Friday, February 27, 2009

THE CENTRAL PROBLEM

Interesting piece over at Jesse's Cafe Americain the other day. Seems a UK newspaper reported on a FT/Harris poll of European public opinion in which a whopping 74% of respondents placed most, if not all, of the blame for the current financial crisis on central bankers. "Only" 60% blamed regulators or governments.

Now, in my opinion (and Jesse's, as you'll see), this is remarkable. For two reasons. First, to anyone with a basic understanding of modern economics, central banking policy, and institutional finance/banking, this is a no-brainer. Not even profound, really. Debates may exist over matters of degree, but it's not really controversial. That's why 3/4 of Europeans agree.

Which brings me to the second reason this poll is remarkable: how many Americans could even tell you what a central bank is? What one does? What the name of America's central bank is? Whether it's public, private, or quasi-public? How its charter works? When it was established? Why? What its official mandate is? Whether it's lived up to that mandate? Who heads the central bank? Who proceeded him? Who headed it during the depression? When we went off the gold standard? When we fought inflation almost 30 years ago? Who headed its (completely) private NY Branch which fed money straight to Wall St. as recently as early January?

Let alone know enough to offer an intelligent opinion as to its role in the current crisis?!

As Jesse said, quite comically:
A similar poll in the States, however, had very different results:
Q: Who is responsible for the financial crisis sweeping the world?

34% Whatever is wrong, Obama will save us.

33% Will they reschedule American Idol because of the President?

11% Sorry I'm in a hurry to buy 'supplies' and apply for a passport

22% Can I have a bite of your sandwich?
As he also said, suggesting that the role of central banking was so huge, it's amazing every American isn't demanding answers now:
Our interpretation of the poll is that the European public believes that the financial crisis was caused undoubtedly by the commercial and investment bankers, but that the central bankers promoted the environment that allowed it to occur and had the responsibility for preventing it.

That is rather surprising, because Trichet and his predecessors have been as Jacksonian stalwarts compared to Easy Al [Greenspan] and Zimbabwe Ben [Bernanke].

It would have been interesting to see the poll, and to have added a question about monetary policy and a return to 'hard money.'

* * *
One might infer that the Federal Reserve and Wall Street have a much closer relationship with the mainstream media, among other things.
As usual, I'm not gonna try to sum up in one short blog post the particulars of Federal Reserve banking, policy, lending, and stimulating under Greenspan and Bernanke (let alone under Volcker or William McChesney Martin). Poke around on Google for "Fed and housing bubble," or "Fed and tech bubble," or "acceptable rates of inflation," or "Chicago school" (plus Milton Friedman & Irving Fisher), or "discount window" (plus Federal Open Market Committee), or "fractional reserve banking" and start piecing it together. It's not easy, but it's not that hard either.

And if you really attempt to understand it, to acknowledge the Federal Reserve's dual policy of expanding and extending money & credit to a handful of privately-owned banks that are first in line, you'll understand exactly why banks and other institutions were able to engage in the practices that destroyed the financial system:

* Extend cheap credit
* Spend lavishly on risky "assets" and compensation
* Spin off derivatives and other creative financial vehicles with tenuous connections to reality

In other words, without cheap money and cheap credit -- from the Federal Reserve -- in a barely-regulated fractional reserve system, the banks & Wall St. could not have practiced their trade as loosely, riskily, and irresponsibly as they did. Why? Because they wouldn't have had either the upfront capital or the knowledge that the "lender of last resort" had their backs if they got into trouble.

And all of this went on before the crisis started, and none of it was hidden. Except for the parts that the American public, press, and congress willfully hid from their own eyes.

Fiscal policy is important. At the governmental, institutional, and personal level. We've lost our way in that area. We've lost our minds, as the $1.75 trillion deficit in the proposed budget demonstrates. But monetary policy -- as implemented by a quasi-governmental entity that doesn't have to answer to the democratic process -- controls everything. It has had undue control over the economy. And it drove that economy straight into the ditch for the benefit of a very small cadre of Insiders.

We need to wake up. We need to speak up. We need to fix things.

