Sunday, October 05, 2008

A pyramid of foolishness

Many of the more sober critics of the US government's bailout package have realised the present economic turmoil is not a failure of capitalism, it's a failure of government, but they've still failed to get their head around the fundamental cause of the crisis, or of the bubble that set it off.

They've talked about Smart Growth and the dictatorship of the planners that locked up land and sent housing prices soaring in the more planned markets, but they haven't realised that it only 'directed' the inflationary bubble into housing; it didn't directly cause the bust.

They've talked about the complications of bundled securities that leave even the organisers of those securities clueless as to what they're really based on -- but they haven't understood that this was just a way bankers chose to deal with the flood of easy credit coming down the pike'; and they haven't yet understood that it was the flood of easy credit that was the primary problem.

They've talked about Jimmy Carter's Community Reinvestment Act and "community organisers" like Barack Obama who pushed indigent non-payers into sub-prime 'first-home,' 'easy credit,' 'low-doc' loans, without realising that without the flood of government credit, the number of sub-prime loans being made would have dried up like a pub without beer.

They've talked about Fannie and Freddie, which since 1938 (in the case of Fannie) have been accidents waiting to happen, but they've failed to notice that up until the latest blow out the accidents have only been small.

Each of the proponents of these points is correct in their analysis, at least as far as they go, but in ignoring all the other factors involved they don't go far enough, and in ignoring the more fundamental explanation -- that we've been floating a sea of counterfeit capital fed by a spigot of paper money, and jacked up by a fractional reserve banking system that "leverages" those paper dollars to turn the flood of paper into a tsunami, and every dozen years or so when the spigot is eventually turned off, we see another crisis -- the bubble blows out the same every time, it just blows out in different places.

As Hans Sennholz points out, the fundamental cause of the problem goes back several decades, nearly a century, all the way back to 1913, and the creation in the United States of "the Federal Reserve System," which was never anything but "a creature of politics." 

    It sprang from the most revolutionary single piece of legislation in American currency and banking history, the Federal Reserve Act of 1913.  It meant to improve the earlier financial system created by the National Banking Act of 1863 which placed the federal government in the very center of American money and banking.  Both Acts were designed to reform the market order which was deemed to be unstable and unresponsive to the needs of the federal government and the national economy. 
    Actually, they constituted early steps toward a hybrid fiat system which in time spread to all corners of the world.  It is neither a command system in the manner of radical socialism nor a market order on a gold standard; it probably is the most unstable financial system conceivable which no human being, no matter how brilliant and distinguished, could manage satisfactorily.
    The American money and credit system now resembles an inverted pyramid that rests on legal-tender Federal Reserve notes and credit.  These support various forms of bank money such as commercial bank deposits, savings accounts, large time deposits, and other liquid assets.  The base of some $672 billion may expand rather moderately, presently at some 6 percent a year or $40 billion; the layered superstructure of $8.333 trillion bank money (M3) may grow at a similar rate or $529 billion (as of 10/23/2002).  Commercial banks tend to "securitize" their loans, converting them into marketable securities for sale to investors which enables them to grant new loans in a continuing process of lending, securitizing, selling, and lending again. 
   
Massive non-bank credit constitutes the upper layers of the money pyramid; there are Federal Home Loan Banks, thrift institutions, life insurance companies, brokerage firms, mutual funds and other credit grantors.  Last but not least, offshore banks in the Bahamas, the Cayman Islands, Panama, Hong Kong, and Singapore, enjoying favorable regulatory and tax treatment, provide the top layer of the multitrillion dollar money pyramid.  And high above the American pyramid hovers the international pyramid which builds on the U.S. dollar standard. 
   
The Chairman and his fellow governors are expected to balance it all with their high-powered Federal-Reserve-dollar base.  They are expected not only to manage this monstrous pyramid of fiat money and fiduciary credit but also to safeguard the stability of the American economy, to maintain asset prices, protect the value of the dollar, and avoid the business cycle.  They are supposed to manage a monstrous structure which politicians built for their own use and glory.  That's too much to ask of any mortal.

You see, even if they had a clue, it would still be impossible.

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11 Comments:

Blogger Callum said...

If you're into Austrian economics, the underlying cause of this recession can be summed up in three words:


Artificial credit expansion.

10/05/2008 12:05:00 pm  
Blogger Owen McShane said...

I am not an expert in money supply so my analyses stick to my knitting.

I identified the housing supply problem back in 1995/96 and was aware of the Carter/Cllinton/Gore contributions to the pressure to lend to unsecure borrowers because that too is my area of expertise.

Given my position, if I step outside my expertise I am subject to attack - the the global warming alarmists use this all the time.

If one mentions the credit supply issue "in passing" then too many assume you are a born again social creditor.

Also these cannot be totally unravelled - if the supply of credit is the real problem how come Houston and indeed the whole of Texas is essentially unscathed?

Because of their free market in land house prices did not inflate in value and people did not have to borrow excess funds to purchase the house and there has been no collapse in housing prices.

