The Filter^

Richard Cobden on currency regulation

I hold all idea of regulating the currency to be an absurdity; the very terms of regulating the currency and managing the currency I look upon to be an absurdity; the currency should regulate itself; it must be regulated by the trade and commerce of the world; I would neither allow the Bank of England nor any private banks to have what is called the management of the currency...

I should never contemplate any remedial measure, which left to the discretion of individuals to regulate the amount of currency by any principle or standard whatever... I should be sorry to trust the Bank of England again, having violated their principles [the Palmer ruke]; for I never trust the same parties twice on an affair of such magnitude (Q. 519, 520, 527)

cited in Development of British Monetary Orthodoxy 1797-1875, Frank W. Fetter, Cambridge, Mass.

"Central bankers are politicians with tenure"

Joe Salerno on Fox Business News:

Horwitz defends Mises as a free banker

For the last couple of months I've been thinking a lot about the 100% reserve vs. free banking debate. Whilst I agree that it is important to utilise a holistic, contextual, and charitable reading of a scholar, there is sufficient textual evidence to find evidence in Mises supporting both 100% reserve requirements and free banking. As Steve Horwitz puts simply, “Mises did defend free banking and was not ‘always a supporter of the 100% reserve gold standard.’” Steve Horwitz has three posts defending Mises as a free banker, here, here and here.

I've also been looking through Nicolas Cachanosky's paper, “Mises on Fractional Reserves”(.pdf)

Here are the key quotes:

• Free banking is the only method for the prevention of the dangers inherent in credit expansion. It would, it is true, not hinder a slow credit expansion, kept within very narrow limits, on the part of cautious banks which provide the public with all the information required about their financial status. But under free banking it would have been impossible for credit expansion with all its inevitable consequences to have developed into a regular—one is tempted to say normal—feature of the economic system. Only free banking would have rendered the market economy secure against crises and depressions." Human Action (1966, p. 443)
• "Of course, all of this is true only under the assumption that all banks issue fiduciary media according to uniform principles or that there is only one bank that issues fiduciary media. A single bank carrying on its business in competition with numerous other is not in a position to enter upon an independent discount policy. If regard to the behaviour of its competitors prevents it from further reducing the rate of interest in bank-credit transactions, then - apart from an extension of its clientele - it will be able to circulate more fiduciary media only if there is a demand for them even when the rate of interest charged is not lower than that charged by the banks competing with it. Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow an independent interest policy. But in doing so, they help to stabilize the objective exchange-value of money. To this extent, therefore, the theory of the elasticity of the circulation of fiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completely misapprehended its cause [i.e., not understanding that it requires competition to work]." The Theory of Money and Credit (1938, p. 312)
• "In theoretical investigation there is only one meaning that can be attached to the expression Inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term) so that a fall in the objective-exchange value of money must occur. Again, Deflation...signifies: a diminution in the quantity of money (in the broader sense) which is not offset by a corresponding diminution in the demand for money (in the broader sense), so that an increase in the objective-exchange value of money must occur." The Theory of Money and Credit (1938, p. 240)
• "Suspension of the banknotes’ convertibility and legal-tender provisions had transformed ‘hard’ currencies of many countries into questionable paper money. The logical conclusion to be drawn from these facts would have been to do away with privileged banks altogether and to subject all banks to the rule of common law and the commercial codes that oblige everybody to perform contracts in full faithfulness to the pledged word. Free banking would have spared the world many crises and catastrophes" Theory of Money and Credit, (1981 p. 482)
• Is therefore in a position to undertake greater obligations than he would ever be able to fulfil; it is enough if he takes sufficient precaution to ensure his ability to satisfy promptly that proportion of claims that is actually enforced against him." Theory of Money and Credit, (1980 p. 299)

18 years growth and a couple of years blip

Brilliant graphic. This is from Martin Wolf, via Free Thinking Economist.

A Beginner’s Guide to Liberty

This is wonderful news - 'A Beginner’s Guide to Liberty' is now available to buy from the Adam Smith Institute. The book is a short primer on various aspects of political economy, written by some fantastic authors (and me - I contributed chapter 9: Banking, inflation and recessions). The volume was edited at a fantastic speed by Richard Wellings, here was his brief:

His remit was to produce something that was accessible to sixth-formers but interesting for everyone

It's available for just £10. There's even a free download here (.pdf). I'm delighted it's out in time for Christmas, so get ordering!

Where’s That Inflation? - Reason Magazine

“I believe we are currently witnessing a bubble in Treasury debt. I consider the current yields on 10-year U.S. government bonds to be absurdly low, just like the price of housing was absurdly high in early 2006. After this bubble bursts, investors will slap themselves on the forehead and say, ‘What were we thinking? Why did we rush into Treasurys even as the government told us it was planning to double the federal debt burden in a decade?’ 

via reason.com

"What Went Wrong?"

