Supply-Side Forum

[Dick_Fox]

Ed,

Thank you for taking so much time on that post. I know it took you a while to complete it. It was outstanding. I hope writing it down helps you solidify your thoughts. It is easy to just throw something out there but you have to think it through to write it down. It is helping me to understand where you are coming from.

Yes, I am more into theory just because I believe that the facts must fit a mechanism. That being the case I think I do understand what you are saying about asset values being "money."

But I do need to think on it a little...no, a lot more, because your comments on inflation versus hyper-inflation threw something new into the mix as far as the collapse of a currency is concerned. My first thoughts were that perhaps the American Continental collapse would be a good example of what you are talking about, but that may not be the case because there was inflation when congress and the states increased the supply.

Not sure I am there on your concept of hyper-inflation versus inflation, but let me ponder it before asking another question.
_________________
"We must make the building of a free society once more an intellectual adventure, a deed of courage."
F.A. Hayek

[ebreen]

Henry, it was never my intention that anyone could read what I wrote and conclude, as you have, that I am saying that 'inflation is bringing deflation'. I am sorry that I have not been more clear and that you could think that is what I meant.

Let me state it differently and as simply as I can....inflation requires credit expansion. If there is no credit expansion the increase in base money supply, no matter how you define it, does not matter...there will be no increase in asset value without credit expansion...period...inflation is characterized by credit expansion and the flow of capital into tangible assets. You can't say there is inflation if prices don't rise.

Deflation and deleveraging are the same thing. Deflation is characterized by credit contraction, the flow of capital out of tangible assets and the resulting decrease of value of tangible assets.

Since the financial crises of 2007-2008 that resulted in a liquidity crises and a solvency crises, the liquidity problems were solved and the solvency issues have been papered over...but the result in the private economy has been a deflationary contraction of credit that is ongoing. This has been deflation all along since the crises. I am not trying to parse out the decades I am only talking about the current crises and it is all deflation.

This is not obvious becuase the keynesian and normal monetary response to the credit collapse was to increase liquidity, reduce rates, increase the fed balance sheet, and spend government 'stimulus' money in buckets. This attempt at reflation to combat deflation did not work, it never could have worked...becuase no one understood the role of credit in inflation or reflation...so they increased money supply while they lowered leverage ratio's that prevented the increase in money supply from reaching the real economy with effects to support prices. This is really Fisher's theory of collateral asset devaluation following a credit collapse and his recomendatoin to reflate as a remedy. Proplem is that they did not understand the role of credit and expecially levereage in the reflation process. So, the policies that we have followed have only held the deflation at bay, slowed it down, built up some pressure for when it returns like a tide against a sand castle wall. At the same time we have wasted our treasure at the sovereign level by borrowing money on our good credit and wasting in by spending it in ways that make the situation worse. At the same time we poison the potential optimism of growth in the future by inflaming a current debt situation that appears to demand austerity measures that include dramatic tax increase. This is not inflation creating deflation....What would you call it?

[Dick_Fox]

Ed,

Your post seems to be at odds with what Jude taught. Am I wrong?
_________________
"We must make the building of a free society once more an intellectual adventure, a deed of courage."
F.A. Hayek

[Henry Meers]

Ed,

Take what you are saying one step further. The short form is that the credit expansion you describe cannot happen without the acquiescence of the monetary authority, since we are no longer on the gold standard.

For the price of an asset to rise, absent it being more productive etc., the value of money has to go down. This is why I went back to England to find what I thought was a politically or monetarily neutral example.

Dick and I went around about this, but I will accept the position that the reserve requirement is a multiplier for this eample. If the banks can create unlimited money by creating credit, and the market doesn't know which dollar is which, it can do so for a long time -- at the expense of a declining currency value. (I do realize that banks could issue dollars and that people had to be able to trade them in for the bank's gold by law in the nineteenth century. If you remove that requirement, they can print as many dollars as they want against projects in their markets.)

When the central bank doesn't care about the value of its money, as is the case of the Federal Reserve and the politicians these days, it will allow the expansion of "the money supply" to continue and will have to aid in the process. This is the Keynesian thinking to a great extent: pay people to dig those holes and fill 'em up to get money into circulation. Fine and dandy. As milk goes from $1 a gallon to $3, all you have to do is keep digging, only faster.

