A bizarre piece from Gregory Morris writing for Bloomberg:
Today, as its 100th anniversary approaches, many followers of both the Tea Party and Occupy Wall Street movements are calling to “End the Fed.” The rich irony here isn’t that reactionaries and radicals are in agreement on something; after all, they are both passionately populist. The irony is that it was populist outrage and calls for reform that created the Fed in the first place.
The three decades from the demise of the second central bank to the point where the Lincoln administration began printing greenbacks to finance the Civil War were known as the years in the wilderness for American finance. Banks printed their own notes — and let the buyer beware. Bank runs and panics were a common fact of life.
Even with the terrible economic conditions we’ve seen in the past few years, it’s difficult today to comprehend the precarious state of business and personal finance in those days. Not only was there no central bank to restrain economic swings, there was no deposit insurance and no social safety nets. Banks were chronically undercapitalized and went bust with alarming frequency. There was no recourse for depositors. Farms and shops were foreclosed, families put on the street.
Really? Populist outrage led to the creation of the Fed?
I thought it was a cabal of bankers and financiers meeting in secret.
At the end of November 1910, Senator Nelson W. Aldrich and Assistant Secretary of the U.S. Treasury DepartmentA. Piatt Andrew, and 5 more of the country’s leading financiers, who together represented about one-fourth of the world’s wealth, arrived at the Jekyll Island Club to discuss monetary policy and the banking system, an event led to the creation of the current Federal Reserve. According to the Federal Reserve Bank of Atlanta, the 1910 Jekyll Island meeting resulted in draft legislation for the creation of a U.S. central bank.
Now I know that depositors want their deposits insured. I know that a world of bank runs and panics is not a very reassuring atmosphere for businesses. But let’s be honest — things weren’t that bad. Here’s real GDP-per-capita from the end of the Civil War to the end of World War I:
Does that look like stagnation or weakness to you? No — it looks to me like a consistently rising standard of living powered by significant wealth creation. Sure — bank runs and panics, and bank failures and foreclosures were common. That’s the nature of creative destruction — good ideas can much more easily succeed if bad ideas are free to fail. That meant that society, and the economy, were much more experimental. And that’s the cost of innovation, and endeavour and experimentalism — an atmosphere of volatility.
The real issue is that the Fed’s defenders don’t really like creative destruction, because it is too risky. They cling to the comfort blankets of mild-to-moderate yearly inflation via money printing, significant government intervention to save failed businesses like GM, AIG and Bear Stearns, and an economy and political system swung (if not controlled) by too-big-to-fail megabanks, and their CEOs. Most fiercelythey cling to the risk-free 6% dividend they receive year-in-year out — a risk-free 6% of which most private citizens and investors can only dream.
The reality is that modern economic planning is the art of papering over the cracks. The social safety net, and depositors insurance are there not to create wealth (for they do no such thing) but to keep the febrile masses from rioting. The Fed’s defenders are puzzled that after all those monetary helicopter drops (stimulus, QE, QE2, etc, etc) the masses (Tea Party, Occupy) are still demanding more. The “great moderations”, and free lunches have (as I have explained in detail here and here and here) created a hyper-fragile monolith of delayed crises — America’s huge debt load, youth unemployment, biflation, etc — ready to crash down on society.
Loose monetary policy has created tsunamis of malinvestment, and bubbles (housing, NASDAQ, etc) that ultimately drag the economy back down to earth, resulting in crises that — as Paul Krugman so memorably put it back in 2001 — are reinflated, and reinflated, and reinflated by more and more and more interventionism, and new bubbles to replace the old.
That isn’t sustainable economics, or sustainable growth. Sustainable growth is driven by investment in the things that society wants and needs. It’s driven by people working, saving, and investing in products, services and businesses that they deem to be valuable. That is the nature of a free market, not the government or central bank firing off trillions of dollars to whoever they designate as “systemically important”. Sustainable growth is driven by experimentalism. If an experiment fails, it falls to pieces and a gap in the market is opened for the next experiment. Sustainable growth is not driven by bailouts and moral hazard — ever. That means that investors and financiers will think long and hard before committing capital, instead of throwing it into ponzi schemes and derivatives-black-holes.
There is a sensible middle ground between creative destruction and modernity. If anyone is to be bailed out, it should be the poorest, not billionaire bankers and Wall Street megabanks. Let the government insure the deposits of the masses. Let the government provide a safety net to prevent homelessness and starvation, and sickness — so long as it is funded sustainably from tax revenues, and not borrowing.
But let failed businesses fail. Let bad experiments end. Let bad debtors default on their debts. If the financial system is fundamentally weak then let it crumble — let a new system take its place.
And unfortunately for Democratic political systems, the uneducated masses have the vote. As a result they will elect populist leaders who promise to “Fix” things.
Socialism creeps into the system by stealth.
In Mein Kempf – Hitler made this observation; when he saw the Monarchy in Austria being undermined by democratic politicians, arguing and bickering. A benovelent Monarchy is by far the best system for a nation in the long term. The “family” has a vested interest!
I heard that Paul Krugman denies his 2002 statement in that NYTIMES article was an endorsing of Alan Greenspan’s loose monetary policies. I wonder what arguments he’s using since the text is there and couldn’t be clearer. Usually, people that can just go on as if nothing happened after such major failures are classified as psychopaths.
The irony is that Paul Krugman’s Nobel winning research (on one of my favourite topics — the shape of globalisation) is stellar stuff, and goes some way to partially explain the problems America faces in the 21st Century (not enough population density compared to China and India to compete in labour intensive industries).
