23rd January 2009
Building a monetary and financial system for a free society
By Sanjeev Sabhlok, published in Freedom First, Mumbai, January 2009.
For a wealth-destroying event of the magnitude of the global financial crisis (GFC) to have taken place despite celebrated economists running Western economies tells us that ‘standard’ economics has failed at a most fundamental level, like theories which said the earth is flat. Instead, the ideas of thinkers like Ludwig von Mises and Friedrich Hayek (the economics Nobel prize winner of 1974) of the Austrian school of economics, who repeatedly warned about the dangers of state-induced distortions in money markets, have been fully vindicated.
Unfortunately, the economics taught today continues to ignore these great economists’ insights. Current economics is more inclined to side with Marx who dreamt of state-controlled credit in the hands of a national bank. It is time the world asks these ‘standard’ economists the blunt question: why must free societies have Marxian central banking?
Unfree financial markets
People exchange goods and services in the free market at a mutually agreed price. The unit and medium of exchange, money, is also created by these markets. For instance, notes issued by private banks in medieval Europe, being commitments to pay specified amounts of gold to the bearer of these notes, were readily accepted as money. This system of money creation and banking, based on the ‘gold standard’, arose spontaneously from freedom.
However, in 1694, the British government, in financial distress, found a convenient way to produce money from thin air by giving sole rights to produce money to the newly established (private) Bank of England, and receiving an advance of £1.2 million in return. This anti-competitive distortion of previously free money markets became very popular among later governments. Some enlightened governments did allow free banking for a while: for instance, in Sweden between 1830 and 1902. Indeed, this (Swedish) free banking episode eliminated booms and busts and dramatically reduced bank failures. But Sweden soon abandoned free banking because it demands great discipline from governments which would rather follow Robert Mugabe’s inflationary footsteps, instead.
The free market also ordinarily determines the price of money, which is the interest rate that this money commands in a competitive marketplace. This market-based interest rate perfectly matches the society’s time preference of consumption. But central banks are established exclusively to interfere with this free determination of interest rates by distorting money supply and fixing the price of money. Naturally consumers and entrepreneurs are confused in these economies.
We can see why Americans save so little and borrow so much. By deliberately preventing the time preference of society from being disclosed through the market, and by (often) forcing interest rates to fall below their market rate, people are motivated to consume more and save less. Sensible persons won’t save when their savings don’t earn much interest or even earn a negative interest after inflation and taxes. They would rather borrow at low interest rates and consume in excess. Americans are quite rational; it is their politicians and central bankers whose heads need a check up.
Betrayal of freedom
Like other socialist planners, central banks are prone to imagine that the solutions to the world’s problems lie inside their presumably super-intelligent but in reality deeply flawed and ill-informed brains (we are all similarly endowed: that is the basic truth about human frailty). Fatal conceit afflicts them as they try to ‘fine tune’ the economy by randomly tinkering with money supply and its price. Alan Greenspan (whom the great philosopher of freedom, Ayn Rand, erroneously considered as her disciple) wrote in the 1960s that the US Federal Reserve (Fed) had ‘nearly destroyed the economies of the world’ in the 1920s, and that ‘a free banking system stands as the protector of an economy’s stability and balanced growth’. This was, no doubt, good thinking.
But strange things happened between 1987 and 2006. As Chairman of the Fed, Greenspan changed colours. Not only did he not liberate the money markets, he kept interest rates artificially low, particularly between January 2001 and June 2004. Had he recalled the Austrian trade cycle theory (which Ayn Rand endorsed) he would have realized the great dangers of administering the price of money. His artificially low interest rates persuaded entrepreneurs worldwide to build things like houses and car factories in great excess, leading to the same over-investment that led to the roaring 20’s and thence to the Great Depression. Greenspan thus did exactly what he had earlier decried. Freedom was betrayed by the man once considered its great votary. It is now time to stop this stupidity of having a controlled product (money) in otherwise frees societies. Central banking, the illegitimate child of mercantilist monarchs and communist utopians, must be abolished. We must get free banking, instead: based on the gold standard.
US government’s socialist interventions
These massive failures of the Fed were greatly exacerbated by American welfare socialism. Nationalised Fannie Mae was created in 1938 to funnel federal funds into home loans, artificially boosting the demand for housing. It was (notionally) privatised in 1968 but remained guaranteed by the US government. Freddie Mac was later created in 1970 to allegedly provide Fannie Mae with competition. American welfare socialism worsened with Jimmy Carter’s 1977 Community Reinvestment Act which required all banks to give loans to people without income or on low income, over-riding good lending practices. Fannie May and Freddie Mac (FMFM) were thereafter ‘leaned upon’ by successive US governments to buy the sub-prime mortgages issued by banks. Then started what can only be (in polite terms) termed as government-supported fraud. FMFM started guaranteeing sub-prime loans issued by Bear Stearns and also directly sold such debt to foreigners.
