Wednesday, 15 August 2007

Sense on the credit crunch

Some economic sense on the sub-prime economic meltdown from Austrian economists George Reisman, Robert Blumen and John Paul Koning. The mainstream economists have clearly delivered a bust (and the reason for the bust is the one question you must never ask a mainstream economist), so perhaps it's time to listen to some sense? Says Blumen in The Unfolding Credit Crisis:
With the collapse in the price of sub-prime mortgage backed securities and credit derivatives, the credit boom has moved into the crisis phase. This is the place in the cycle where it becomes clear to the market the investments made possible by unfunded credit were mal-investments and they are re-priced.
Reisman agrees, and he fingers the culprit as the massive credit expansions facilitated by central banks. In The Housing Bubble & the Credit Crunch he says:
The situation today is essentially similar to all previous episodes of the boom-bust business cycle launched by [central bank] credit expansion. The only difference is that in this case, the credit expansion fed an expanded demand for housing and, at the same time, most of the additional capital funds created by the credit expansion were invested in housing. Now that the demand for housing has fallen, as the result of the slowdown of the credit expansion, much of the additional capital funds invested in housing has turned out to be malinvestments. In most previous instances, credit expansion fed an additional demand for capital goods, notably plant and equipment, and most of the additional capital funds created by credit expansion were invested in the production of capital goods. When the credit expansion slowed, the demand for capital goods fell and much of the additional capital funds invested in their production turned out to be malinvestments.

In all instances of credit expansion what is present is the introduction into the economic system of a mass of capital funds that so long as it is present has the appearance of real wealth and capital and provides the basis for sharply increased buying and selling and a corresponding rise in asset prices. Unfortunately, once the credit expansion that creates these capital funds slows, the basis of the profitability of the funds previously created by the credit expansion is withdrawn. This is because those funds are invested in lines dependent for their profitability on a demand that only the continuation of the credit expansion can provide.

In the aftermath of credit expansion, today no less than in the past, the economic system is primed for a veritable implosion of credit, money, and spending. The mass of capital funds put into the economic system by credit expansion quickly begins evaporating (the hedge funds of Bear Stearns are an excellent recent example), with the potential to wipe out further vast amounts of capital funds.
The prognosis is not pretty, says Reisman, and the latest knee-jerk credit expansion is just adding more fuel to an already out-of-control fire.
...the likely outcome will be a future surge in spending and in prices of all kinds based on an expansion of the money supply of sufficient magnitude to overcome even the very powerful impetus to contraction and deflation that has come about as the result of the bursting of the housing bubble.

Another outcome will almost certainly be the enactment of still more laws and regulations concerning financial activity. Oblivious to the essential role of credit expansion and of the government’s role in the existence of credit expansion, the politicians and the media are already attempting to blame the present debacle on whatever aspects of economic and financial activity still remain free of the government’s control.
Explosive expansion of central bank credit has been going on for the last decade or more, and it's like having a tiger by the tail--it gets harder all the time to let go of that tail. But there is a way to extricate ourselves from the mess. In response to recent injections of credit by the Fed, Reisman concedes "the only thing that can prevent the emergence of a full-blown major depression is the creation of yet still more money."
But that new and additional money does not necessarily have to be in the form of paper and checkbook money. An alternative would be to declare gold and silver coin and bullion legal tender for the payment of debts denominated in paper dollars. There is no limit to the amount of debt-paying power in terms of paper dollars that gold and silver can have. It depends only on the number of dollars per ounce.

To be sure, this is an extremely radical suggestion, but something along these lines will someday be necessary if the world is ever to get off the paper-money merry-go-round of the unending ups and downs of boom and bust, accompanied since 1933 by the continuing loss of the buying power of money.
And there is a difference in the latest $38 billion central bank intervention that John Paul Koning points out. Instead of buying treasury bonds and bills its been buying mortgage-backed securities at a furious rate, meaning in just 3 short days the Federal Reserve has effectively become one of the major real estate owners in the USA.

UPDATE: Fran O'Sullivan offers a robust local view.


  1. The rub is what's the axiomatic Austrian advice? Buy, sell, hold?

    Would also like to point out that the NZX, described by Mark Weldon as, "not exposed", is already a good 50 points below its bottom during the March China drop whereas the Dow is currently 1000 point above. Solid market that NZX.

  2. Greg

    Buy, sell, hold- depends on class of investment.