By the way, the answer to three of the questions I asked above are Ben Bernanke, Tim Geithner, and Paul Volcker. All three of whom are "in the mix" right now. You can guess how I'd like to see those three shifted in and out of positions of power.

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13 Comments:

Anonymous Anonymous said...

Great post, as usual, Mike.

I wouldn't hold my breath waiting for Boobus Blogospherus to educate itself, beyond, say, linking to its favorite made-for-TV economists.

Applesaucer

8:53 AM  
Blogger Mike said...

I wouldn't hold my breath waiting for Boobus Blogospherus to educate itself

Perhaps not. But his close genetic relative, curiositus blogospherus, a less dominant species to be sure, may poke around.

8:58 AM  
Blogger Smitty said...

I would consider myself a Curiositus Blogospherus, subspecies Trepidus. Thus, your blog is usually my first stop for the readers Digest version, then on to your links for the Magazine version of what's going on. Soon, I may actually have to shoot for the Encyclopedia Britannica version.

Your blog provides me with a great frame of reference with which to understand the bigger posts and links you send me to.

Is the only thing that will get us out of this actually having "hard" money again? Returning to a monetary system where money is given value via production and the like, and not money-valued-by-other-money? It seems like it and if that's the case, this is gonna last a looong time...

11:49 AM  
Blogger John Royal said...

Forget about Idol. Will this cause Obama to bump an episode of Battlestar Galactica?

Now that would make me frakking angry.

5:40 PM  
Blogger Mike said...

Is the only thing that will get us out of this actually having "hard" money again? Returning to a monetary system where money is given value via production and the like, and not money-valued-by-other-money? It seems like it and if that's the case, this is gonna last a looong time...

Tough question to answer. The "Idealist" answer is, "yes, return to hard money."

Acknowledging, however, that the federal reserve isn't going anywhere I'd suggest a chairman who has a fucking clue what he's doing, as opposed to some second-rate, academic, Milton Friedman acolyte. I.e. Volcker over Bernanke, or some similar exchange.

I'd also suggest revamping the reserve rules. If these goddamn vampire banks are gonna get first dibs on the reserve window, we have to place limits on how much credit they can extend. With all the liquidity the Fed has extended to the banks, the money multiplier is gonna be stratospheric once they start lending.

But deep down, I want the reforms to go much further. I want to limit the Milton Friedman model of central banking, and its encouragement of low-level inflation.

8:47 PM  
Blogger steves said...

Smitty, you aren't suggesting a return to the gold standard, are you?

As for European understanding of the problem, it must be the European media. Their media is 10 times worse in terms of telling people what to believe, so the only conclusion I can draw is that papers over there have taken the position that the crisis is caused by central banks. I am not a fan of most European media (which is completely unrelated to this topic). I doubt the average European has an in-depth knowledge of their banking system that is any better than the average American.

Considering that sheer volume of laws and regulations that deal with banking, I don't see how it is possible all of the blame on central bankers or the government.

7:45 AM  
Blogger Mike said...

Steves:

1. Why anti-gold standard?
2. Why so quick to let the central banks off the hook?
3. Where do you lay the blame, and how do you extricate central bankers from your web of blame?

9:26 AM  
Blogger steves said...

1. Fiat money certainly has it's problems, but I am not convinced that a gold standard would be the best choice either. Fiat offers some flexibility in the case of a recession and in the cases of some kind of emergency, such as a war. Then there is also the problem with the limited supply of gold and the limited number of places it is mined.

A better idea may be to tie money to some other agreed upon commodity. I wouldn't say I am anti-gold standard, just skeptical-gold standard.

2. I am not, so I apologize for giving that impression. They played a key role in the problem.

3. Bankers and regulators are to blame.

10:18 AM  
Blogger Mike said...

the problem with the limited supply of gold

What you call "the problem" is exactly the source of what I like: that it's limited. It's real. It can't be conjured out of thin air.

Fiat offers some flexibility in the case of a recession and in the cases of some kind of emergency, such as a war

Maybe we need a little less of that flexibility. If policians knew their ability to finance a war was limited, perhaps they'd be a tad less eager to get us into them.