From on email:

Big Think Convenes Unprecedented Online Commission to Document the Causes of the Financial Crisis

NEW YORK -The on-line think tank, Big Think today launched "What Went Wrong?" an eight-week, Web-based educational series with leading economics experts collaborating to understand the root causes of the recent global financial crisis, in the interest of preventing yet another.  

This ambitious and innovative initiative, sponsored by the Charles G. Koch Charitable Foundation, comes out of the urgent need to improve our understanding of the factors that led to the crisis and assess proposed reforms to avert new crises already looming.

The interactive series will combine Big Think's singular ability to engage a range of top figures in government, business, academia and media with an open network of the world's leading economics bloggers and columnists -- who will drive the agenda of the series through their questions and analysis.   

Upon the release of each expert interview, the prominent nexus of bloggers will analyze the views expressed in a concerted and open dialogue that will appear on each participant's website.     

The aims of this groundbreaking collaboration are to "expert-source" a uniquely authoritative and comprehensive educational resource on the lessons gleaned from the financial crisis and leverage their combined reach to expand the public dialogue about our best way forward.  The content of the series will in turn be collected and highlighted on Big Think.

This week will feature John Allison, former CEO of BB&T:

·         John A. Allison IV, Chairman of BB&T Corporation; Chairman and CEO of BB&T, (1989-2008 and Distinguished Professor of Practice, Wake Forest University School of Business 

Excerpts:

·         Allison: "In my career, Citigroup has failed three times, been bailed out by the government three times, and every time, they've gotten bigger and worse.  There is a tremendous moral hazard to the government constantly keeping poor run institutions in business and it prevents a natural market correction process."

Update: See Allison on banking here.

Should Britain declare bankruptcy?

This is a something I've been thinking about (almost seriously), but I have a couple of questions:

• What's the best resource about JP Morgan's role in the US government crisis of 1895? How big was he in relative terms? Is there a possible contemporary equivalent?
• Are we witnessing a boom in UK government debt? How would we tell whether this was a bubble?

People are speculating about whether Britain is heading for a sovereign default, and some believe Britain is already bankrupt(.pdf). Of course most governments are bankrupt but stumble along due to the power of inflation. That's why Jeff Hummel predicts it, and  Pete Boettke and Scott Beaulier just come out and propose it. Thoughts welcome.

Falling Wage Rates « ThinkMarkets

Great insight, and great writing, as ever from Jerry O'Driscoll:

The reflationists (whether monetary or fiscal) conflate cause and effect.  Falling wages rates are the consequence of prior bad policies and decisions.  They are not the cause of current problems.  Moreover, fiscal and monetary stimulus cannot restore the lost capital.  Printing money or redistributing income does not create real wealth.  

Falling real wages and declining living standards put flesh on the skeleton of macroeconomic policy debates.  They are the real-world consequences of bad macroeconomic policy: easy money, politically directed investment and regulatory capture.  All those bad policies are being continued or enhanced.  Only further misery will flow from them.

via thinkmarkets.wordpress.com

Put your money where your mouth is: ABC edition

..Your Majesty, economists did something even better than predict the crisis. We correctly predicted that we would not be able to predict it

Regarding the Queen's famous challenge to economists, (and Geoff Hodgson's insightful response.pdf), I've been considering the role of forecasting. So has Sandy Ikeda, who asks a typically insightful and humble question:

Who, if anyone, firmly within the Austrian camp — let’s say associated with NYU, GMU, WVU or current members of the SDAE — called this latest boom and bust? I certainly didn’t

There are plenty of answers in the comments section. I think that all public Austrian economists who are now claiming that Austrian theory both explains (i) what caused the credit crunch; (ii) why orthodox policy responses are wrong-headed; do have a responsibility to respond to this issue. And we can answer it in two ways.

Firstly, as Sandy suggests, where is the textual evidence that this was discussed ex-ante? The power of blogging is that there's no excuses about academic publications having lags and/or a bias against contemporary relevance - if you weren't writing about this before 2007 then you didn't foresee it.

Secondly, students have every right to expect us not only to have predicted it, but to have prospered from it. I'm not suggesting that economists should make their family finances public, but we could be more transparent about how our personal investment strategies tie into our proclaimed wisdom. If we did see it coming, what concrete action did we take to benefit from this materially?

So the questions I think all economists (academic and commentators) should answer, and my personal responses:

1. Is there any evidence that you foresaw the credit crunch?

In 2006 I hired two student assistants to work on a project on the UK mortgage market. I wanted them to build a database showing the proportion of "subprime" mortgages that we could track over time. The assumption was that there'd be a downturn in house prices and there'd be an adverse selection argument. This is from an email I sent on 16th November 2006:

"I took one of the student research assistants with me to Chatham House yesterday, for a lecture by 2004 Nobel Prize winner Finn Kydland on "The Dynamics of Business Cycles and Monetary Policy - Links and Drivers".