    My advice (and in my dealings I am usually of the Austrian persuasion) is to hold useful assets (house, car etc.) only. Personal portfolios should remain unexposed to shares or derivatives. Exception allowed for when you only hold stocks in your own company or one you have a close involvement with. Same goes for derivatives- only have them if you need them to transact YOUR business with, else dump and run. Only have these things if you really know what you are doing.

    As for the spare cash. Get it spread wide but only in productives.


  3. Oh, yes. Get rid of debt that you are personally liable or guarantor against. Borrow agressively otherwise.



  4. Mark is correct actually - there is no significant exposure and the hysteria here is overdone.

    "Dump and run' is what we want to hear banker - get rid of the morons in the market so we can buy up at bargain basement prices! Same as property - tell everyone it's unaffordble so we can make a few more million!

    FPH is a bargain - bought a large parcel today. Good time for kiwi FX plays as well - I am up 50k over the last 2 days!

    As I said, in every market there are winners and losers. You choose which side you want to be on.

  5. Anon

    God to hear you're doing well. that's good news and always gives me a lift when I hear of someone doing it right. Keep it up. You contrarian you! Anyway, best of wealth to you.

    As I've written and said before, I'm shorting the lot. Margin trades are doing much productive lately. Looking very good.

    Most of the muck on the stock market is not going to give the reasonable returns that could be got elsewhere for less risk and effort (as you are about to prove, I'd suspect). It's a really, really bad place to park one's money. Unless you know a great deal of fine detail about the company you have purchased stock in, you should not be in there. Far too risky and far too likely to make a loss or at best, make parsimonious return.
    Still, that's never stopped gamblers who buy in on the most flimsy of specific knowledge.

    Best to dump and run a mile from the stocks, or the other investment instruments for that matter, unless one is intimately familiar with the details of what they are, how they are operating and who is involved.

    As for bargains- depends what you mean. Something with a pe of 20 or more is not a bargain. It'd need to fall to around 3 - 5 before you'd be honestly able to say that it is worth consideration. I like to see stuff around the 2-3 mark or less. In general stocks are far too non-productive for me to get excited about.

    As for property, shhhhhhh. Don't wreck the game! You'll give it away!

    Best wishes for an exciting Friday's action. Could be a long fast one.


  6. Good morning Banker,

    Thank you - and happy investing to you today as well!

    I think we may be getting close to the bottom - risk aversion is so extreme - all the traders stopped out and retail fleeing in terror. Good times for greedy bargain hunters and day traders. If the kiwi doesn't find support at these levels we are looking at a technical retracement to 64. FPH is significantly undervalued on these predictions.

    I agree that those who don't know what they are doing should exit the market until we see good technicals at least.

    I'm not having a go at you - my beef is with the extraordinary negativity trotted out daily on this blog about everything under the sun. There is a tendency to call everything a “crisis”. We can debate whether the shakeout on debt markets is a “crisis” or not. Domestic and global economies remain in strong shape.

    My advice to people is don't put on a hair-shirt and cloister yourselves. Abandon all thoughts of global warming, premature baldness, The Muslim Peril, RMA or whatever etc. Life is good - hell even Bollard is sitting on 80m paper profit from his 'intervention', by sheer dumb luck!

  7. I trust the morning's hunting has gone well for you both.

    I'll be interested to hear your news.

    I'm astonished however to hear from Anonymous about the "beef" he/she has with "the extraordinary negativity trotted out daily on this blog about everything under the sun. There is a tendency to call everything a “crisis”."

    Perhaps he/she is confusing this with another blog? I think he/she would find that "crises" here are generally seen as an opportunity to puncture rampant hysteria.

    And I like to think that any negativity found here will generally be found directed at the grey ones getting in the way of progress either politically or philosophically, often by means of some made-up crisis.

    I'm sure you're aware of Mencken's injunction: "The whole aim of practical politics is to keep the populace alarmed, and thus clamorous to be led to safety, by menacing it with an endless series of hobgoblins, all of them imaginary."

    I like to think of Not PC as exposing the hobgoblins by keeping the population informed, rather than alarmed.

  8. PC

    Yes, a good day's effort. Went to an all-nighter. This was the culmination of some years of preparation and expectation here. What I've done is bet that the govts have done wrong and that they have acted with gross incompetance. Turns out it was a safe bet and that Mises was correct about the causes of the business cycle all along (but we already knew that).

    All I've been doing is executing to plan, prepared previously and already well known ahead of time. The formulation is no secret. It's all in the public domain. How about that!