Catching and punishing those who make false or misleading claims about a product is a primary function of the government, but the US Office of Federal Housing Enterprise Oversight (charged with supervising FMFM) did nothing to block these falsehoods. Activities of a similar nature were also unfolding in the private marketplace in relation to financially engineered products. For instance, Credit Suisse Group Sellers misled markets about the risks of its securities by touting the AAA ratings it got (bought?) from Standard & Poor’s. Self-regulation dramatically failed in the financial sector.
In addition, urban planning laws in many parts of the USA prevented urban boundaries from expanding even though thousands of new housing loans had been issued. This caused house prices to skyrocket. All these bad policies, together with low interest rates, fuelled a major housing bubble which has now burst. The main lesson we can draw from the GFC is that economic booms and busts are always created by government interference, mismanagement, and incompetence; not when markets are free and held to account.
I fear that worse things may be in store for the USA, including the possible collapse of the US dollar by about 2018 given its massive unfunded social security and medicare obligations (the only way to save USA would be for other countries to follow even worse policies!). After destroying and socialising its financial system, the USA government has now started throwing its taxpayers’ money at failing companies. In a free society each business or company must take responsibility for its own decisions; if it becomes insolvent it must declare bankruptcy as part of its accountability. If any value is still left over, private investors will buy it out. Using taxpayer funds to bail out companies that no one wants to touch, amounts to theft of taxpayers’ hard-earned money. Also, by rewarding incompetents, it creates disincentives for prudential management.
Lessons for India
Despite being founded under the banner of liberty, America has never been completely free. But its badly regulated money and financial markets, coupled with its socialist response to the GFC, shows that it is no longer fit to talk about freedom. This makes it even more important for India to show the way.
India’s Reserve Bank should get out of the business of creating money and fixing the price of money. It should become an independent regulator of a private money and banking system. Its current functions should be unbundled: coins and notes should be issued only by private banks; the lender of last resort function should be performed by private insurance companies. Reforms on these lines will disclose the market’s true interest rate, and price risks transparently, thus enabling uninterrupted economic growth. Good fiscal policy would have to accompany such reforms, including policies to minimise inflation, but I’ll touch upon these related policies in a separate article.
The Freedom Team of India
India needs leaders urgently to take it to freedom. I’d like to request you to consider joining the Freedom Team (freedomteam.in) to lead India. The task is clearly becoming more urgent than ever before.
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Addendum 13 June 2009. A sensible article by Paul Kelly in The Australian today. Fix it, Don’t Break it.
Addendum: ‘Recession is ‘cleansing’, Corbett says‘, 15 May 2009 by Nine MSN.
Addendum: Eight centuries of financial folly and counting, 23 April 2010. Public Sector Development Blog
Addendum: Copy of the entire article by Paul Kerin (“There should be less government intervention, not more”, published in The Australian, 14 Sept. 2009):
MANY claim that the global financial crisis has slain the most important economic theory of the last half-century — the efficient markets hypothesis (EMH) — and, therefore, that much more government intervention in financial markets is necessary.
In fact, the GFC didn’t even give the EMH a flesh wound. At least in Australia, there should be less intervention — not more.
Kevin Rudd blames the EMH for engendering the “belief in the superiority of unregulated financial markets” that he holds responsible for the GFC. Even my excellent MBS colleague Ian Harper — member of the 1997 Wallis Inquiry into Australia’s financial system — says the GFC had “blown efficient markets theory out the water”. Other doubters include ASIC chairman Tony D’Aloisio and Warren Buffett, justifiably the world’s most admired investor.
EMH critics either don’t understand what it is or (in Harper’s case) refer to one particular corollary, on which doubts are most defensible. In 1965, Eugene Fama — who fathered the EMH — defined an “efficient market” as one in which individual security prices “fully reflect all available information”.
Critics often cite economist Robert Shiller, author of the best-seller Irrational Exuberance, which was published just before the dotcom crash. Shiller agrees with the famous “Samuelson dictum” — that financial markets are micro-efficient, but may not be macro-efficient. That is, markets price individual securities well, but overall market levels may not reflect reality. Nobel Prize winner Paul Samuelson propounded his dictum in the midst of the dotcom boom and soon after the Asian financial crisis.
The entire rationale for light regulation rests on financial market’s micro-efficiency, not macro-efficiency.