At the point the Fed or Treasury begins to worry about the dollar's value, say they can't sell bonds as easily as they would like, the amount of their money floating around has to be reduced to the point it gives them a market price of the dollar they want.

Those are the two choices, although the width of the spectrum between them is vast. The banks can lend against appreciating assets until people won't buy them any more, and that ending is an ineviatble occurrance. It has to be inflation creating deflation. Think women's handbags. When they are hard to get and expensive, they are fashionable; when the Chinese knock off millions disregarding the property rights, no one wants them any more -- they are virtually worthless.


"Fisher's theory of collateral asset devaluation following a credit collapse and his recomendatoin to reflate as a remedy. Proplem is that they did not understand the role of credit and expecially levereage in the reflation process." Maybe. I would think they didn't understand the role/effect of the new Federal Reserve, having grown up on the gold and silver money.

The more money they put into the system, reflate, absent an independent value of money, the more they are going to undermine the value of the loans supporting the assets. The banks "lose money on every one (mortgage), but make it up on the volume?" Then the pardigm shifts to the asset collapsing, so no matter what happens to interest rates, the mortgage is undercollateralized.

[ebreen]

Dick, Jude believed that inflation was caused by an oversupply of base money above the demand for that money. He believed a targeted gold price could serve as a demand metric for the Fed to manage base money supply. Once the Fed broadcast a gold target range it would buy and sell treasury debt through the open market window in order to manage the supply of base money according to the gold target. He had a traditional view of the quantity theory of money and the definition of money supply. Until this crises I believed the same.

It is worthy to note now however, that even in this view of the fed managing money supply by the sale or repurchase of treasury debt we see that that it is as much the supply of credit that expands and contracts as it is the supply of dollar reserve note debt.

Nonetheless, we now see that money supply alone and a simple spot gold price does not predict forseeable changes in the price change indexes that should occur if inflation is driven by money supply expansion. I would now argue with Jude the same way I am arguing with you, that we now need to engage the quantity theory of money to include credit; otherwise it does not work.

As I have said many times, Jude discounted the gold price movements according to his own intuitition about extraneous gold price movements driven by temporal geopolitical events. He did not see each days movement in the gold price to be a diffinitive measure of inflation by itself. He saw the temporal spot price as the present sum of the mistakes in monetary policy over prior years and a warning for the future. I believe he would have embraced the GVM as a functional quantitative expression of his theory; and I beleive he would have learned from the GVM through this crises as I have.

[ebreen]

Henry I disagree with what I think is the implication of your statement, "the credit expansion you describe cannot happen without the acquiescence of the monetary authority." If you mean the monetary authority controls credit demand I disagree. Inflationary credit demand comes from the private market, the consesnsus of individual economic actors who demand credit so that they can acquire tangible assets. This consensus as I have written above, comes about from an expectation of rising tangible asset values that reaches a tipping point and then becomes self reinforcing. Certainly the Fed and its regulator and bank examining minions can seek to reduce credit expansion by changing regulatory leverage ratios and terms of loan underwritting. This is not generally the way the Fed has reacted during past expansions. They have tried to use the short term interest rates to reduce credit demand. I think we have seen that this does not work well. Recently China, used regulation to reduce leverage ratio on loans and in China it seems to have worked effectively and quickly...perhaps too much so. Nonetheless, by and large, credit demand has been in the realm of the fiscal context and the private market. It is very difficult to promote credit formation just from the monetary side as we have seen during this past year...and you can't do it with interest rates.

I also disagree with your idea that the creation of credit is unlimitted. Capital limits credit formation; state differently, solvency limits credit formation. If you will remain solvent the creation of credit is always limitted by the value of collateral and the value of the debtor's guarantee. Both banks and sovereigns who would expand debt beyond these boundaries will soon run out of capital and they will lose the ability to extend credit.

[Henry Meers]

Ed,

Thanks. I'll mix my response to yours to Dick as well.

First, I wouldn't be so "quick" to give up on Jude's thinking, because the current crisis is probably the blow-off move at the end of 75 years of bad monetary policy, not the start of something new.