Key point was that "residential construction" is the clearest driver of the business cycle (with a 3-4 quarter lead) and "consumer electricals" is also a strong driver (with a 2 quarter lead). I think this is very strong evidence that the current cycle is partly being fuelled by the housing market. Add to this the evidence that interest rates have been kept artificially low recently (even The Economist has questioned whether a little deflation would be a good thing) and will inevitably rise more in the future.

Add also the amount of debt home owners are taking on who enter the market (i.e. "marginal homeowners" and therefore how exposed they are to a rise in rates....

There's a very clear narrative ...- marginal investers tempted in when there's cheap money about, inevitable bust will occur"

I also found an unpublished project proposal that was written in April 2007:

"If the adverse selection argument is true, we’d expect the downturns in subprime lenders to become especially prevalent, and evidence from America suggests that this is happening. According to Morgan Stanley, late payments rose from 7% in 2003 to 12.6% last Autumn, and HSBC’s bad-debt costs rose by 36% to over $10billion in 2006."

Then of course there's The Filter^. Here are a few quotes about this (note I couldn't find any that contradicted this view, so this isn't a case of selective evidence):

• "the question isn't "will the housing market slow down?" because it will. We have enough economic knowledge to know that the current growth rates are unsustainable...With cheap access to capital, (via low interest rates) and a "bricks and morter" reaction to the tech crash, house prices have largely been inflated by people buying second homes to let. This is why rents are so low at the moment. Interest rates have gone up recently, and the more they do so the less profitable these investments are, making it more of an incentive to sell up... So we know it will end, but we're not sure when. How will it end? Here, I'd claim 'self-fulfilling prophecy' - if people expect a crash, as soon as prices dip they'll put theirs up on the market to cash in, and in doing so produce a crash... Dare I forecast? I think it's the right time to sell." April 2004
• "when house prices begin to really fall, and people lose a lot of wealth, I am sure there’ll be much criticism of “capitalism” or “the market”.  Be very warned that the real reason behind the house price bubble is the engineering of those too stubborn and controlling to leave free the complex economic ecosystem" July 2005
• "ABC is on the rise: trust me, i'm on it." June 2006
• September 2006 I posted a round up of economic commentators that used Austrian theory
• "Central Bank Independence isn't a binary issue; contemporary Central Bankers have yet to be properly tested;  there's a lot more credit available than blunt proxies illustrate." March 2007
• "it seems sensible to assume that the housing market is frothing (rather than it's operating beautifully and the excess credit is manifesting itself in a hitherto unspotted part of the economy)... When interest rates rise - as they surely must - house prices will cease surging, but it's up to the next Chancellor how this process is managed. The economy is an airbed: Brown merely squeezed on the Dot Com bubble to shift the air pocket to house prices. At some point the charade has to end and the valve released. We've been living beyond our means, and the crunch is coming. When that happens, remember who's to blame." April 2007

2. Did you put your money where your mouth is?

• Faith sold her house in 2004, we returned to the UK in 2006 and rented rather than bought
• Put money into cash ISAs and online savings account so that we had liquid assets

What I didn't foresee was the policy responses to this. I was expecting house prices to fall by more than they have, and for the value of my savings to be higher than they were (we've recently bought somewhere). But as we know, the government's response has been to bailout reckless borrowers at the expense of prudent savers.

One very important caveat - my motivation is not to create money. In this regard my investment strategy is mainly to protect the wealth I create from being a Professor, rather than to advance that wealth. In this regard I am an observer of capital markets rather than a participant, and this distinction is, for me, key. But the bottom line here is don't trust an economist, trust yourself. And if you take the time to read these three books, I'm sure you'll understand the pull of Austrian analysis:

• The Failure of the New Economics(.pdf), by Henry Hazlitt (1959) - or buy from Amazon here.
• Prices and Production(.pdf), by Friedrich Hayek (written 1929-1937) - or buy from Amazon here.
• What Has Government Done to Our Money?(.pdf), by Murray Rothbard  (1980) - or buy from Amazon here.

Update: Sandy's follow up:

The response to my bleg has been very helpful and quite heartening, and I thank everyone who responded.  Based on “accuracy and distance,” however, the winner appears to be Fred Foldvary, who in 1997(!) hits it on the nose:

“the next major bust, if there is no major interruption such as a global war, will be around 2008.”

(American Journal of Economics and Sociology 56(4): 521-41, quote at p. 538.) Thanks to Dan Klein for the tip and the cite.