There may be an explanation which shows that the supply issue is irrelevant but I am yet to hear it or read it.

10/05/2008 12:39:00 pm  
Anonymous Anonymous said...

Owen,
P C used the term "directed' credit into the housing market. Such credit will go to were a apparent profit can be made from simple owning over time. Land supply restrictions serve to create such a market. Were supply restrictions are less, additional supply can be added at a stable cost, and easy credit is likely to be directed elsewhere. Thus price pressure on supply attracts a credit induced "bubble"
Ken

10/05/2008 02:21:00 pm  
Blogger PC said...

Yep, what Ken said.

Pointing out the problems with land supply is good work, but recognising primary causes is more important still.

Inflated credit goes to where is sees inflated prices -- the land supply problems you point out started to kick that off, hence the inflated credit went to those markets with rocketing prices, causing them to rocket even further, and home-owners started to think their homes with these rapidly-inflating prices were "investments" rather than a consumption cost, and started using them as an ATM.

The bills for that are now starting to come in.

10/05/2008 03:31:00 pm  
Anonymous Anonymous said...

Yeah right.

Perhaps its caused by little green men in flying saucers?

Or - more simply than both these explanations - perhaps its just endemic corruption in the democratic party?>

I mean: Obama is bought & paid for by Fannie & Freddie.

Ockam's razor makes a clean cut on this one

10/05/2008 09:06:00 pm  
Anonymous LGM said...

Anon

You are really as thick as pigshit! Enough of your idiocy already!

Your blind faith assertion fails to identify anything useful when it comes to understanding the causes and mechanisms of the recession; presently moving into depression (hopefully things won't go that far, but recent developments are not looking good). Delusional ranting about how your favourite party is to blame, and that Obama is some sort of Son of Satan, is yet another expression of your silly childishness. In the end you're all about blind faith in small "c" conservatism.

Try very hard to understand- there is no significant difference between Democrat and Republican Parties. These two have rooted the USA in a long running coalition (similar to the Labour-National one in NZ) for many, many years. They share the same premise.

When it comes to economics both your Satan Party and your Messiah Party are equally hopeless. Both have contributed to the present problems. Both have erected, developed and exploited a huge rort for power, prestigue and greed. Rather than your charmless expressions of faith, how about shutting up and doing some learning? Or is that too hard for a moron like you?

LGM

10/05/2008 10:17:00 pm  
Anonymous Anonymous said...

When it comes to economics both your Satan Party and your Messiah Party are equally hopeless.

Nice in theory but simply not true.

there are things such as facts: you should try them some time.

Bush cut taxes: Obama will raise them.

Obama took money from Government organisation like Fannie and Freddie

Bush took money from independent private businesses

big big differences.

Or do you want to wave the white flag of surrender?

10/06/2008 08:52:00 am  
Blogger PC said...

Nice in your dreams, but simply not true.

FACT: Bush presided over the biggest spending congress in history.

FACT: For six years, he didn't veto a single bill, depriving the nation of checks and balances.

FACT: Under George Bush and his Republican Congress Government spending increased faster than it did under Bill Clinton.

FACT: At the end of Bush's reign, more people work for the federal government than at any time since the end of the Cold War.

FACT: Even with post-9/11 defence spending taken off the table, domestic spending has ballooned by 23 percent since Bush took office.

FACT: Despite Bush’s much vaunted tax cuts, Americans actually pay more in taxes today than they did during Bill Clinton’s last year in office.

Big, big differences?

In your dreams.

10/06/2008 09:13:00 am  
Anonymous LGM said...

Idiot!

They are two sides of the same coin. Both take money coerced from ordinary people and squander it on no good cronies and scams and rorts. That has never changed and isn't about to now- Obama or not.

Try very hard to understand that the entire Democratic-Republican Party coalition is populated by many, many "representatives" and staff who take other people's money in exchange for favours, rorts and the like. They are all into it. Yes, many of your precious Republicans accepted money from dubious sources such as Fannie. They accepted "favours" (yes even sexual ones, you know, hookers and the like), "trips", "consulting jobs", "donations", "contributions" and so on from lobbiests and military contractors etc. etc. etc. All this while they continue picking the pockets of everyone else. You'd do well to stop deluding yourself about it.

Stop trying to demonise one guy or one portion of the coalition as the heart of the evil. It doesn't wash. It is childish of you to even attempt to pass your self-delusional fibs of as if they bore the slightest resemblence to reality.

Best advice to you is to shut up until you know what you are on about. Go do some learning. Surely that isn't too difficult for you?

LGM

10/06/2008 10:01:00 am  
Anonymous LGM said...

BTW my last email is directed to the idiot who posted as "Anonymous" immeditely prior to PC.

LGM

10/06/2008 10:08:00 am  
Anonymous JaneD said...

LGM, people come here to read PC's writings and not to be abused by you. I wondered if the decline of PC's blog ranking to 7th is something got to do with you. You chase readers away from coming back to make comments here. There will be a time when no one comes to read Not PC blog anymore because of your arrogant behavior.

10/06/2008 12:31:00 pm  

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