In 2005, Shiller concluded: “Substantial evidence vividly illustrates the truth in Samuelson’s dictum for the US stockmarket since 1926.” His key reason is that substantially more information is available on the drivers of individual firms’ cashflows (hence their intrinsic values) than on the overall market’s drivers (such as future macro-economic growth).
Even the world’s best-known EMH advocates recognise that macro-inefficiency may exist. Six months before the 2007 market peak, Burton Malkiel (author of A Random Walk Down Wall Street) questioned in The Wall Street Journal whether the market was exhibiting “irrational complacency”, given that macro-economic indicators were already slowing.
Critics also mock assumptions that they claim the EMH makes. Even the otherwise sensible Lindsay Tanner wrote: “The efficient markets theory and the assumption that people act rationally are under intellectual siege.” But Fama explained in 1965 that this and other assumptions — if true — were sufficient for the EMH to hold, but not necessary. Those assumptions probably don’t hold in the banana market either, but it works pretty well.
If critics cite any micro-inefficiency examples, they’re the usual suspects: the Dutch tulip and South Sea “bubbles”. The tulip case actually reflected a government-supported change in trading rules and a ban on short-selling. As tulip bulbs cannot be uprooted between October and May, the large price rises between November 1636 and February 1637 were on futures contracts, which obligated buyers to pay the contracted price for next season’s bulbs. But from November 1636, the Florists Guild had been moving to give buyers the right to avert this obligation by paying a small fee — and for this change to apply retrospectively to all contracts made from that time.
That is, the market knew that “futures” contracts may become “options” contracts from November. The likelihood of this happening kept rising until it was mandated in February 1637. As that likelihood rose, buyers willingly agreed to higher prices because they were less likely to have to pay them. The “crash” in February 1637 simply reflected the fact that, in any market, options trade at a small fraction of futures prices. “Tulipmania” claimants are comparing the prices of apples and bananas. Indeed, UCLA’s Earl Thompson concluded that “Tulipmania” was actually a “remarkable illustration of market efficiency”.
The South Sea fiasco didn’t reflect market inefficiency. Market prices can only reflect available information. Instead, it highlights the dangers in governments granting monopolies to private companies. After the crash, fraud by South Sea directors and corruption in the British Cabinet was exposed. The chancellor of the exchequer was jailed.
While macro-inefficiency may be possible, stockmarket crashes do not “prove” it. We often und
erestimate the impact that new information can have on estimated intrinsic values. The intrinsic value of a share paying $1 a year dividend with expected annual growth of 5 per cent and a 10 per cent cost of equity is $21. Suppose a “shock” (subprime crisis, say) raises investors’ risk premium by 1 per cent and makes them expect a 30 per cent dividend cut to 70c a share for the next three years, before 5 per cent annual dividend growth is restored. Rational investors would cut their estimated intrinsic value fall by 49 per cent — about how much our market dropped by.
While most EMH tests are of micro-efficiency, there is even some evidence supporting macro-efficiency. A 2008 study by Australian researchers Jae Kim and Abul Shamsuddin of sharemarket indices (like the Nikkei) before and after the Asian financial crisis found they were efficient in relatively developed markets, such as Hong Kong and Japan. Market efficiency was strongest in nations with business cultures and regulatory arrangements conducive to transparent corporate governance (such as good disclosure rules).
In questioning the EMH, D’Aloisio cited the collapse of various unlisted managed investment schemes and debenture issues. But no EMH advocate has ever claimed it applies to these over-the-counter products, for good reason. Investor prices (on both buy entry and exit) are set by issuers, not by a free, competitive, transparent market. In the latter, sophisticated investors and arbitrageurs work to keep security prices sensible; they cannot do so with the products D’Aloisio cites.
And D’Aloisio was wrong in claiming that the Wallis Inquiry said “there shouldn’t be capital requirements” on issuers of these products due to “the efficiency of the market”. The Wallis committee didn’t recommend capital requirements because they were unnecessary to protect financial system stability — those products, in total, represent too tiny a share of total financial assets to pose any significant systematic risk. Wallis instead emphasised the need for good disclosure requirements, which ASIC is now moving to strengthen.
The very best protection for retail investors is free, competitive, transparent securities markets, because prices are then most likely to reflect intrinsic values. Governments should certainly ensure transparency by mandating good disclosure and punishing rumour-mongering and insider trading. But interventions like short-selling bans actually inhibit market efficiency — putting retail investors at more risk, not less.