Second, the Fed and Treasury are a monopoly issuers of dollars. If they wanted to control the price/value of money, they have the power on their trading desk. Nothing new or special is needed. Greenspan and Bernanke saw what was going on. They may not have understood it properly, as Jude often remarked; but the two of them could have changed it any time they wanted. Greenspan gave his "irrational exuberance speech", and shortly thereafter the dollar headed up as he starved the economy for money.

Third, money and credit are not the same thing. You have demostrated this to an extent talking about asset prices/values moving around without the Fed. it is in charge of holding money's value for the purposes of this discussion, which is where the monetary base comes in.

The governmet issues the money, it doesn't tell what to do with it. Well, that's the theory. Anyway, the point is they call it dollars and used to maintain a value.
We create credit, deciding how much to lend others etc. The Fed cannot contol that, but we measure it in dollars for lack of a better language. Bernanke cannot do anything directly about that. But, he can change either the value of those dollars or the cost of credit.

What you are talking about with assets creating money is using them as a sort of barter. In a margin account, you don't have to bring in dollar bills to open it or meet a maintenance call. You can deliver assets of sufficient value to have enough equity. With treasuries, you can borrow 90% of their market value; so, $1 million of them is the same as bringing in $900,000 in cash.

A building that is worth $10 million might have a loan value of $1/2 million, even though you bought it for less than that ten years ago. But that value is set by the market, you and I deciding what to pay for it. With a market price, a lender can write a check to the borrower based upon whatever lending policies there may be.

The Fed does not live in the real world of business and credit, because it is a government agency. It says it is against inflation, but lets the dollar loose to lower rates. It is a political instution subject to the pressures the public puts on it, albeit in a very indirect and disguised way. Just look at who appoints its board and managers.

When you say the Fed uses short-term rates to reduce credit demand. Why would they want to do such a thing?

What possible purpose could the Fed have to manage credit demand, except to control the economy? Who thinks any government can do that, or should? That was the big difference between the Republicans in 1908 making sure there would be enough cash to stop a bank run and the Democrats in 1913 creating the Federal Reserve, once they had a Progressive in the White House to sign the legislation.

Greenspan and the others used it to stop growth, which they confused with inflation. This is a very subjective sort of decision for a government to make. Individual banks should be doing it; they are equiped and operate in a competitive environment.

LIMITS TO CREDIT CREATION

My observation was that they are unlimited demands for credit. Everybody can use a little more money, has one more project you should look at. The market limits that by putting a price on credit. If your idea will earn more than the rate you have to pay, it might be worth considering. The banker/lender has to use his experience to decide whether he should lend or not.

You are right there are not unlimited resources in an economy, capital as you called it. Go to a situation where money doesn't matter, Germany at the end of WWII, in need of technical people and skilled workers to make "victory weapons" (or vengence). Hitler's people looked around for them to develop the new stuff, and most were dead on the Eastern Front. So, all the money in the world couldn't have produced what he wanted. The result was a limited number of projects, which were a disaster economically, due to the Nazi organizational system.

We have only so many people making so much wealth. That is where money and price come into play.


What is solvency in this case? If it is the ablility of goverment to pay its bills, the people have to accept its money in return for their services. What are those boundaries and how do they affect the economy? No one knows until it's over.

This why there has to be a value of money and it has to be maintained. Otherwise, we are just trading asssets in a game of Old Maid.

The central bank has to withdraw money from circulation when the value declines (and add liquidity when it rises) beyond the benchmark. That is the process which reins in the lenders, and borrowers for that matter, since the scarcity of credit is reflected in its cost, interest rates.

It is the declining price of that money that sets the asset appreciation into motion in the first place: the whole Austrian Boom-Bust Cycle.

If 80% to 85% of the economy is credit transactions, the monetary people get a huge effect from their pricing of money, really through the monetary base valuing the dollar, where it trades in the open market -- and they don't care right now. We understand it easily in gold, because we can see the price of the metal reflection the value of the dollar. In today's world, we have to rely on other far more diverse and imprices indicators. As John Tamny noted the other day, the commodity markets were a "sleepy place" until Nixon broke the last, tenuous link American money had to gold as a limitation on its price. From that point, huge fortunes were made and lost at the Chicago Board of Trade -- betting on the dollar's moves, even if most traders didn't know that.

