondly, you can't expect a ton of replies if you provide prior notice that your ideology purity squelch is wheeled up to max. In fact, I'd not be surprised if this is the only one you get.

Posted by: Shane Matthews | 2010-08-13 7:08:19 AM

Central bank policy over the past ten years or so can be compared to building a roadway and then forgetting to post a speed limit. While it's true that excessive speed is dangerous, it's inevitable that some people would take advantage of that situation. Others will then feel compelled to keep up with them, and pretty soon most traffic on the road will be moving at a potentially dangerous clip. Those who try to drive prudently, on the other hand, will wind up being a hazard to the fast cars, and therefore will find themselves driving at imprudent speeds just to keep traffic flowing smoothly.

Ultimately, blame lies with the central bankers who insist on creating capital out of thin air. Much less blame lies with those who take advantage of apparently "free" capital to overextend themselves financially. However, none of the blame lies with people who have been financially prudent and lived within their means. Therefore, the financially prudent are under no moral obligation to subsidize those who are not. That, I believe, has been Mike's point, and a very sensible one, all along.

Posted by: Dennis | 2010-08-13 8:06:34 AM

"P.S. What argument have I not addressed?"

As usual, you've addressed none of my points. Unlike you Shane, I am intellectually curious. You've been debating on this site for how long? And you've never bothered to attempt to understand Austrian economic theory. Whether society has adopted certain ideas has nothing whatever to do with the validity of those ideas. Can you actually post one comment without making a blatent error in logic? If the implementation of the ideas proposed by Austrian economists are impossible politically, then we will continue to have financial crises. In fact, I believe that we will never see the implementation of these ideas. But it does not mean I'm incorrect regarding what causes recessions - it simply means we will go on having recessions.

Now, are you capable of addressing the theory I have outlined or not? And no, the fact that the majority of economists disagree or the fact that the execution of the ideas is politically improbable in no way invalidates the correctness of the idea.

Posted by: Charles | 2010-08-13 8:25:08 AM

"Except that currency and trade are now pretty much globalized, and while one government’s policies can make things difficult for its own people, the true value of any venture’s assets are determined by the overall value of world currencies"

Shane, I really don't even know what you're trying to get at here. You see, I understand foreign exchange markets and how money works.

The fact that money and debt is "globalized" is a meaningless statement.

When you have current account deficits with other countries, it means you're literally borrowing from that country; you're buying more from them than they are getting back.

In order for this to work, you have to maintain a flow of currency exchange to facilitate the trade. But if there is an account imbalance, then you get a currency imbalance.

The only way you get around this, and the way we DO get around it, is by having the central banks buy treasury debt against that country. This is why, for instance, why every country that has a trade surplus with the US has to, effectively, lend the US money in order to facilitate the trade. Otherwise, the USD exchange, left to market forces would collapse against the exporting currency.

This is why China, Japan, Korea, and Taiwan own huge piles of US treasuries. It's that simple.

All that's happened here, Shane, is the negative effects spilling into other countries in the other direction. It's the same problem I'm describing for domestic consumers and business, but entangled with the rest of the world.

During the recession in the US, this imbalance has continued to deteriorate. However, China has made moves to stop buying US treasuries. And if China were to float their currency, the US consumer would lose their buying power overnight.

Suddenly, $1000 LCD TVs at Best Buy will cost $3500, then $5000, then $10000. The effects will spill over into food imports, energy imports, etc.

This globalized money is a ticking time bomb on an epic scale.

Posted by: Mike Brock | 2010-08-13 8:34:22 AM

"And where is your proof that the Austrian school of economics is the only one worth considering?"

When have I ever said that? I've thoroughly analyzed classical economics (Say, Smith, Ricardo, Marx, Mill, etc.), the marginalists (Menger, Jevons, Walras, Marshall, etc.), Keynes and neo-Keynesians (they're not the same), monetarism (Fisher and Friedman), neo-ricardians (Sraffa and his socialist followers), neo-classical economics (with its models - in fact I was trained as neo-classical economist / financier), and the Austrians (Menger, Bohm-Bawerk, Mises, Hayek, Rothbard). After all this I have come to agree with the Austrians. What have you studied?