It is also important to distinguish between macro-inefficiency in financial markets versus the real economy. Samuelson once said that the real economy’s business cycle “like herpes, has always been with us”. A Keynesian, he supports activist macro-economic policies to keep that disease in check — but not activism in financial markets. The Federal Reserve’s 1929 intervention to prick what it saw as a stockmarket bubble — and the Great Depression that followed — demonstrates the danger.
My big worry is that our Prime Minister will overreact. Rudd had advocated “constraining excessive expansion of derivatives markets” and a “fundamental regime change” to “social capitalism” — “a system of open markets, unambiguously regulated by an activist state”. Activism can be taken far too far.
Politicians may think markets overreact, but never look in the mirror. At least markets soon correct themselves. Politicians rarely do.
Paul Kerin is Professorial Fellow, Melbourne Business School
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Here’s an excellent article: “Milton Friedman and the Case against Currency Monopoly” by Selgin, George; Cato Journal, Spring-Summer 2008, v. 28, iss. 2, pp. 287-301 (EconLit with Full Text)
http://bit.ly/c3bKdk – Crisis puts nails back in Keynesian coffin, by Michael Stutchbury, Economics editor From: The Australian June 15, 2010
http://www.theage.com.au/opinion/politics/fiscal-time-bomb-yet-to-explode-20100614-ya3c.html (Fiscal time bomb yet to explode, Tim Colebatch The Age, 15/6/2010)
http://www.theage.com.au/business/pm-accused-of-panic-in-global-crisis-20100622-yvtr.html It is never going to be easy to kill such panics. Considered infrastructure funding is hard, mindless throwing away of taxpayer funds is easy. This is an article with much useful information to add to fiscal policy debates.
See this blog post at Marginal Revolution: http://www.marginalrevolution.com/marginalrevolution/2010/09/on-austro-european-business-cycle-theory.html
http://cafehayek.com/2010/11/has-the-fed-been-a-failure.html. Research shows that “The Fed’s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed’s establishment”
http://cafehayek.com/2010/11/denationalize-money.html
A debate at: http://www.marginalrevolution.com/marginalrevolution/2010/11/xxxxxxxx.html
Housing: Too Good to be True: June 04, 2004 by Mark Thornton
The myth of deregulation being a cause of the GFC.
http://www.freebanking.org/2011/06/04/free-banking-and-classical-liberalism-a-potted-history/
How much did Fannie and Freddie cause the financial crisis?
http://catallaxyfiles.com/2011/11/03/a-nice-piece-on-one-of-the-causes-of-the-us-housing-debacle/ [A nice piece on one of the causes of the US housing debacle]
MURRAY AND BIER: Avoiding a lost decade: Obama on course to repeat Japan’s errors of the 1990s {one of the best articles on the subject}
The widespread demand after the financial crisis for radical modifications to capitalism typically paid little attention to whether in fact proposed government substitutes would do better, rather than worse, than markets.
Government regulations and laws are obviously essential to any well-functioning economy. Still, when the performance of markets is compared systematically to government alternatives, markets usually come out looking pretty darn good.
Also see this blog post for a clear rebuttal of false claims by Steve Horwitz: https://www.sabhlokcity.com/2011/10/if-you-still-believe-that-capitalism-caused-the-financial-crisis-then-read-this/
Here’s a nice summary of what went wrong: http://catallaxyfiles.com/2011/10/28/politics-not-incompetence/
(The turning point was the spring and summer of 2004. Fannie and Freddie had kept their exposures low to loans made with little or no documentation (no-doc and low-doc loans), owing to their internal risk-management guidelines that limited such lending. In early 2004, however, senior management realized that the only way to meet the political mandates was to massively cut underwriting standards.)
ADDENDUM 18 June 2014
The Virginian 2 hours ago
I would fully endorse the Justice Department criminally pursuing the people who did the bad deeds. But, they instead have chosen to treat the banks as piñatas and a ready source of cash to fund U.S. government operations.
These large fines don’t do anything to the people who did the deeds – they just reinforce the belief that it’s a cost of doing business.
Instead, they wreak tremendous damage on stockholders, which are primarily American citizens, their pension funds and insurers.
Let’s not forget that most of the ‘bad deeds’ began by the exhortations of:
1) Barney Frank (a famous US Congressman who was the Chairman of the House Financial Services Committee), who pushed U.S. banks to loan money to poor people who couldn’t qualify for mortgages as part of his belief in social justice … and who famously said “I want to roll the dice a little bit more in this situation toward subsidized housing.”