Very large amounts of credit found their way into the CBOT, because prices were rising, and peole were willing to pay up for credit. 1925 to '29 wasn't a whole lot different either. A history of the last fifteen or twenty years of Continental Illinois National Bank and Trust Company is the whole thing in a microsm.

I don't know how far we want to go with this, but there is a moral dimenson to this about the adbication of responsibility, duty etc. The Federal Reserve has been at the root of most, not all, of our economic problems since it was founded, because it is an authoritarian/Progressive institution in a free market environment. It gets between us and markets. The "Nanny State" on Wall Street.

The U.S. government through the Treasury Department was supposed to provide money as defined by Congress to the economy and get out of the way. The Fed came along in an arrogant era of the intelligentsia, which ended abruptly for European Progressives in 1918. In the U.S., the Fed destroyed, or prevented the return of, a monetary standard that gave the world 100 years of prosperty. It didn't return until something like the 1980's for trade and '90's for capital investment.

The Fed certainly isn't controlling this instability, but it is the cause of it. Congress gave up its monetary responsibility to an unelected bureaucracy almost a century ago, and we're still paying the price. Fiscal policy is another mess, but not for now.

[Dick_Fox]

Thanks Ed. You knew Jude a lot better than I did so it is presumptive on my part to talk to you about Jude's thoughts. Understand this is more for others who wish to investigate the issue more completely.

I have to join Henry in saying that we should not discard Jude's concept too quickly. Yes, your explanation of Jude's position on inflation/deflation is exactly how I understand his concept from his writing, but Jude went farther than you have. Jude also talked about contraction and expansion.

My confllict with you earlier was on this point. We do not disagree on concept but on semantics, but in this case semantics makes a difference. Here is a lesson by Jude from the Supply Side University concerning the issue. I am not posting this for you because I know you are well aware of Jude's lesson, but for others who wish to study the issue and make up their own minds. In this lesson Jude makes it clear that his distinction between inflation/deflation and contraction/expansion is whether the cuause is monetary and can be solved by monetary means.

Don't misunderstand me. I recognize that you are not making the monetarist argument. You have made it clear that you do not believe that monetary expansion would solve the problem. What I am actually hearing you say is basically what Jude said but you are combining what Jude called deflation with what he called contraction and then calling this deflation.'

From Jude's expression of this there can be inflation/deflation without any immediate change in prices. In our current situation I believe that Jude would recognize huge inflation in the past decade, but he would also recognize that the FED has essentially sterilized the expansion of the money supply by other means. I also believe he would connect the monetary expansion indicated by the price of gold to the real estate and credit crisis as he did with the price of gold and the oil price in the late 1990s.

I know that I step out on a limb when I put words into Jude's mouth but I do believe this would be consistent with what he taught and what I believe.

Now this actually does not change conceptually anything you have written. All of your concepts fit with what Jude taught. The only difference is the labeling of deflation and contraction. It is for this reason I take issue with your statement, "You can't say there is inflation if prices don't rise." I understand under your definition this is true but this changes the definition of inflation significantly from what Mises and Jude taught. Inflation is not about prices but about the quality of money.
_________________
"We must make the building of a free society once more an intellectual adventure, a deed of courage."
F.A. Hayek

[ebreen]

Henry, you and I disagree, money cannot be seperated from credit...it cannot expand in the real economy without credit expansion...for deep historical perspective reveiw John Law and the Mississippi Scheme Bubble and consider the role of credit in the sale of the 'Company of the West,'...what was the difference between credit and money? I don't have time to continue to parse this out, have been travelling...left the mountains and am now in low country. Nothing in you response changes or engages anything I have said.

Dick, I have to think more about your comments but consider the full quote of Milton Friedman's famous formulation of 'inflation'...

"Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output." Everyone forgets the fiscal clause...how do you think credit works in the function of the 'fiscal caluse. More when I get a chance.

[Henry Meers]

Ed,

Of course money can't be separated from credit, that's my whole point; but they are different. Isn't credit money to people?

Ask yourself why people want or would use money. Why not just promise to swap something they own down the road?

Have a great trip. Use your credit card and let the bank work out the details.

[ebreen]

Dick, I would suggest that what distinguishes a deflation from a contraction is the deleveraging. I think you can have an economic contraction in response to a monetary mistake that does not precipitate a credit crisis but once credit begins to contract the forces of deflation are released as the credit contraction has the real economic effect of a shortage of money and preference for unleveraged cash equivalent assets over leveraged tangible assets.

