Shocking Lack of Oversight of the Federal Reserve

The first thorough audit of the Federal Reserve by the Government Accountability Office, revealed that between December 1, 2007 to July 21, 2010, the Federal Reserve provided $16.1 Trillion in secret loans to bail out American and Foreign banks! For a break down of the loans, scroll down to page 131 of the report. The key issue is that this occurred with a shocking lack of transparency and oversight. This is not only a question of political principles, but of economics, because the Federal Reserve's expansionary monetary policies of the past decade played a key role in the formation of the housing bubble, whose collapse played a key role in the severe economic downturn that we are now facing. And the Fed enabled politically connected financial firms to engage in the socialization of loss and the privatization of gain, which progressives and free market conservatives alike find deeply troubling.

While some (dubiously) argue that this massive intervention helped salvage the economy, the lack of transparency and oversight allowed for clear conflicts of interest that reek of outright corruption. For example, the CEO of JP Morgan Chase served on the New York Fed's board of directors at the same time that his bank received more than $390 billion in financial assistance! And in 2008, William Dudley, who is now the New York Fed President, was granted a waiver to allow him to keep investments in AIG and General Electric at the same time the said firms were being bailed out. In addition, the Fed outsourced virtually all of its emergency operations, mostly through no bid contracts, to politically connected corporations, such as JP Morgan and Morgan Chase. This is a clear example of the crony capitalism that we once though was confined to the sclerotic economics of the third world. 

I am in complete agreement with Bernie Sanders that "no agency of the United States government should be allowed to bailout a foreign bank or corporation without the direct approval of Congress and the president." Because of a complete lack of transparency, the risk that these loans posed to American Taxpayers and the economy as a whole was not known. Nor was it determined to what extent were these loans driven by foreign influence in the Federal Reserve, that may have also constituted a conflict of interest. 

On a broader level,  the expansionary monetary policies that occurred surely required open congressional debate and oversight. Nonpartisan economists, with no conflicts of interest should have informed the congress and the public at large of the potential costs and benefits, risks and rewards of such bold monetary actions, before they were undertaken.  For such policies run the risk of generating inflation, debasing the dollar and a host of other unintended consequences. Directors of the Federal Reserve argue that they acted within the powers granted to them by the Federal Reserve Act Of 1913. Hence, Dr. Ron Paul is correct, not only must we expand the audit of the Fed, but we must also reconsider its role as the steward of the American Economy. Progressives and conservatives alike should question the wisdom of placing vital monetary decisions in the hands of a quasi-governmental agency beset with cronyism and conflicts of interest. Why this is not on the front page of every American Newspaper speaks very poorly of the media, or perhaps of the American People, whose vigilance is vital in maintaining the integrity of the economic and political life of our republic.  

Saluting Bernie Sanders!

Holy cow, I agree with Senator Bernie Sanders (I - Vermont), a self styled "socialist democrat"! Although we differ on a vast array of topics, I admire Mr. Sanders for his commitment to promoting government transparency. This was demonstrated during a hearing in which he grilled Douche Vader (Ben Bernanke), pressing him to reveal which banks received $2.3 Trillion dollars from the Federal Reserve. To view the hearing, click on the following link:

http://www.youtube.com/watch?v=oOpQkRsEfaU

http://en.wikipedia.org/wiki/Bernie_Sanders

Meltdown by Thomas Woods

Awesome, insightful book by Thomas Woods that explores the role of the federal reserve in the economic crash. What is most important is not if you agree with his conclusions and recommendations, but if you at least explore the questions that he poses. To here a discussion on the book, click on the link:

http://www.youtube.com/watch?v=541bajR4k8g

Keynes You Can Believe In!

As most of my readers are aware, I am generally not a follower of the economic principles of John Maynard Keynes . However, I did come across some of his writings on inflation that I found insightful. He exhorted his reader on the economic and social damage caused when governments inflate the currency to help pay for unsustainable domestic and foreign adventures (welfare & warfare). According to Mr. Keynes, "profiteers" and "speculators" are not the cause of rising prices, rather they are the consequences of it.

In the case of the housing bubble, first the low interest rates and flood of loose credit generated by the Federal Reserve discouraged savings and encouraged prolific borrowing. And a combination of tax policies (deduction of interest paid on mortgages) and federal mandates (to increase home ownership in diverse communities) channeled this speculative energy towards the housing market. Once a price bubble is created, it becomes a self sustaining phenomena, growing as it attracts more and more capital and labor from productive segments of the economy, until a painful market correction occurs.