Posted by: Charles | 2010-08-13 8:40:55 AM

As usual, you've addressed none of my points.

You accused me of already not having addressed someone's points, by which I infer those made by Mike Brock. I have addressed his; but then, he didn't behave like a bellicose toad and start off with something to the effect of, "Man, isn't that Shane an asshole?"

You've been debating on this site for how long? And you've never bothered to attempt to understand Austrian economic theory.

So? You've never bothered to attempt to understand the alternatives; you know, the ones that everyone actually uses. Your system is the untried one; the burden of proof therefore lies with you.

Whether society has adopted certain ideas has nothing whatever to do with the validity of those ideas.

Not true. People on the losing side of an argument who argue that the world is wrong and they are right are almost always themselves wrong. Logically, no, it makes no difference. But empirically, oh yeah.

Can you actually post one comment without making a blatent error in logic?

Can you actually post one comment that actually has a basis in reality, as opposed to being purely theoretical? You say reserve fractional banking doesn't work. But I have yet to see a comprehensive explanation as to what to replace it with. Instead, you chastise me and the rest of the world for not reading the same textbooks you read, and on the strength of having thus chastised, consider your case made. By the way, the word is "blatant," not "blatent."

If the implementation of the ideas proposed by Austrian economists are impossible politically, then we will continue to have financial crises. In fact, I believe that we will never see the implementation of these ideas. But it does not mean I'm incorrect regarding what causes recessions - it simply means we will go on having recessions.

That's the first thing you've said that's made a concession to reality, Charles; congratulations. But the fact of the matter is that there were recessions long before the days of John Maynard Keynes. Boom and bust cycles are driven by greed, not government policy. Just ask any Dutch economist about the tulip bubble of 1637.

You haven't put one forth. The cycle you describe happens whether there is central economic planning or not. However, the extremes of the cycles are less severe with central economic planning. As I believe I have said, every recession since the Great Depression has been the worst since the Great Depression, or so people at the time have claimed. But not one of those recessions has lasted ten years, seen half the banks in the country fold, or or put a quarter of the populations on the breadlines. You're asking us to go back to that, in exchange for what? Being theoretically or logically purer? Get real.

Posted by: Shane Matthews | 2010-08-13 8:45:59 AM

"Boom and bust cycles are driven by greed, not government policy."

Boom and bust cycles are driven by the creation of artifical bank credit. Fractional reserve banking existed before the Great Depression, genius.

So now explain to me why the first time the gov't interfered in the economy, there was a Great Depression. 10 years prior, the gov't did nothing and the economy recovered. The reason there was massive unemployment is precisely because Hoover and FDR interfered and prevented the necessary liquidation of malinvestments.

As I said, I have presented you with a legitimate economic theory. Hayek won a nobel prize based on this theory. Now either address it or move to something else since you clearly do not have the competencies to engage in a rational debate.

Posted by: Charles | 2010-08-13 8:55:25 AM

Congratulations, Dennis. You have put into a simple, lucid paragraph the very idea that Mike seemed to struggle across multiple posts to get across. Well done.

That said, I still don't agree. Since I have recently started always driving the speed limit, I can relate to your expressway example, but the fact of the matter is that I can just ignore what's happening in my rearview mirror, and eventually the impatient one will either change lanes or back off.

Also, it's not just the "central" bankers creating capital out of thin air; that is how any modern bank functions: by taking deposits and partially lending them out and charging for the service. And those toxic loans were put out by individual banks, not the central bank. Everyone, from bankers to bankees, cheerfully went along with the ride, when common sense should have told all of them that the situation was untenable. And ultimately, all have paid, which is appropriate.

