I am sure some of you will find this article interesting. ****************************** The Man Who Predicted the Depression Ludwig von Mises explained how government-induced credit expansions led to imbalances in the economy. By MARK SPITZNAGEL Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today. Mises's ideas on business cycles were spelled out in his 1912 tome "Theorie des Geldes und der Umlaufsmittel" ("The Theory of Money and Credit"). Not surprisingly few people noticed, as it was published only in German and wasn't exactly a beach read at that. Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention. Left alone, interest rates would adjust such that only the amount of credit would be used as is voluntarily supplied and demanded. But when credit is force-fed beyond that (call it a credit gavage), grotesque things start to happen. Government-imposed expansion of bank credit distorts our "time preferences," or our desire for saving versus consumption. Government-imposed interest rates artificially below rates demanded by savers leads to increased borrowing and capital investment beyond what savers will provide. This causes temporarily higher employment, wages and consumption. Ordinarily, any random spikes in credit would be quickly absorbed by the systemââ¬âthe pricing errors corrected, the half-baked investments liquidated, like a supple tree yielding to the wind and then returning. But when the government holds rates artificially low in order to feed ever higher capital investment in otherwise unsound, unsustainable businesses, it creates the conditions for a crash. Everyone looks smart for a while, but eventually the whole monstrosity collapses under its own weight through a credit contraction or, worse, a banking collapse. The system is dramatically susceptible to errors, both on the policy side and on the entrepreneurial side. Government expansion of credit takes a system otherwise capable of adjustment and resilience and transforms it into one with tremendous cyclical volatility. "Theorie des Geldes" did not become the playbook for policy makers. The 1920s were marked by the brave new era of the Federal Reserve system promoting inflationary credit expansion and with it permanent prosperity. The nerve of this Doubting-Thomas, perma-bear, crazy Kraut! Sadly, poor Ludwig was very nearly alone in warning of the collapse to come from this credit expansion. In mid-1929, he stubbornly turned down a lucrative job offer from the Viennese bank Kreditanstalt, much to the annoyance of his fiancée, proclaiming "A great crash is coming, and I don't want my name in any way connected with it." We all know what happened next. Pretty much right out of Mises's script, overleveraged banks (including Kreditanstalt) collapsed, businesses collapsed, employment collapsed. The brittle tree snapped. Following Mises's logic, was this a failure of capitalism, or a failure of hubris? Mises's solution follows logically from his warnings. You can't fix what's broken by breaking it yet again. Stop the credit gavage. Stop inflating. Don't encourage consumption, but rather encourage saving and the repayment of debt. Let all the lame businesses failââ¬âno bailouts. (You see where I'm going with this.) The distortions must be removed or else the precipice from which the system will inevitably fall will simply grow higher and higher. Mises started getting some much-deserved respect once "Theorie des Geldes" was finally published in English in 1934. It is unfortunate that it required such a disaster for people to take heed of what was the one predictive, scholarly explanation of what was happening. But then, just Mises's bad luck, along came John Maynard Keynes's tome "The General Theory of Employment, Interest and Money" in 1936. Keynes was dapper, fresh and sophisticated. He even wrote in English! And the guy had chutzpah, fearlessly fighting the battle against unemployment by running the currency printing press and draining the government's coffers. He was the anti-Mises. So what if Keynes had lost his shirt in the stock-market crash. His book was peppered with fancy math (even Greek letters) and that meant rigor, modernity. To add insult to injury, Mises wasn't even refuted by Keynes and his ilk. He was ignored. Fast forward 70-some years, during which we saw Keynesianism's repeated disappointments, the end of the gold standard, persistent inflation with intermittent inflationary recessions and banking crises, culminating in Alan Greenspan's "Great Moderation" and a subsequent catastrophic collapse in housing and banking. Where do we find ourselves? At a point of profound insight gained through economic logic, trial and error, and objective empiricism? Or right back where we started? With interest rates at zero, monetary engines humming as never before, and a self-proclaimed Keynesian government, we are back again embracing the brave new era of government-sponsored prosperity and debt. And, more than ever, the system is piling uncertainties on top of uncertainties, turning an otherwise resilient economy into a brittle one. How curious it is that the guy who wrote the script depicting our never ending story of government-induced credit expansion, inflation and collapse has remained so persistently forgotten. Must we sit through yet another performance of this tragic tale? Mr. Spitznagel is the founder and chief investment officer of the hedge fund Universa Investments LP, based in Santa Monica, Calif. http://online.wsj.com/article/SB10001424052748704471504574443600711779692.html
if you allow a company like aig to commit fraud by claiming they have x reserves and that fraud destroys a company who in good faith thought they were purchasing a guaranteed product you destroy confidence in the system. capitalism can not work if no body can trust anybody. regulations build confidence in the system by ensuring that you are treated fairly.