2) the Federal Reserve, which pressured the banks to buy the companies that often did the bad deeds in order to save the U.S. financial system and, by extent, the world economy as the economic crisis deepened. (The most famous example is Bank Of America’s purchase of Countrywide, which actually made the bad loans BAC is being punished for.)There is plenty of blame to go around … but, much of it is directly attributable to the U.S. Government Congress, both political parties, and our vaunted regulatory agencies which aggressively enforced the political clamor to make mortgage loans to poor people so they could own homes, regardless of their ability to repay).
Hypocrisy is an elemental part of the political process and we see it every day in our government. I just want it to finally be moderated here so that us stockholders can regain our savings and fund our retirements … and so that our banks are again willing to make the loans necessary to grow our economy.
Right now, the U.S. government is actively sabotaging all three of these necessary requirements through their extended bleeding of Bank America, Citigroup, JP Morgan, and other banks.
ADDENDUM
An alterantive view (which I don’t find persuasive): The housing bubble: Perceptions and reality – Scott Sumner. My comment:
This article is off the mark.
That the steep decline in the Fed funds rate in 2002-2004 set off a housing bubble is clearly vindicated by looking at this chart of house prices:
http://www.jparsons.net/housingbubble/us_home_prices_vs_rents.png
This bubble was purely created by loose monetary policy. That doesn’t mean everyone has to start defaulting in their payments immediately. It would be a mistake to default if your house price is increasing in value.
However, in the US, most mortgagees can walk out of their mortgage once the property goes below its purchase price. So AFTER the bubble burst (due to many factors – all bubbles burst sooner or later), the default rate THEN shot up. The buyers who had bought high, walked out, setting off a chain reaction, making it attractive even for those who could pay, to default.
The problem with Erdmann’s spurious argument is his assumption (2):
“2) As rates rose, low income households with unsustainable ARM mortgages couldn’t afford their mortgage payments. Delinquencies started to pile up.”
No one in his right mind said that. See my January 2009 article in which I refer to the HOUSING BUBBLE (not delinquencies) and a range of socialist policies as the driver of the GFC.
https://www.sabhlokcity.com/2009/01/building-a-monetary-and-financial-system-for-a-free-society/
Even a Harvard professor understands that government caused the Global Financial Crisis:
BAN ON PRIVATE MONEY IN AUSTRALIAThis is a note for my record. Following on the suggestions in Heyek’s paper, “A Free-Market Monetary System” (http://www.lewrockwell.com/orig6/hayek2.html) I inquired into the feasibility of starting a money-issuing business in Australia by writing to the Reserve Bank, thus:I am contemplating (if legally feasible) preparing a business plan to establish a bank purely to issue gold-backed currency. I am considering buying gold backed securities from the Perth Mint (and other mints across the world) and issuing high denomination ‘gold dollars’ that can be used as a medium of exchange. The market would then be able to consider using this fully gold-backed money, particularly for trade. Will such an idea violate any law? Could someone from RBA please advise me on this?In response I find that it is banned here as well (as it is in US, for instance). The Reserve Bank Act 1959 confers on the Reserve Bank of Australia the responsibility for the production and issue, reissue and cancellation of Australia’s banknotes. Further, section 44 states that a person or state “shall not issue a bill or note for the payment of money payable to bearer on demand and intended for circulation”. In addition, the Banking Act 1959 talks about the legal requirements for the establishment of a banking facility.Clearly this can be seen as a socialist restriction on money, which is, at its heart, a commodity like any other.
Being in the midst of all the action I would have to say that this was a failure of regulators and their inability to value these exotic financial instruments which investment banks invented. As if Mortgage backed Securities were not enough they came up with Credit Default Swaps on top of these securities, real asset, the mortgage loan, was so much below these layers that ultimate investors had no idea what they were buying. Even if you build complex models to value these assets its so hard to get underlying loan level data that the modeler ends up making lot of assumptions about loan level characteristics( not to mention that each type of loan has different cash flow characteristics). If input to a model is wrong how can the output be correct even if we assume model is trustworthy.This ability of wall street to create a basket of loans with different tranches made a 30 yr maturity product attractive to lot of different types of investor raising the demand for MBS. Wall street started paying premium to buy loans form originators to securitize them, putting pressure on originators to originate more loans to make quick money. Originators needed new borrowers and they started relaxing their lending guidelines, qualifying borrowers who will not be able to get mortgage otherwise, creating new set of buyers in market and pushing housing prices even higher, raising the demand for MBS even further. When these borrowers, who bought what they couldn’t afford, were not able to pay their mortgages, foreclosures started and we all know the story after that. Worth mentioning that this housing bubble started when Alan Greenspan lowered the lending rates to steer the economy out of dot com collapse and kept them low for a long timeMy questions – 1. How do people like us who belive in freedom of markets to operate with minimum government intervention explain this to fellow socialists( or people with socialist inclination )? 2. Freedom obviously can not work without accountability, and as Sanjeev rightly mentioned somewhere that freedom of one man ends where other man’s chin is, but what about the market. When does the freedom of market to create these instruments end, even if there are buyers ready to buy the product. When does it stop being a business and become fraud ? 3. Who is at fault here auditors who consented with the valuation process under pressure from their clients even if they themselves did not understand it properly, Investors who were ready to buy everything without thinking, originators giving loans to every one they could grab on the street or wall street for inventing these instruments ? 4. Or we all should think of this as a way market is correcting itself and assume that market has learnt by its mistake and this is just another cycle, which means that Fed should not have come up with $750 billion package ?Is it true that Karl Marx is laughing in his grave ?