This recession is particularly severe because it was based largely on real estate, which owing to demographic pressures (thanks largely to the baby boomers) has been greatly inflated beyond its true value for a great many years. Everyone knew the inevitable correction would be catastrophic; they just hoped they'd be out of the market and above the fray by then, having already made their killing, passing the cost on to other suckers. And that, my friends, is capitalism.

Posted by: Shane Matthews | 2010-08-13 8:56:09 AM

"You're asking us to go back to that, in exchange for what? Being theoretically or logically purer? Get real."

Given I believe the central bank and fractional reserve banking caused the bubble in the first place, that is the opposite of what I'm saying. Again, you haven't bothered trying to figure out what my (and Mike's) argument is.

Posted by: Charles | 2010-08-13 9:03:40 AM

Shane, I really don't even know what you're trying to get at here. You see, I understand foreign exchange markets and how money works.

Then why did you come so close to bankruptcy, if you know more than the economists who actually run the system?

The fact that money and debt is "globalized" is a meaningless statement.

Ah, no. What it means is that just because your country is a victim of runaway inflation doesn't make everything you own worthless. It just makes the money your government prints worthless.

When you have current account deficits with other countries...if there is an account imbalance, then you get a currency imbalance. The only way you get around this, and the way we DO get around it, is by having the central banks buy treasury debt against that country...This is why China, Japan, Korea, and Taiwan own huge piles of US treasuries...And if China were to float their currency, the US consumer would lose their buying power overnight...This globalized money is a ticking time bomb on an epic scale.

Things have a way of working out in the end, Mike. Back in the 80s, people were saying the same thing about Japan. In the end, it comes down to resources, resources, resources. America got clobbered in the recession, don't get me wrong. But countries like Iceland, Ireland, and Greece, with globally insignificant resources that were riding high due to sheer speculation, are in much worse shape.

In the end, America can provide for itself with the resources within its borders. Even the oil issue is resolvable with a sufficient effort of will, because 15,000 square miles of biodiesel-producing aquafarming in the Mojave desert could meet all our current petroleum needs. Canada can too. So can China, Russia, France, Germany, the UK, and a few others. The rest have become almost totally dependent on other nations, in one way or another, for their wealth creation. That is why those countries were hit so hard. They need us more than we need them.

Posted by: Shane Matthews | 2010-08-13 9:09:46 AM

"has been greatly inflated beyond its true value"

Good grief. This statement actually shows a bit of insight. So how was the bubble inflated Shane? How do price increases occur? Last time I checked, price increases occur when you increase the money supply faster than you increase the number of goods and services.

Posted by: Charles | 2010-08-13 9:12:09 AM

For anyone interested, Jesus Huerta de Soto (in a rather long but interesting book) has clearly shown that the boom and bust cycles we currently have only began appearing when bankers began to violate depositor contracts (i.e. lending out deposits). The evidence is pretty overwhelming.

Posted by: Charles | 2010-08-13 9:19:55 AM

Then why did you come so close to bankruptcy, if you know more than the economists who actually run the system?

Not for my financial mismanagement. But rather, personal circumstances beyond my control, Shane. Besides, even if I did lose all my money because of my own stupidity, it wouldn't make my arguments incorrect. So, to quoque, in any case.

Ah, no. What it means is that just because your country is a victim of runaway inflation doesn't make everything you own worthless. It just makes the money your government prints worthless.

No, it doesn't make the stuff worthless. In fact, this is why I encourage people to invest in commodities, agriculture and precious metals, given the situation.

But much of the "stuff" that we consider valuable isn't really all that valuable -- at least, not as valuable as we think it is, speculation aside. We can't, for instance, ship our house to China to pay our debts.

I don't think they'll want our used toasters with burnt breadcrumbs inside. Etc.

So this is the classical fallacy in statistics and science. That, past performance is no guarantee of future success.

You make the mistake, Shane, of assuming that I'm not familiar with the 1980s. You think that my education in economics is limited to a small window of the past 10 years? I have, in fact, studied the 1970s and 1980s extensively, and I don't think the economic rebound we experienced then plays against anything I'm saying.