I am currently reading Gillain Tett's "Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan was Corrupted by Wall Street Greed and Unleashed a Catatrophe." (Along with Ron Paul's "End the FED.") AIG made the mistake of accepting Wall Street' s risk models, which were greatly in error for CDOs and derivatives. I'm inclined to think that we should have bailed them out with 12% loans, and shot Paulson when he refused to let Bank of America buy Merrill Lynch at a discount. How GS got 1oo cents on the dollar from AIG will never be told.
When you buy insurance, you do research the firm's financial position right ? Why is it that a different standard applies to sophisticated investment bankers who should have figured what AIG was doing and the possible outcome in case of a credit crunch ?
The Fraud was committed by the derivative writers, who >probably< knew that AIG was charging too little because the derivative writers were WAY underestimating the risk. Sometimes Senior Tranche when the underlying were defaulting mortgages.
how do you research your insurance. i bet you go by ratios established by some regulatory body to compare the health of the different companies. without regulations establishing what a company may say about themselves how can you trust what they are saying?
Hey no fair: using facts , reason and evidence. For God's sake you must be operating under the delusion that economics is rational.
i agree with many of the things paul says. i saw the interview this morning. liesman was spot-on with the "run on the banks" - there were runs on the banks long before there was a "fed". i'm surprised (and disappointed) that paul didn't know that.
Youre kidding right ? The value of the dollar is down to 5 cents from what it was when the Fed was created in 1913. Is that your idea of 'stability' ? This thread is full of so much b.s. that its hard to start. Most have no idea what Austrian economics is about, the point of the gold standard, or the CENTRAL ROLE of central banks in creating booms and their subsequent busts. Booms and busts are monetary phenomenon created by bank money expansion. (Many do try to talk as though their heads aren't stuck up their behinds, however.) And as for the guy who seems to think that the Keynesians, Austrians, etc all had a part in the current mess (must have been taught that equal blame is 'good' and 'fair') - - well he is absolutely ignorant. He is mentioning economic philosophies which are 180 degrees opposed to one another. Austrian economics hasn't had a part in U.S. economic policy (kinda) for 90 years. Check out the Depression of 1920 - - never heard of it ? That's because the Feds did nothing, and after a year or so things corrected and the economy was back on track - - - until bank money expansion bloated the stock and real estate market bubbles and later lead to the crash and Great Depression 1. If you want a great illustration of Keynesian economics check out Japan. They didn't let companies 'too big to fail' go under (their excuse was Japanese social 'unity' or some such rubbish). They dropped their interest rates down to zilch. And they did so many 'stimulus' public works projects that at one time Japan was pouring as much concrete as the U.S., even though they only had half the population and 4 % of our land mass. The results ? A crap economy for the last 20 years. Ron Paul is the only politician that I know who has a clue about economics, and has been a proponent of the Austrian school for a very long time. It is amazing to me that Keynesians and Friedman followers can go back and watch the 'predictions' of Bernanke going back for years and keep believing the guy and the failed economics practiced in Washington. - - - But then again, I just got back from having a discussion with a guy in the economics section of a bookstore. He was a Keynes admirer. I was amazed to hear that he thought the banks just 'wrote checks' expanding the money supply & causing so many problems. He thought the Fed had no role or power to create money at all Not that he had a clue of the role of central banks in the economic cycle. - - While he lived in Japan for awhile (as did I) and recognized the Japanese economic mistakes, he seemed to think it was some kind of mystery as to why they got those results - - another sad product of the American public 'education' system, no doubt. - -
I doubt full-of-shit LIES-man has a clue what Ron Paul economics (Austrian school) is. - - - Probably parrots the bullshit that 'capitialism' failed. - - - Pretty hard for something to fail that hasn't been tried for many, many years. A system controlled by a monopolistic central bank, favored large corporations with 'private profits' and 'socialized losses', and politicians paid off in campaign contributions and other loot - - - sure ain't free market capitalism. Capitalism didn't fail, 'banksterism' sure did - - for us, not for them. - - -