[Dick_Fox]

Ed,

I don't want to take this discussion into a debate on semantics. I believe in principle you and I agree.

Where we seem to disagree is if you say the effect is a shortage of money then supplying money should correct the problem. I do not believe either you or I believe that more money will solve our current problem. I believe that Jude's concept of the money illusion is important. To believe that increasing the money supply will resolve a contraction is an illusion. The leverage problem you point out is not the result of monetary errors. It is the result of fiscal errors that allowed assets to be leveraged beyond their real value. The deleveraging is not deflation but a revaluation of assets to real values.

Yes, this does effect credit. Excess credit was created by the fiscal error that caused the excessive valuation and credit was destroyed when the excessive valuation became manifest, but throwing money at the problem will not solve it. It is not a monetary problem.

The problem with Friedman's quote is that money need neither increase nor decrease for there to be inflation and deflation. As Jude points out Friedman makes an error not recognizing that demand for money has more influence than he gives it credit. He virtually ignored velocity. But I see that as a separate issue from the leverage/deleverage discussion.
_________________
"We must make the building of a free society once more an intellectual adventure, a deed of courage."
F.A. Hayek

[ebreen]

Dick, velocity has everything to do with our discussion of money supply, leverage and credit. In the excellent Supply Side University article that you linked to, Jude observed that "in a deflation 'V' decreases." Much of what I have been suggesting is an attempt to examine and explain how velocity actually operates...what makes it increase in an inflation and what makes it decrease in a deflation. I suggest that the function of leverage in the private credit market is the key to understanding the role of Velocity...the dynamics of 'demand' in Judes paradigm.

I don't want to be impatient but I am amazed that you can suggest that I am suggesting that the deflation is cause by a shortage of money that could therefore be cured by increasing the money supply. Did you get nothing out of many pages and pages of discussion about the conflation of 'money' and 'credit' in the modern global floating currency fractional reserve banking system? I have been suggesting that supply of money cannot today be understood without including private credit supply. I would suggest you think of money as 'Money-PCredit,' where base money in the traditional M sense is merely a preditcate to money in the economy which is characterived and given velocity by the flow and change of aggregate private credit. So, if I talk about money supply I mean 'Money-PCredit' supply. And when PCredit is contracting in the aggregate you cannot expand it by adding to M, so long as M is meeting the threshold level of regulatory reserve requirements. The expansion of PCredit, which is inseperable from Velocity in MV=PT, must come from the fiscal side context which drives expectations about the future that are key to the demand for private credit.


I would also suggest that value is not real. You talk of value in the Platonic sense that there is some real value that all other notions of value must aspire to. I would suggest that there is no real value and that value is merely an expectation about the future that is shaped by a matrix of variables in the present. Value is an illusion based on expectation. It is the present value of a tenuous possessive right to a future income stream which is uncertain...so the discount rate can be as ephemeral as notions of current fashion...especially in today's political context. The highly leveraged values are as real as the unleveraged values. Leverage is just one of the variables in the maitrix of value that are subject to change and reversal.

[Dick_Fox]

[Dick_Fox]

There is so much that needs discussion but I don't have the time right now. Let me address one thing not to you but in general. Value is very real. Value is the importance individuals place on scarce resources relative to one another. Situations such as environment, distance, personal tastes, substitutions, government intervention, taboo or more, and many other things affect value but it is still real.

Now money is a medium of exchange. Anything that alters this role of money reduces its value as money. Because money is a medium of exchange when its role changes the terms of exchange change, but such change always increases the cost of the exchange. Change in cost will always change the value individuals place on goods and services, but value, given the circumstances, is still a real thing that traders deal with every day whether the homeless choosing which bottle of wine to buy or the richest man in the world choosing which Champaign to buy.

The Keynesian and monetarist forget that individuals are interested in goods and services and so determine value based on their desires. Keynesians and monetarists hold the illusion that changing money can improve the terms of trade but this is their illusion.
_________________
"We must make the building of a free society once more an intellectual adventure, a deed of courage."
F.A. Hayek

[Judith]

I guess I am still in the inflation/contraction camp. The credit contraction on top of this is creating another layer of asset 'deflation' = asset price depreciation due to reduced leverage capability (reduced ROI).