Dear AnupamThe area you have pointed out can be classified as a failure of under-regulation and bad enforcement by bad regulators. It perhaps needs beefing up through re-regulation and training.But as I have suggested in my article, the regulatory failure (government failure) in GFC goes much deeper, at its root being the monopolistic control of money by central banks. For instance:a) For the most part, it was Fannie May and Freddie Mac (government -backed bodies) with a dedicated regulator that refinanced bad loans and packaged them as AAA securities. That can be called (bluntly) government-backed fraud.b) Then there is the ongoing failure of money supply where central banks are involved a problem well known and endemic to the fiat money system.But despite these obvious failures of statism, this seems to be a very bad time for the message of freedom. Leaders all over the world are winding back freedom, nationalising banks, etc., even as they refuse to privatise money – the key failure of government behind the financial crisis and all trade cycles. Despite government failure everywhere the entire world seems to be demanding more government this mad chorus being led by so-called Nobel laureates in economics!Understanding capitalism is very hard. Most politicians and economists do not understand, nor care, for freedom. In my (draft, second) book (The Discovery of Freedom), I am estimating that it will take at least 200 years of excellent education for the message of freedom to be widely understood. Our job is to understand issues and educate the people.The immediate question before us is: What policies can we recommend for FTI to consider on money, banking, and financial markets? If you wish to put up a proposal, we can discuss further.RegardsSanjeev
Sanjeev,I agree with you what you have suggested. Government intervention was the cause of great depression as well. Alan Greenspan said in fronf of congress that his faith in free market is shaken with recent events, here is a little excerpt –I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms, Mr. Greenspan said.Referring to his free-market ideology, Mr. Greenspan added: I have found a flaw. I dont know how significant or permanent it is. But I have been very distressed by that fact.Mr. Waxman pressed the former Fed chair to clarify his words. In other words, you found that your view of the world, your ideology, was not right, it was not working, Mr. Waxman said.Absolutely, precisely, Mr. Greenspan replied. You know, thats precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.But he did not say that markets are not free to begin with. We do have a daunting task in front of FTI to come up with financial market and banking policy. I would be more than happy to help in any way I can but I will definitely need lot of hand holding as I have a 30,000 feet level view of the issues and a policy needs detailed knowledge. What do you suggest, how/where do we get started ?Anupam
As the policy we will come up with will be specifically for India at this point( it might eventually become something for others to follow ) I would suggest that why don’t we get started wit current Banking and monetary policy in India.If FTI had to come to power and steer India towards a free market we can not make all the changes in first 6 months, there will have to be stepwise approach to slowly free the market and banking sector if we don’t want sudden chaos due to lack of people’s and government officials understanding of of the nitty gritty of free market economies.I would suggest that FTI will have to come up with a road map which will slowly move India from current policies towards the free market economy which is on existent in any other part of the world. This could take a long time but we have to ensure that we have a clear road map for subsequent governments to follow.Anupam
Thanks AnupamIn ‘Breaking Free of Nehru’ I’ve taken the approach of ‘road-mapping’ as you have suggested, namely, providing detailed steps for achieving various key policies, with specific time-frames. I wrote briefly on a public finance policy (available in ‘Online Notes’ publicly) but not on money and banking. However, road mapping is perhaps too much detail for us to aim for at this stage. For FTI draft policies, I’d suggest we first outline very briefly the key elements of the policy we want (after structural adjustment), ie the goals.Only after 1500 members have assembled and agreed to these high level policy goals should we then work out the next steps (point A to point B). If you’d like to begin, we can then get started. This will evolve through many iterations. Indeed, I have suggested many elements of the high level policy goals we may wish to aspire for in my article, above, but I leave it to you to start the discussion.RegardsSanjeev