When the fiscal policies of regimes cause out of control inflation; speculation, hoarding, black markets and eventually bartering become the only means in which individuals can avoid losing their savings and livelihood. And when governments seek to curb inflation with price controls and heavy handed measures against "speculators", they only exacerbate the problems that they caused in the first place. And when prices are frozen by government mandates to ensure "affordability," shortages always ensue, Thankfully, for now, we are nowhere near that point.

In the coming year we should pay heed to Mr. Keynes' warnings about the adverse effects on foreign trade that occurs when a central bank debases the currency. Early in the Great Depression, trade wars erupted that heralded the near universal imposition of high tariffs, which impeded trade and economic recovery. If Mr. Keynes is correct, our government's conscience efforts to devalue the dollar may lead to a "devaluation war," which will weaken trade and the economic welfare of the United States and other nations. He must be rolling in his grave that epic fiscal irresponsibility and monetary mismanagement are being carried out in his name.

Keynes on Inflation

Excerpts from The Economic Consequences of the Peace by John Maynard Keynes, 1919. pp. 235-248.

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

In the latter stages of the war all the belligerent governments practiced, from necessity or incompetence, what a Bolshevist might have done from design. Even now, when the war is over, most of them continue out of weakness the same malpractices. But further, the governments of Europe, being many of them at this moment reckless in their methods as well as weak, seek to direct on to a class known as "profiteers" the popular indignation against the more obvious consequences of their vicious methods.

These "profiteers" are, broadly speaking, the entrepreneur class of capitalists, that is to say, the active and constructive element in the whole capitalist society, who in a period of rapidly rising prices cannot but get rich quick whether they wish it or desire it or not. If prices are continually rising, every trader who has purchased for stock or owns property and plant inevitably makes profits. By directing hatred against this class, therefore, the European governments are carrying a step further the fatal process which the subtle mind of Lenin had consciously conceived. The profiteers are a consequence and not a cause of rising prices. By combining a popular hatred of the class of entrepreneurs with the blow already given to social security by the violent and arbitrary disturbance of contract and of the established equilibrium of wealth which is the inevitable result of inflation, these governments are fast rendering impossible a continuance of the social and economic order of the 19th century. But they have no plan for replacing it....

The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent governments, unable or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance. In Russia and Austria-Hungary this process has reached a point where for the purposes of foreign trade the currency is practically valueless. The Polish mark can be bought for about [three cents] and the Austrian crown for less than [two cents], but they cannot be sold at all. The German mark is worth less than [four cents] on the exchanges....

But while these currencies enjoy a precarious value abroad, they have never entirely lost, not even in Russia, their purchasing power at home. A sentiment of trust in the legal money of the state is so deeply implanted in the citizens of all countries that they cannot but believe that some day this money must recover a part at least of its former value.... They do not apprehend that the real wealth, which this money might have stood for has been dissipated once and for all. This sentiment is supported by the various legal regulations with which the governments endeavor to control internal prices, and so to preserve some purchasing power for their legal tender....

The preservation of a spurious value for the currency, by the force of law expressed in the regulation of prices, contains in itself, however, the seeds of final economic decay, and soon dries up the sources of ultimate supply. If a man is compelled to exchange the fruits of his labors for paper which, as experience soon teaches him, he cannot use to purchase what he requires at a price comparable to that which he has received for his own products, he will keep his produce for himself, dispose of it to his friends and neighbors as a favor, or relax his efforts in producing it.

A system of compelling the exchange of commodities at what is not their real relative value not only relaxes production, but [also] leads finally to the waste and inefficiency of barter. If, however, a government refrains from regulation and allows matters to take their course, essential commodities soon attain a level of price out of the reach of all but the rich, the worthlessness of the money becomes apparent, and the fraud upon the public can be concealed no longer.

The effect on foreign trade of price-regulation and profiteer-hunting as cures for inflation is even worse. Whatever may be the case at home, the currency must soon reach its real level abroad, with the result that prices inside and outside the country lose their normal adjustment. The price of imported commodities, when converted at the current rate of exchange, is far in excess of the local price, so that many essential goods will not be imported at all by private agency, and must be provided by the government, which, in re-selling the goods below cost price, plunges thereby a little further into insolvency....

The note circulation of Germany is about 10 times what it was before the war. The value of the mark in terms of gold is about one-eighth of its former value....