I think velocity (or lack thereof) is adding to the asset price depreciation.

However, I think the massive weight of fiscal mistakes is exacerbating the credit problems. Unemployment numbers are up again, they just reported. Something is going to have to change.

[ebreen]

Judith, I basically agree with your concise observations. I have simply been trying to explain the dynamics of how it all works financially. How the operation of the private credit market is at the crossroads. The definition of contraction, recession, deflation is not so important to me...I see them as all as degrees of credit expansion slowing, credit stagnation, or credit contraction. Problem is the credit contraction phase can generate its own support and accelerate the process. In that it is like inflaiton once a tipping point is passed the process is self reinforcing.

Dick, I am sorry I misunderstood your comment and I appreciate the clarification regarding money supply. You do understand in that quote from my comment that when I wrote "effect of a shortage of money" the statement was in the context that credit supply and money where of one piece...the irony is that the contraction of credit operates in the quantity of money theory dynamic as a contraction of money supply. Clearly, if the contraction of credit is operating like a contraction of money supply in the quantity theory sense, then the remedy can only be in supporting or incentivizing the creation of private credit (PCredit) so the aggregate begins to expand. It is further clear that the policy mechanisms that can encourage credit to expand are on the political fiscal side and not on the monetary side. Certainly interest rate adjustment would not be effective.

Lets put aside the philosphy of real value discussion for now...there are more tangilbe and immediate issues of concern.

[Henry Meers]

Judith,

Although Ed B. and I have been going around about this and history, we are looking at some sort of replay of the Carter years. That was the blow-off of the currency collapse that began with Johnson and led to Nixon "closing the gold window". People dumped the dollar for anything else, whether they realized it or not. Volcker didn't have a clue either.

The issue before the assembly is what happened this time. Everybody piled into real estate, hard assets, and gold shot the moon. Europeans stopped taking dollars at various times at the end of the 1970's and in 1980. The stock market, as a proxy for the economy, crashed in 1974 and kept declining in real terms into the 1982 low.

I don't think anybody is giving enough weight to the purely political side of this crisis. That is the "spend-elect-spend" cycle of FDR, Johnson and Obama. The housing crisis comes out of an attempt to buy votes by lowering credit standards to buy a house, a blatant attempt to recruit voters at the low end of the income scale. Johnson used Medicare and Medicad; FDR used everything under the sun.

All the polling data tells us that the less you have going for you economically, the more likely you are to live up liberty for "security" (a government handout). These programs are a cynical attempt to mobilize those people at the expense of the productive ones, who don't want handouts and the limitations that come with them.

The mortgage crisis, the asset malinvestment being the new money, is simply Lenin's old comment, "the capitalists will sell us the rope we will hang them with." With Clinton involved, you can bet somebody made a lot of money too. Arkansas politics? Mortgage brokers? Huge amounts of money were diverted to this sector and the bottom fell out. Where did it go? How about right down the drain, as investors see the properties they bought with the "funny money" go to zero (which they really have, since you can't sell or refinance them). All that's left are the interest payments you owe.

The roots of this crisis are, therefore, not financial, although we have to deal with a financial catastrophe right now. The public is going to step in and replace the whole board of directors in November. BUT -- will that be just another reform ticket in the big city the machine can dodge for a few years by lying low? That's how they traditionally handled such things in Chicago and New York.

The whole thing is really a character issue. Do "they" represent us in Washington or themselves, constantly setting up for reelection? I think we're going to get a lot of new people there who may push hard to reestablish the Constitution in January, which is why justices like Kagan are so important to the Democrats' perpetual motion machine today -- they can read the handwriting on the wall too. Bernanke is helping too, whether he realizes it or not, by debasing the currency in true Leninist fashion (with Greenspan's help).

We are going to have to take a close look at Washington after the new Congress is seated in January. Between WWII and Ronald Reagan, the Republicans tended to clean up the Democrats messes by raising taxes or other counterproductive means. If they do it again, we will see a continuation (15 years left in the Wall Street bear cycle?) of today's economy, a low plateau as was the case under FDR.

On the other hand, the new Congressmen could return power to the people and preside over a golden age. Interesting choices, huh?