I think we will need to have a vision document first defining clear goals for the Fiscal policy, and I am not talking about regulations yet, just a 2 page document defining what we mean by non government run banking, free market and true capitalism. Someone who among us understands this best should put this together and then rest of the team has to come to an agreement on this.Once we have the vision document approved by the team, we will form a 2-3 person workgroup to study current Indian fiscal policies and the changes that need to be made to reach the final goal defined in vision document. That work group should propose a road map to slowly steer India towards free markets without causing major chaos. Overall time frame from current state of affairs to the final goal could be as long as 50 years.I think that the first step is to define that vision document.Anupam
Re: the daylight robbery of taxpayers’ money by Merrill (Merrillbonus.pdf):I think the whole thing points dramatically to the failure of regulation and regulators. Apart from US central bank which has acted as a monopoly with absolutely no idea what it is doing or why it is doing it, the SEC, in 2004 eliminated the liquidity requirements (I forget details) from 1 to 15 or so (see last weeks’ Time magazine). We also saw how the regulators of semi-nationalised Freddie and Fannie connived at the issue of fradulent securities. The government sold garbage as gold! These frauds in the American system did not take place without connivance at the government level; it was in many cases promoted actively by it.What is needed is a clear-cut difference in responsiblities – checks and balances.The checks and balances Montesquieu and Jefferson insisted upon for politics must apply equally to distinct roles of government and business.The government must not dabble in business, it must purely regulate it. By taking on business roles including the issue of money or refinancing mortgages, the government was captured by businesses. It was a mercantalist system, not capitalist. The hodge-podge capitalism of USA and the West more generally must go.Sanjeev
A note to myself: An excellent section that can be incorporated in toto into a policy position of FTI:== FROM http://mises.org/story/3317 ==In a freely created monetary cartel without a public central bank, different banks are issuing their own currency, but they make arrangements for these currencies to be perfectly substitutable one to the other, which is profitable for money users. For instance, in a genuine gold standard, banks give two sorts of convertibility guarantees for the currency they issue: * A guarantee in terms of gold, with each bank being responsible for its own guarantees. This means that if one is ever creating too many units of currency, it may be unable to reimburse them in gold and may go bankrupt. Thus money producers are induced not to issue too much money. * A guarantee by which all banks recognize the currencies issued by the other members of the monetary cartel, thus producing substitutability between the different currencies, which means that each currency has a potential larger area of circulation and becomes more desirable.In such a case, the optimal dimension of the monetary area is discovered by the market. The risk of overissuance is low because * Each bank is responsible for giving convertibility guarantees. * There may be a system of mutual surveillance.Therefore, systemic risks have no chance to occur in such a system, contrary to present monetary systems with a public central bank in which the banks are protected from outside competition by legal-tender laws and are induced to overissue money, because of the role of “lender of last resort” of the central bank.Now, we need not decide from outside that a gold standard is the best monetary system or that a 100% reserve system is to be preferred. We have to experiment, to let producers of currency and users of currency freely enter onto the market for currencies.I am sorry to say, here, at this Mises Institute event, that I am not necessarily a supporter of a 100% reserve ratio. But I am a defender of free currency and capitalist solutions. You cannot prevent banks and other institutions from creating fiat currency. But you can design a system in which there are limits to money creation and to instability in money creation.