In fact, all the of sins that were committed in the 1980s and 1990s played into what happened with the NASDAQ bubble, and ultimately the housing bubble, and the financial collapse we found ourselves in in 2008.

This has been a long process of shifting our economy away from a savings and capital creation-based economy, to a debt and consumption based economy.

The critics you speak of in the 1980s, were, as matter of fact, not wrong. They just failed to contemplate the degrees to which governments and central banks would go to keep the whole charade going for as long as it did.

I mean, I don't think the most ardent Austrians in the 1980s thought that the situation would get as bad as it has. But the truth is, this problem we're talking about is a cancer that started slowly spreading through our economy the day that the Bretton Woods consensus was scrapped.

Posted by: Mike Brock | 2010-08-13 9:25:19 AM

"...that is how any modern bank functions: by taking deposits and partially lending them out and charging for the service. And those toxic loans were put out by individual banks, not the central bank. Everyone, from bankers to bankees, cheerfully went along with the ride, when common sense should have told all of them that the situation was untenable."

Simply because most if not all modern banks function this way doesn't mean that this is a good idea.

Inflation is not a sensible, win-win method of central planning. It is first and foremost an act of fraud, of theft, of deception. Demand deposits are meant to be liquid; i.e. subject to withdrawal by the depositor at any time. Lending out those deposits to others amounts to placing multiple claims on the same asset, leading to intractable and catastrophic consequences when too many depositors demand their money back.

By placing less than 100 percent reserve requirements on bank deposits, central banks wind up "stimulating" the economy for brief periods, which are inevitably followed by busts as the duplicated asset claims must be sorted out. Any bank which tried to buck this trend and act prudently would be trounced by its competitors in the marketplace due to the fact that the profits that fractional reserve banking generate would be unavailable to it. In reality, it is very difficult and in some cases impossible to insulate oneself totally from the irresponsible behavior that central planning promotes.

Posted by: Dennis | 2010-08-13 9:33:48 AM

Dennis, that's a very elegant way of putting my "rational actors" argument I was trying to make to, Shane.

In a system which is designed unfairly to begin with, playing fairly simply means you lose.

So by Shane throwing up his hands and saying, "well, it doesn't matter the system is unfair, you should play fairly anyways. If you get burned playing fairly, your own fault. If you get burned playing unfairly, your own fault."

Thus, Shane has constructed a complete tautology here, and is building an entire argument simply on begging the question; assuming the initial point, that the system is the way it is, and the system itself cannot be blamed. Only the actions of individuals can be blamed.

Well, this is just silly. Shane is the one who likes to make the arguments for intentional community and all that stuff, but then falls back on blanket personal responsibility when it comes to this issue.

It strikes me that Shane is actually more intelligent than this, though. I think he just really, really likes arguing.

Posted by: Mike Brock | 2010-08-13 9:40:12 AM

Simply because most if not all modern banks function this way doesn't mean that this is a good idea.

Nor that it is a bad idea. This is what Charles and Mike are attempting to prove. But they cannot erase the fact that recessions before central economic planning tended to be longer and more severe than those that came after. This is why so many, including me, resist their ideas; because they have been tried before, and history tells us the result was less than satisfactory.

Inflation is not a sensible, win-win method of central planning. It is first and foremost an act of fraud, of theft, of deception.

And that statement is first and foremost a matter of opinion. If one does not extend this concession, the rest of the argument is critically weakened.

Demand deposits are meant to be liquid; i.e. subject to withdrawal by the depositor at any time. Lending out those deposits to others amounts to placing multiple claims on the same asset, leading to intractable and catastrophic consequences when too many depositors demand their money back.

And if you had proof that people were actually being denied the opportunity to get their money back, Dennis, you'd have a case. What you have just described is no less true of the stock market than it is of the banks; if too many stockholders cash out, the exchange crashes. The difference is there's no FDIC on stock shares.