    I didn't actually need to do anything much myself yesterday, just watch the team execute a well rehersed series of actions. They are a machine! Having said that, the real work was in geting correctly positioned over the last few years. Gotta line up the ducks!

    You might like to know that the analysis I employ is according to the economic work of L Von Mises and G Reisman. Understand these two and it is very difficult to go wrong.

    I expect things to get tougher for most people in the coming year or two. That's the cost of being egalitarian and socialist. They'll deserve what they'll get.

    I'd prefer stabilisation and consolidation until 2010 or 2012 or so and then expect things to go south in a serious way, but it may be that this series of speed wobbles will topple the bike anyway. Have to take a breather and see what to do next. There are two options presently.

    Anyway, I probably should retire now, start telling everyone how I told them so. Thing is, there's much more action to come yet. It's like a soapie- have to tune in to see what happens next even though you already know the whole plot.


    PS. That creature Cullen is such a craven commie pest, don't you think? Hard to imagine anyone better qualified as an incompetant causal agent in disaster. A smarmy, simpering twit.

  9. Anonymous

    Crisis are good. These ones illustrate the utter foolishness of socialist planing and regulating. They give rise to volatility and volatility is good news (for me anyway).

    The fly in the ointment is that planners and regulators will lie about the nature of the day's occurances. They'll shill old Ma and Pa Kettle with stories about how what is required is more socialist mumbo jumbo regulation. That is a negative. Hard to see an up-side to that.

    How did you do yesterday? Are you still in or have you cashed up?


  10. Pleased you're doing well Banker.

    I made a little on NZD/AUD yesterday - Aussie RB was buying to prop it up.

    Who would have thought Bernanke would have emulated my hero Sir Alan Greenspan. The gold bug's nemesis. Markets might fly on Monday - but then again the herd is in full gallop and it will take a bit of skidding around before they change direction! Which is why I find these 'crises' fascinating. I like to read what everyone is doing and do the opposite and it has always worked well.

    To answer your last question --I don't hold anything in a downtrend over the weekend...;-)

  11. "These ones illustrate the utter foolishness of socialist planing and regulating"

    This and similar crises have nothing to do with socialism or regulation. In fact its quite the opposite.

    This crisis is a product on unfettered expansion of the global money supply and speculative activity on the back of it.

    Yes it's been coming for some time. As Fred Harrison writes in "Boom Bust: House Prices, Banking and the Depression of 2010", these busts come every 18 years. He has documented this going back 400 years.

    Oddly enough the central bankers use the same language each time.

    What happened over the last 3 weeks is simply the start of the unwind.

    And then we can start all over again in 2011 :-(

  12. How is this a crisis?

    The latest market "collapse" sees the DOW only 7% off its recent high for heaven's sake.

    It's a correction - a market cleansing if you will. People constantly overestimate how bad things are supposed to be.

  13. Sustento

    Really? And who was responsible for growth of the money supply?

    If you knew and understood the significance of that you'd never have written what you just did.

    Socialist planning and regulating is causal in what is occurring.


  14. Banker,

    You'll have to explain your point in more detail.

  15. Sustento

    Start by considering:
    a) Who increased the money supply?

    b) What do you suppose the Fed has been doing for the past few decades?

    Clue: you can find out in "What has the government done to our money?" by Murray Rothbard. An excellent description and critique of what is going on is also available to you in, "Capitalsm", by Prof George Reisman. Both those authors have contributed to the Ludwig Von Mises Institute web site. Also you can get the Von Mises books on line for free. Prof Reisman has a website of his own as well. His is at the Jefferson School. How about that!

    Do the research and then you'll have absolutely no trouble understanding my point.


  16. Banker,

    a) The private banking system has been increasing the money supply.

    b) The Fed has been incompetent in allowing this to happen to the point where they abandoned M3 as a measure of the money supply.

    What that has got to do with socialist planning is beyond me but i'm all ears.

    Thank you for the research references. I have a few Rothbard books on my shelf. As well as being in the financial markets for 20 years, i have been involved in money reform for the last 10 so i am reasonably well read in this area.

  17. Susteno

    You've got it exactly wrong. Where have you been these last 20 years- under a rock?

    The Fed is doing a lot more than "allowing". It is causal in enabling the increase.

    Tell me, from where does the Fed get its monopoly powers?

    Seriously, you need do the research if you are sincere about wanting to KNOW.



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