It is a hazardous enterprise for a merchant or a manufacturer to purchase with a foreign credit material for which, when he has imported it or manufactured it, he will receive mark currency of a quite uncertain and possibly unrealizable value....

It may be the case, therefore, that a German merchant, careful of his future credit and reputation, who is actually offered a short-period credit in terms of sterling or dollars, may be reluctant and doubtful whether to accept it. He will owe sterling or dollars, but he will sell his product for marks, and his power, when the time comes, to turn these marks into the currency in which he has to repay his debt is entirely problematic. Business loses its genuine character and becomes no better than a speculation in the exchanges, the fluctuations in which entirely obliterate the normal profits of commerce....

Thus the menace of inflationism described above is not merely a product of the war, of which peace begins the cure. It is a continuing phenomenon of which the end is not yet in sight....

http://en.wikipedia.org/wiki/Keynes

http://en.wikipedia.org/wiki/Keynsian

The Austrian School of Economics

Pictured Above: The Great Ludwig Von Mises

I am not a strict adherent to the Austrian School of Economics and Ludwig Von Mises, because I recognize that their methodology poses some problems, however their explanation of the business cycle does seems to fit our current situation. As with any school of thought, it's worth exploring and integrating the more sound theoretical elements into your worldview and rejecting that which does not stand up to the tests of observation, experience and analysis.

Austrian economists focus on the amplifying, "wave-like" effects of the credit cycle as the primary cause of most business cycles. Austrian economists assert that inherently damaging and ineffective central bank policies are the predominant cause of most business cycles, as they tend to set "artificial" interest rates too low for too long, resulting in excessive credit creation, speculative "bubbles" and "artificially" low savings.[35]

According to the Austrian business cycle theory, the business cycle unfolds in the following way. Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable "monetary boom" during which the "artificially stimulated" borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas which would not attract investment if the money supply remained stable.

Austrian economists argue that a correction or "credit crunch" – commonly called a "recession" or "bust" – occurs when credit creation cannot be sustained. They claim that the money supply suddenly and sharply contracts when markets finally "clear", causing resources to be reallocated back towards more efficient uses.

http://en.wikipedia.org/wiki/Ludwig_Von_Mises

http://en.wikipedia.org/wiki/Austrian_school

Quantitative Easing Explained

http://www.youtube.com/watch?v=PTUY16CkS-k

David Stockman - This Man Makes Sense!

David Stockman was the Director of the Office of Management And Budget, until he resigned in 1985, owing to his concerns about mounting national debt brought on by the Reagan Administration's failure to match its tax cuts with equal cuts in spending. Stockman is an independent minded fiscal conservative who has spoken out against the Bush Tax Cuts, as well as the out of control spending of the Obama Administration. His critique of the Federal Reserve is most insightful, especially regarding the erosion of its independence and the danger of the latest round of quantitative easing. He stated "I think the Fed is injecting high grade monetary heroin into the financial system and one of these days it's going to kill the patient."

http://www.youtube.com/watch?v=2lVDS9hwKs0

On the Limits of Central Banks...

As most of you are aware, the Federal Reserve has been granted an enormous amount of power and resources to pursue the recovery of the American economy. Under the Bush and Obama administrations they have spent trillions of dollars with little to show. In theory, a powerful central bank could be exercised for the benefit of the people, but like most examples of having the state seek to command the economy, it is limited by the competency and corruption of its administrators. Nowhere is this better demonstrated than in a public hearing in which the federal reserve inspector general is questioned where trillions of dollars spent by the federal reserve have gone:

http://www.youtube.com/watch?v=cJqM2tFOxLQ

Federal Reserve Cannot Account For $9 Trillion

By Gold Investments on May 14, 2009

Rep. Alan Grayson talks to the Federal Reserve Inspector General Elizabeth Coleman of the Federal Reserve, asking her questions regarding trillions of dollars that came from the Fed’s expanded balance sheet and what the losses on its $2 trillion portfolio are.

The Inspector General does not have the answers Grayson is looking for.

Grayson asked Coleman if her agency had done any research into the decision not to save Lehman Brothers, which “sent shockwaves through the entire financial system,” Coleman said it had not.

“What about the $1 trillion plus expansion of the Federal reserve’s balance sheet since last September?” Grayson asked.

“We have different connotations,” Coleman replied. “We’re actually conducting a fairly high-level review of the various lending facilities collectively.”

Translation: Nobody at the Fed knows where the money went.

Do you know what who got the $1 trillion or more in the Fed’s expansion of its balance, Grayson pressed.

