Regulars may have already come across this article, but if not, click on the link as this is a good item showing that the “Austrian” school of economics, in particular, did predict the credit crunch and the problems associated with it. It is just no good for folk to prattle that “no-one saw this coming” yadda yadda. (H/T: Adam Smith Institute Blog).
As an aside, the award-winning FT journalist, Gillian Tett, whom I once met many years ago, has a book out about making the argument that modern financial engineering has to bear much of the blame for the crisis. I have not seen many reviews of it – is it any good? My worry is that no analysis of the crunch makes sense if you ignore the broader issues of how financial systems become deranged in a world of fiat money in which central bankers start to believe in their own myths and where the rules create perverse incentives. Blaming derivatives for the crunch is a case of shooting the messenger, methinks. Even so, I’d be interested to see what Tett has to say. She holds a doctorate in anthropology, by the way, which gives her a bit of an insight into things like crowd behaviour – a very useful insight indeed.
Gillian Tett’s talk to the LSE about the book:
http://richmedia.lse.ac.uk/publicLecturesAndEvents/20090430_1830_foolsGold.mp3
At 45:25 Gillian is asked why she is focusing on a symptom (derivatives) and not the root cause (central bankers).
Fiat money is not the problem. Fiat money is a red herring. Exponents are the problem. As Karl Denninger has repeatedly explained, and any middle schooler should be capable of understanding, the very nature of interest-bearing loans – which is fundamental to capitalism – requires that the rate of return on the loan be higher than the baseline growth in the economy – otherwise it’s not worthwhile as an investment. But you can’t do that forever, otherwise that higher rate would BE the baseline growth rate; some investements work, and some fail. Those that fail need to be defaulted and the books brought back into balance. This needs to be done regularly, every decade or so works well. This is what causes recessions. If it is not done, the undefaulted bad debt balloons and gets its tendrils into bigger and bigger segments of the economy, and the apparent economic activity grows as a bubble based on the false numbers, until the point where it is forced to default, at which point the collapse is far worse than it otherwise would have been.
Regular small recessions are an inevitable and beneficial consequence of risking money in an investment. It becomes a problem only when people who lost money on a bad bet try to avoid having to recognize the losses. People who complain about fiat money simply don’t understand the mathematics.
>She holds a doctorate in anthropology, by the way, which gives her a bit of an insight into things like crowd behaviour
Well, that depends on how much postmodernism there was in her doctorate.
Thanks for the link. V useful article by Thornton.
Karl Denninger’s blog.(Link) Informative. Maybe a higher authority might consider adding him to the Samizdata blogroll?
“the very nature of interest-bearing loans – which is fundamental to capitalism – requires that the rate of return on the loan be higher than the baseline growth in the economy – otherwise it’s not worthwhile as an investment. But you can’t do that forever, otherwise that higher rate would BE the baseline growth rate”
I’m skeptical. In any case, why can’t you do that forever? If the higher rate WAS the baseline growth rate, then the people who saved would end up with a greater share of new wealth than the people who didn’t. Nothing paradoxical about that.
I am with Hugo. I fail to see the logic – although I suppose you may argue my maths is not of the “middle schooler level”. If some investments work out, and others don’t, then presumably there is a reversion to the mean, with the average performance of all investments approximating to the economic growth of an economy, right?
And the dismissal of fiat money as a factor is too easy. Fiat money means that the total amount of money lent to finance investments can exceed the stock of savings (I think that is actually the idea). And as we have seen with the way that central banks have printed money, the current crisis is intimately connected to the way the monetary system works.
“The baseline growth of economy” – classic “macro thinking”.
In reality if someone has some savings (some money they have decided not to spend) they loan them out (either directly or via a bank or other enterprise) in order to get a return.
Of course if they could get a higher return setting up a factory (or whatever) themselves them may do so (if they decide a higher return is worth all the extra work).
Costs and benefits are often subjective things (for example depending on how people regard work), and lending out money at interest is a matter of time preference anyway.
Someone who really wants his money now (to spend on a new car) is not going to be interested even in an “interest rate that is higher than the baseline rate of economic growth” (to go into all the macro thinking in those few words would requre an essay).
Someone who does not care about consumption very much may loan out money for no interest at all.
It all depends…………
However, I agree that “fiat money is a red herring” at least in the sense that it is possible to think of fiat money without thinking of credit money bubbles (although I can think of no real world examples of such a thing).
The credit money bubbles are the main thing of course.
The lending out of more money than actually exists in real savings.
If that happens one has a credit bubble – by definition.
It is normally helped along by Central Bank (such as the Federal Reserve system – and Alan Greenspan certainly the present mega bubble by “saving” the bankers whenever it looked like reality was about to hit the economy over the head, thus making the eventual hit bigger each time he “saved the world”).
However, a credit money bubble can uccur (with fractional reserve banking) even when a Central Bank does not exist (1907, United States).
What matters is that (by various complex smoke and mirror games) more money has been lent out than actually exists in real savings.
Once such credit expansion happens (by whatever means) a correction is inevitable – and sometimes the correction can be very nasty indeed.
Sometimes the slump will be short (however sharp), as it was in 1921 – when wages and prices were allowed ajust.
And sometimes wages and prices are not allowed to adjust – then one gets things like the 1930’s in the United States.
Anyway the economics of credit bubbles is fairly well explained – start with Ludwig Von Mises’ “Theory of Money and Credit” (1912) and “Human Action” (1949) then go to the other works that the Ludwig Von Mises Institute will be happy to direct you to – some (such as Thomas Woods’ book “Meltdown” published only a few months ago).
Of course Rollory has not and will not read any Austrian school work.
He is like that nice chap in the “Spectator” magazine who said that the present crises “refuted Hayek” (not well known as a supporter of credit bubble finance in general and the Federal Reserve system in particular) and showed the need for “public investment”.
Note – anyone who calls government spending “investment” is deeply ignorant.