There are reasons to be optimistic, beginning with the defeat of the old bulls. We are coming out of a 100 period of violence and disruption, which may have ended with the Soviet Union, say 1994 with the end of the First World War. Then, there is the 60-year cycle of party dominance in Congress and the White House. The real power shift was the 1994 election. Reagan set the stage. There are also the evangelical reformative waves often seen in the U.S.Maybe we're having another out of revulsion with the current political state of affairs nationally.

[Dick_Fox]

[Henry Meers]

We may be dancing around the obvious. What Ed is describing, assets driving asset pricing, is really the death throws of a collapsing currency. Of course modern medicine can cure it, if it is used.

If assets are pricing themselves, the currency has become worthless. That is precisely what happened in the Weimar Republic. You could use the Mark for the split second it takes to transfer assets from buyer to seller, but immediately after that, it had a whole different value.

What was being produced probably held a sort of constant value in that it took so much time and material to create day after day, while the currency fell taking nominal prices higher with it. We cannot overlook what that did to a free-market economy. It destroyed the capitalist society by making capital virtually useless. No one knew what to charge for a loan in Marks, especiall for more than overnight.

A successful free-market is a relatively delicate appartatus, in that a lot of things have to operate together for it to work: banking, transportation and the legal system for example. It doesn't matter, by the way, whether the instablility is inflation or deflation.

[Dick_Fox]

Sorry, Henry, but I don't agree. Assets always price other assets. All money does it put this pricing into a common unit.

I may misunderstand EdB but I don't think he is talking about asset leverage due to a degradation of the value of the currency. Ed is talking about traders assigning more value to an asset and so making it worthy of a greater "collateral" value. Leverage is when credit is issued because lenders value assets at a great enough value to issue more credit. When lenders determine that they cannot issue more credit profitably then they withhold credit and assets lose value and lenders refuse to issue credit. There is deleveraging. In with this, those who hold assets cannot borrow because their assets are assigned less value and they have credit levels uncomfortably high relative to their asset portfolio values.

His comments that value is not real is because the value assigned is determined by preferences not anything intrinsic.

This is not a currency issue in the sense that a currency is either stronger or weaker. My point when I say that the FED accomodates credit creation is that as the demand for credit increases the FED satisfies the demand to what ever level is necessary. If the FED does not satisfy this new demand then the credit expansion is restricted and leverage is limited.

But this is not a sign of the currency failing.
_________________
"We must make the building of a free society once more an intellectual adventure, a deed of courage."
F.A. Hayek

[Henry Meers]

Dick,

Then why do we even talk about fractional reserve banking? Of course, things and output price each other. Four cows might be the same value as a four-door sedan. The dealer prefers cash in the showroom for obvious reasons. How could cars become worth more than cows, absent some new technology?

I can easily see people putting more of their assets into cars to support a blossoming pizza delivery industry that would give a better return, but something else has to change. In Ed's example money creation is out of control. We started this talking about non-interest-bearing debt of the federal government and how that was burying the economy.

Banks looking at ten loans of equal soundness have to decide which ones to fund when they have money for only 7. They can fund all ten with more deposits or borrowing. Without that, they either walk away from some or raise their rate until three go away. This also happens to the economy in general.

Something has to give the lenders the MONEY to lend. I realize he is talking about credit, but it is denominated in money. When the value of money changes so does the value of the loan. Or, the next one, the refinance.

When the public become willing to take on more risk, more credit will appwar too. At some point, that has to be settled, and it is possible to create more credit than the monetary value can support.

[Dick_Fox]

[Henry Meers]

Dick,

Yes, but you are leaving out the key concept of the currency and gold market.

Even in the old days of the gold standard governments played games, which is why I go back to the BoE at the beginning of the nineteenth century. This is why Mises favored gold-based currencies.

Banks lend and governments spend money on their friends. The free market tells them when they have gone too far and put too many dollars, in our case, out there.

In today's world, there is added complexity of the U.S. being the largest economy, which makes its trading partners devalue along with the Fed and Treasury to maintain market share.

If the U.S. doesn't care how much the dollar falls, everybody can lend more and Washington can spend more. The only casualty is the man in the street, who can't raise his income as fast as those guys can create money! (That, by the way, was Keynes' point: wages were slow to respond, sticky, so inflation allowed business to raise prices faster than wages and create capital to invest)