“I do not know. We have not looked at this specific area at the particular point on that specific review,” Coleman answer.

What about the trillions of off-balance transactions since last September, Grayson asked.

Coleman demurred again, saying the IG does not have jurisdiction to audit the Federal Reserve.

Grayson pointed out that it was the inspector general’s job to audit such spending and asked again if the office had done any investigation at all.

Coleman’s answer: Not enough yet to even respond. “We are in not a position to say if there losses.”

Grayson concluded, “I am shocked to find out that nobody at the Federal Reserve, including the inspector general, is keeping track of this.”

http://www.dailymarkets.com/economy/2009/05/14/federal-reserve-cannot-account-for-9-trillion/

Bernanke Anagram

Bernanke means "Butthole Economists Reject Needed Authorization, Kleptocracy Expands"

Unnatural Disaster

Thomas E. Woods


Thomas E. Woods puts forth a compelling explanation of economic booms and busts that emphasizes the role of the Federal Reserve's command of interest rate in producing irrational economic activity. After reading his works no one with intellectual honesty can explain our current economic downturn as primarily stemming from the "free market" or "unfettered capitalism."

Unnatural Disaster

How the Fed creates booms and busts

By Thomas E. Woods Jr.

We accept as a fact of economic life that plush times inevitably give way to lean times. Just as the moon waxes and wanes, the economy goes through booms and busts.

Median home price increased by 150 percent from August 1998 to August 2006. Over the next two years, home prices fell by 23 percent. Foreclosures skyrocketed.

The stock market has followed a similar course. When the New York Stock Exchange closed on Oct. 9, 2007, the Dow was 14,164.53, the highest close ever. Thirteen months later, it closed at 7,552.29, a drop of 46.7 percent. Retirement portfolios have been eviscerated. Unemployment has increased. When the figures are compiled the way government calculated them in the 1970s, the unemployment rate in November 2008 was 16.7 percent.

These personal dimensions of busts are used to justify government intervention, whether creating a safety net or drawing up regulations aimed at smoothing out the cycle supposedly inherent in the free market. But is this inevitable? Is the market economy really prone to sudden, inexplicable episodes of massive business error—or could something outside the market be causing it?

If politicians are honest in seeking a culprit, they will find that it’s not capitalism. It’s not greed. It’s not deregulation. It’s an institution created by government itself.

No one is surprised when a business has to close. Entrepreneurs may have miscalculated costs of production, failed to anticipate patterns of consumer tastes, or underestimated resources necessary to comply with ever-changing government regulation. But when many businesses have to close at once, that should surprise us. The market gradually weeds out those who do a poor job as stewards of capital and forecasters of demand. So why should businessmen, even those who have passed the market test year after year, suddenly all make the same kind of error?

Economist Lionel Robbins argued that this “cluster of errors” demanded an explanation: “Why should the leaders of business in the various industries producing producers’ goods make errors of judgment at the same time and in the same direction?” We call this pattern of apparent prosperity followed by general depression the business cycle, the trade cycle, or the boom-bust cycle. Does it have a cause, or is it, as Marx argued, an inherent feature of the market economy?

F.A. Hayek won the Nobel Prize in economics for a theory of the business cycle that holds great explanatory power—especially in light of the current financial crisis, which so many economists have been at a loss to explain. Hayek’s work, which builds on a theory developed by Ludwig von Mises, finds the root of the boom-bust cycle in the central bank—in our case the Federal Reserve System, the very institution that postures as the protector of the economy and the source of relief from business cycles.

Looking at the money supply makes sense when searching for the root of an economy-wide problem, for money is the one thing present in all corners of the market, as Robbins pointed out in his 1934 book, The Great Depression. “Is it not probable,” he asked, “that disturbances affecting many lines of industry at once will be found to have monetary causes?”

In particular, the culprit turns out to be the central bank’s interference with interest rates. Interest rates are like a price. Lending capital is a good, and you pay a price to borrow it. When you put money in a savings account or buy a bond, you are the lender, and the interest rate you earn is the price you are paid for your money.

As with all goods, the supply and demand for lending capital determines the price. If more families are saving or more banks are lending, borrowers don’t have to pay as much to borrow, and interest rates go down. If there’s a rush to borrow or a dearth of lending capital, interest rates go up.

There are some results of this dynamic that contribute to a healthy economy. Start with the case where people are saving more, thus increasing the supply of lending capital and lowering interest rates. Businesses respond by engaging in projects aimed at increasing their productive capacity in the future—expanding facilities or acquiring new capital equipment.