For my future reference. SanjeevIMF REFORMMar 6th 2009 The IMF blames inadequate regulation, rather than global imbalances,for the financial crisis IN RECENT months many economists and policymakers, including suchunlikely bedfellows as Paul Krugman, an economist and NEW YORK TIMEScolumnist, and Hank Paulson, a former American treasury secretary, haveput “global imbalances”–the huge current-account surpluses run bycountries like China, alongside America’s huge deficit–at the root ofthe financial crisis. But the IMF disagrees. It argues, in new papersreleased on Friday March 6th, that the “main culprit” was deficientregulation of the financial system, together with a failure of marketdiscipline. Olivier Blanchard, the IMF’s chief economist, said thisweek that global imbalances contributed only “indirectly” to thecrisis. This may sound like buck-passing by the world’s maininternational macroeconomic organisation. But the distinction hasimportant consequences for whether macroeconomic policy or moreregulation of financial markets will provide the solutions to the mess.In broad strokes, the global imbalances view of the crisis argues thata glut of money from countries with high savings rates, such as Chinaand the oil-producing states, came flooding into America. This keptinterest rates low and fuelled the credit boom and the related boom inthe prices of assets, such as houses and equity, whose collapseprecipitated the financial crisis. A workable long-term fix for theproblems of the world economy would, therefore, involve figuring outwhat to do about these imbalances. But the IMF argues that imbalances could not have caused the crisiswithout the creative ability of financial institutions to develop newstructures and instruments to cater to investors’ demand for higheryields. These instruments turned out to be more risky than theyappeared. Investors, overly optimistic about continued rises in assetprices, did not look closely into the nature of the assets that theybought, preferring to rely on the analysis of credit-rating agencieswhich were, in some cases, also selling advice on how to game theratings system. This “failure of market discipline”, the fund argues,played a big role in the crisis. As big a problem, according to the IMF, was that financial regulationwas flawed, ineffective and too limited in scope. What it calls the“shadow banking system”–the loosely regulated but highlyinterconnected network of investment banks, hedge funds, mortgageoriginators, and the like–was not subject to the sorts of prudentialregulation (capital-adequacy norms, for example) that applied to banks. In part, the fund argues, this was because they were not thought to besystemically important, in the sense that banks were understood to be.But their being unregulated made it more attractive for banks (whoseaffiliates the non-banks often were) to evade capital requirements bypushing risk into these entities. In time, this network of institutionsgrew so large that they were indeed systemically important: in thenow-familiar phrase, they were “too big” or “too interconnected” tofail. By late 2007, some estimates of the assets of the bank-likeinstitutions in America outside the scope of existing prudentialregulation, was around $10 trillion, as large as the assets of theregulated American banking system itself. Given this interpretation, it is not surprising that the IMF has thrownits weight strongly behind an enormous increase in the scale and scopeof financial regulation in a series of papers leading up to the G20meetings. Among many other proposals, it wants the shadow bankingsystem to be subjected to the same sorts of prudential requirementsthat banks must follow. Sensibly, it is calling for regulation toconcentrate on what an institution does, not what it is called (thatis, the basis of regulation should be activities, not entities). Italso wants regulators to focus more broadly on things that contributeto systemic risk (leverage, funding and interconnectedness), thesignificance of which was probably under-appreciated until the collapseof Lehman Brothers and the subsequent chaos. And there is much more tobe done, it suggests, involving cross-border banking, disclosurerequirements, indices of systemic risk and international co-operation.Yet there is an underlying inconsistency here. The IMF’s version of“how it all happened” is a classic example of institutions gaming theregulatory system. It is impossible to anticipate all the possible waysin which regulations can be evaded. And while the wisdom of hindsightmay make it appear blindingly obvious that non-bank financialinstitutions could become large enough to pose a risk to the entiresystem, clearly this was not apparent to policymakers at the time.Increasing the scope of regulation may well prevent the preciseproblems that led to this crisis from recurring in the same way, butnothing stops financiers from finding ways to evade the plethora ofregulations that the fund is proposing. It is hard to shoot a movingtarget. And what about those pesky imbalances? The IMF’s view, broadlyspeaking, is that without excessive risk-taking by financialinstitutions, which was aided by the absence of regulation, imbalanceswould not by themselves have caused the meltdown. But equally, withoutthe flood of money seeking returns, the risky financial instrumentsthat the IMF is blaming for increasing systemic risk may not have grownand posed the risk that they did. Some blame the IMF’s policies duringthe Asian crisis for spurring countries in the region to build upenormous reserves. That may offer part of the explanation for why theFund has come down so strongly on one side of the debate. See this article with graphics and related items at http://www.economist.com/members/members.cfm?act=login&returnurl=%2Femail%2Femailafriend%2Ecfm%3Fstory%5Fid%3D13251429– COPYRIGHT –This e-mail message and Economist articles linked from it are copyright(c) 2009 The Economist Newspaper Group Limited. All rights reserved.http://www.economist.com/help/copy_general.cfm
A fantastic article to demonstrate the misguided actions of central banks today. This article “1819: America’s First Housing Bubble” http://mises.org/story/3395provides very useful information.
Yet another fantastic article by Mises Institute: http://mises.org/story/3487
It is very clear now that US has taken a very dangerous path and will be in very bad shape as it is forced to pay back up to 8 per cent of its GDP annually as debt in the coming years. Essentially it has chosen to become a banana republic. Expect US policies to radically shift a decade from now as its economy tanks like Zimbabwe’s with high inflation and unemployment.
Here’s an intriguing article the simply shrugs off the administered interest rates as a causal factor.
I’m making note of it here but will need to investigate this claim further when I get some time:
“How much have we learnt from the financial crisis: by Anatole Kaletsky, June 16, 2009, The Australian.
http://www.theaustralian.news.com.au/business/story/0,28124,25641592-30538,00.html