And the libertarian solution to this is to regulate? Because that's the only way you'd have a chance at stopping this behaviour. You say this behaviour is irresponsible and immoral and should be halted. Giving you that for a moment, greedy are going to continue doing it unless force them to stop, which means restricting liberty. Sorry, but I don't see a way out of this conundrum that is consistent with the libertarian perspective.

Posted by: Shane Matthews | 2010-08-13 10:26:34 AM

In a system which is designed unfairly to begin with, playing fairly simply means you lose.

More likely, it means initially you don't do as well as your competitors. But if you keep the slow and steady pace, you'll be out ahead after your competition has gone off the cliff. Also, accepting this argument means accepting that the system is manifestly unfair and not simply operating on principles you find repugnant.

Actually, everything I said assigns blame equally to the lender and the lendee. At NO time did I see the lendee bore ALL the blame. It is your contention that he bears essentially none that I objected to.

It strikes me that Shane is actually more intelligent than this, though. I think he just really, really likes arguing.

This last point is absolutely true. But I don't play devil's advocate. I only argue what I believe. Keep in mind, you misinterpreted my arguments. I'm not saying that the lendee bears all the blame; only that he bears an equal share. That assumption dispelled, we're left with what I actually said, which is no tautology.

P.S. If blaming only the lendee is a tautology, then so is blaming only the lender. Especially when the ones alleged to be rigging the systems are not lenders but a phalanx of bureaucrats who are a bank in name only. You can't walk into the Bank of Canada and open a chequing account.

Posted by: Shane Matthews | 2010-08-13 10:44:00 AM

You can't walk into the Bank of Canada and open a chequing account.

You don't realize how insightful this comment is, and how important it is to the argument I'm making. =)

Posted by: Mike Brock | 2010-08-13 10:53:03 AM

"But they cannot erase the fact that recessions before central economic planning tended to be longer and more severe than those that came after."

Proof please. The FED was created in 1913, it only took 17 years for it to create the greatest bubble the U.S. had ever seen. In fact, both Richard Timberlake and Murray Rothbard provide factual evidence which completely contradicts what you've just stated. Before the creation of the FED, recessions were shorter and less nasty. In fact, if you look at the GDP numbers (as I've done) since the beginning in 1800 up until 1913, you'll notice recessions lasted on average 1.2 years and the decline was on average 3.3%. After 1913, the average length is 2.7 years and the average decline is 7.2%.

But regardless, Charles and Mike aren't suggesting we go back to the days of fractional reserve banking without a central bank; we are suggesting a 100% reserve standard with no central bank.

Posted by: Charles | 2010-08-13 11:25:30 AM

Anyway, as usual things have gotten out of hand. If anyone has an argument superior (not hard to do) to "Austrian economic theory is wrong because it is not implementable politically at this time", I'd love to hear it and debate the ideas and the evidence.

Posted by: Charles | 2010-08-13 11:29:24 AM

Proof please. The FED was created in 1913, it only took 17 years for it to create the greatest bubble the U.S. had ever seen.

I think the proof that should be on the table is that the FED was responsible for that bubble. As for proof that the Great Depression was more severe than any recession since: Are you serious!?

Before the creation of the FED, recessions were shorter and less nasty. In fact, if you look at the GDP numbers (as I've done) since the beginning in 1800 up until 1913, you'll notice recessions lasted on average 1.2 years and the decline was on average 3.3%. After 1913, the average length is 2.7 years and the average decline is 7.2%.

In all seriousness, I'd appreciate a link to that. But how to account for the fact that recessions since 1935 have all been less serious than that one, and that regulation today is greater, not less, than it was in 1935?

But regardless, Charles and Mike aren't suggesting we go back to the days of fractional reserve banking without a central bank; we are suggesting a 100% reserve standard with no central bank.

Has that ever been tried in a modern economic setting? Or only in a country where ninety percent of the population were subsistence farmers (as recently as 1900)? And does that even make a difference? These are the answers I'm not seeing.

Posted by: Shane Matthews | 2010-08-13 11:31:34 AM

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