Then he went extremo-Keynesian with the “re-inflate the bubbles” thing, and the whole “aggregate demand is all that matters” thing, which leads to absurdisms (fake alien invasion would be good for the economy) that he actually seems to revel in because it’s abstract and counter-intuitive and gets the reality-based community into a huff.
In all fairness he has been quite good on my favourite issue recently, saying that Greece would do well to stiff creditors and default. Given his lineage (Enron, etc), that’s a pretty tough thing to say.
The problem is that Paul Krugman is viewed as some kind of influential thinker and that policy makers are supposed to take his opinions into consideration.
But you never know if one of his ideas is:
1. Something that is science fiction and potentially dangerous
2. Something that might actually have some resemblance to reality
There are plenty of insightful science fiction writers that have no claims to being influential policy makers or deserving of prestigious scientific awards.
With regards to general economic theories, I’m very, very skeptical, and I stick to Nassim Taleb’s opinions that in economy, always you should look at things from bottom up and pay attention to anything that might contradict your current views of the world.
I have only read some brief overviews of Krugman’s ideas that were supposedly deserving of a Nobel award (whether or not the idea of a Nobel in economics is a valid proposition is open to discussion) and I can only say they seem plausible – but, as I’ve stated above I wouldn’t bet the farm on anything that has the word “theory” in it when the supposed theory is about the complex social structure of the world. I myself have plenty of plausible abstract ideas going through my head every day, but most of the time I don’t feel they are even worth being jotted down on paper.
Another problem I have with current economics is that the current state of the world is a hodge-podge that came about in a haphazard kludgy way driven mostly by greed. Most economists never, never question the status-quo and just propose band-aids for our current woes. How is a stable equilibrium a world where the idea of “importer of last resort” (US) even makes sense? That is if we suppose the world is even stable – most US residents have no idea that chaos was rather the norm than the exception throughout the world even during the last 50 years (in economic or political terms).
The previous paragraph mostly summarizes my brief overtures into the comment sections of your blog: I want to find out what’s the best (most stable) framework for global economics (hence my ideas about Bancor, gold standards etc.)
I don’t think Krugman’s ’98 theory accurately describes the world. I think that like the theories of various other economists — von Mises, Keynes, Rothbard, Schumpeter, Taleb — it can be illuminating if looked at in the right context. Nothing (no theory — not even Taleb’s anti-theory theory) can be a better guide to reality than reality itself.
And the idea of a Nobel in economics (or any sociological science) is fucking nonsense, simple as that.
Ultimately, I would surmise my own general theory of economics as:
Civilisations need to be aware of their energy, productivity, capital and labour requirements, and they need to prepare for as many foreseeable eventualities as possible, with as much flexibility as possible. Free markets (where actions have consequences) tend to be significantly better tutors of preparation than central planners, because there is much more feedback. Governments should be prepared to save lives, help the sick, and feed the impoverished, but they should never save bad systems and should never create welfare dependency.
Aggregate demand is not a reliable measure of economic output, because it counts “waste” output (Austrians calls this malinvestment, but it’s actually deeper than that). Physical (manufacturing) productivity, employment, energy output and the various measures of civilisational robustness are far better measures of economic output.
And most importantly — war and weapons (and anti-alien invasion) spending — unless it is directly responsible for saving your nation or civilisation from destruction — is usually a big waste of time, capital and labour that away sucks the wealth of a nation.
OK, so what should we do? Because ultimately these abstract ideas need to be put into practice. James Grant for example (from the contrarian camp) openly proposes a return to some form of the gold standard. Some might say: no… we don’t like changing the system to one where we are left with less freedom to act. But the current system did not come out of nowhere: it was created by the will of previous politicians – not necessarily benevolent – and economists, and then evolved from there; and it’s obvious that the current system is neither stable nor actually… working. I’ve listened to a podcast where some trader that supposedly liked gold was against any form of international single currency – but what would you expect a trader (especially FX) to answer? They thrive on instability, crashes, volatility etc. Which is one of James Grant’s opinions that I’ve recently heard: that the current system rewards speculators more than the value-producers.
So bottom line: I think that having good principles is not enough. You have to act on them and actually come up with concrete ideas on how to change/reform the system while also being open to the idea that the new system you are creating is not necessarily perfect and may have to ultimately be reformed or replaced entirely.
The only way to change the world is to invest in what you believe in, and that you know are important to and necessary for civilisation. The market-riggers might be in the business of rigging markets, but they can’t rig reality.
Grant is right that the current system is rewarding speculators over value-creators but we both know this is totally unsustainable. In the long run, the only way to win is to invest in long-term value-creating civilising endeavours. The speculators and arbitrageurs will (with a few notable exceptions, e.g. Universa) get crushed by the coming great treasury crash and the death of the dollar. LTCM is the blueprint.
We won’t have economic stability in a Democratic system. Monarchs (Dictator Dynasties) will always think of the long term, because human ego will always prevail. Every Monarch wants to leave a legacy of greatness.
In a Democracy, ego is crushed at the ballot box. Everybody is out to discredit you, peddle lies and half truths, and those with the press on side or in their back pocket win.
Economists are just Government advisors on the bureaucratic Gravy Train; Pigs at the trough so to speak. The defend Keynesian policy because it justifies their employment. Have you ever heard of a job ad for a Libertarian Austrian Economist?
I agree that the Private sector has better feedback loops to change course. i.e. produce what people actually want!
Evolution works well for biology, and for business and economics as well. Imagine if, say, the Australian Greens were to ‘decide’ which organisms would be given a leg up over the opposition, and which organisms would have intervention to stop them being eaten. Fat, slow cheetahs would be fed fast, superior herbivores and dodos would be a protected species being useless everywhere.
Ultimately, growth stalls when inefficient business is kept on life support innovating nothing and stagnating across the economy. There can be no reward without risk!