And recessions are an economies way of telling us, "slow down." We've gotten ourselves into a such a mess partly because we refused to hear that cry. Printing money to get out of a recession is precisely the wrong thing to do. All you're doing is kicking the can down the road.

As the AAMCO commercial used to say, you can pay me now, or you can pay me later.

But you WILL pay.

10:34 AM  
Blogger steves said...

I should have said "too limited." I agree on too much flexibility, which is why I mentioned that both systems were problematic.

10:42 AM  
Anonymous Applesaucer said...

Money is a medium of exchange. Therefore, increasing the units of such medium of exchange does not increase overall wealth; rather it diminshes the value of each unit.

Just think of a monopoly game where the banker announces that each person gets to start with twice as much money. Is anyone "wealthier?"

And then keep in mind that in the United States, it is the BANKS that get the extra fiat cash first, as money in the US is LENT into existence. So there is not an equal distribution to everybody.

Thinking of money as a medium of exchange, it becomes clear that there will never be a problem with a limited gold supply. In fact, there never has been. If a country does not have any gold, it can offer something in return for it.

Regarding the following statement: "Fiat offers some flexibility in the case of a recession and in the cases of some kind of emergency, such as a war."

As Mike said, this is a huge PROBLEM with fiat currency, as is goes to the heart of limited government. But going past that point, think about this: when the government increases money supply at will, it is engaging in Ponzi finance.

We know that the government is not creating any overall wealth by creating additional monetary units, yet it is laying claim to a greater percentage of society's resources with these units.

This is no different than the Roman Emperor shaving gold and silver coins he issued.

Also, let's turn to the issue of the government creating more money during recessions. I ask the question: if printing more monetary units doesn't create any more overall wealth, then why is it appropriate to create more monetary units to combat an economic slowdown?

I think the answer, from the government's perspective, is that printing more monetary units -- especially if it is associated with suppressing interest rates -- induces people to devote savings to certain, GDP-generating activites.

So, for instance, when the Fed ramped up money supply and sat on interest rates in some combination and at various times over the first half of the decade, the housing industry experienced a temendous boom, both in pricing and activity.

But let's look back at what happened: tremendous amounts of wealth and savings were squandered by this country on housing. Someday, maybe, all of the empty houses will serve somebody. Great. But in the meantime, all this savings could have been directed to something else. And if interest rates had not been suppressed and money supply ramped up, it is less likely that so much wealth, energy and effort would have been squandered.

Finally, I think it's naive to expect a government to adhere to a gold standard during emergencies. Honest Abe didn't do it during the Civil War; European banks confiscated public gold during WWI and then their government, in turn, confiscated the gold from them; and FDR abolished gold ownership in 1933. The US barely felt itself contrained from issuing new currency in the '60s, even though it couldn't possibly redeem all such currency with gold.

So, really, to me the answer is "free money." That is, the people using a medium of exchange that is not issued by the government. Gold seems to fit that need best, but there's no "magic" to it, really.

But, free money is unlikely to emerge in our lifetimes, if at all, so probably the best we can hope for is for some grown ups -- like William McChesney Martin or Volcker -- rather than sycopahnts, clowns and quacks like Arthur Burns, Alan Greenspan and Ben Bernanke to run the show.

I hope Obama puts the grownups in charge sometime soon.

Applesaucer

11:30 AM  
Anonymous Applesaucer said...

By the way, Mike, in the below, cut-and-pasted video, another Mike makes the same case you've been trying to make about the financial sector hostile takeover of the rest of the country.

I think it's straight forward enough to merit its own blog post, rather than remain buried in your comment section, but that's obviously up to you:

http://www.ritholtz.com/blog/2009/02/michael-hudson-six-minutes-with-the-renegade-economist/

Applesaucer

11:51 AM  
Blogger Mike said...

makes the same case you've been trying to make

I try, he makes. That about sums it up!

Anyway, great stuff in that long comment. Well summed up.

6:25 PM  

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