Also consider the saver’s perspective. Saving indicates a lower desire to consume in the present. This is another incentive for businesses to invest in the future rather than produce and sell things now. On the other hand, if people possess an intense desire to consume right now, they will save less, making it less affordable for businesses to carry out long-term projects. But the big supply of consumer dollars makes it a good time to produce and sell.

Thus the interest rate coordinates production across time. It ensures a compatible mix of market forces: if people want to consume now, businesses respond accordingly; if people want to consume in the future, businesses allocate resources to satisfy that desire. The interest rate can perform this coordinating function only if it is allowed to move freely in response to changes in supply and demand. If the Fed manipulates the interest rate, we should not be surprised by discoordination on a massive scale.

But suppose the Fed lowers rates so that they no longer reflect the true state of consumer demand and economic conditions. Artificially low interest rates mislead investors into thinking that now is a good time to invest in long-term projects. But the public has indicated no intention to postpone consumption and free up resources that firms can devote to those developments. On the contrary, the lower interest rates encourage them to save less and consume more. So even if some of these projects can be finished, with the public’s saving relatively low, the necessary purchasing power won’t be around later, when businesses hope to cash in on their investments.

And as a company works toward completing its projects under these conditions, it will find that the resources it needs—labor, materials, replacement parts—are not available in sufficient quantities. The prices will therefore be higher, and firms will need to borrow to finance these unanticipated increases in input prices. This increased demand for borrowing will raise the interest rate. Reality now begins to set in: some of these projects cannot be completed.

Moreover, the kind of projects that are started differ from those that would have been started on the free market. Mises draws an analogy between an economy under the influence of artificially low interest rates and a homebuilder who believes he has more resources—more bricks, say—than he really does. He will build a house much different than he would have chosen if he had known his true supply of bricks. But he will not be able to complete this larger house, so the sooner he discovers his true brick supply the better, for then he can adjust his production plans before too many of his resources are squandered. If he only finds out in the final stages, he will have to destroy everything but the foundation, and will be poorer for his malinvestment.

In the short run, the result of the central bank’s lowering of interest rates is the apparent prosperity of the boom period. Stocks and real estate shoot up. New construction is everywhere, businesses are expanding, people are enjoying a high standard of living. But the economy is on a sugar high, and reality inevitably sets in. Some of these investments will prove unsustainable.

That is one of the reasons the Fed cannot simply pump more credit into the economy and keep the boom going. Yet the economist John Maynard Keynes—back in fashion even though his system collapsed in the early 1970s when it couldn’t account for stagflation—proposed exactly this: “The remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and keeping us permanently in a quasi-boom.”

Keynes was dealing in fantasy. The more the Fed inflates, the worse the reckoning will be. Every new wave of artificial credit deforms the capital structure further, making the inevitable bust more severe because so much more capital will have been squandered and so many more resources misallocated.

As it becomes clear that so much of the boom is unsustainable, pressure builds for liquidation of malinvestments. The misdirected capital, if salvageable, needs to be freed up. Should the Fed ignore this and simply carry on inflating the money supply, Mises warned, it runs the risk of hyperinflation, a severe, galloping inflation that destroys the currency unit.

Writing during the Great Depression, Hayek scolded those who thought they could inflate their way out of the disaster:

Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion. …

To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection—a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end. … It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression.

Although painful, the recession or depression phase of the cycle is not where the damage is done. The bust is the period in which the economy sloughs off the capital misallocation, re-establishes the structure of production along sustainable lines, and restores itself to health. The damage is done during the boom phase, the period of false prosperity. It is then that the artificial lowering of interest rates causes the misdirection of capital and the initiation of unsustainable investments. It is then that resources that would genuinely have satisfied consumer demand are diverted into projects that make sense only in light of artificial conditions. For the mistaken bricklayer, the damage wasn’t done when he tore down the large house he couldn’t complete; the damage was done when he laid the bricks too broadly.

Investment adviser Peter Schiff draws an analogy between an artificial boom and a circus that comes to town for a few weeks. When the circus arrives, its performers and the crowds it attracts patronize local businesses. Now suppose a restaurant owner mistakenly concludes that this boom will endure and responds by building an addition. As soon as the circus leaves town, he finds he has tragically miscalculated.

Does it make sense to inflate this poor businessman’s way out of his predicament? Creating new money doesn’t create any new stuff, so lending him newly created money merely allows him to draw more of the economy’s resource pool to himself, at the expense of genuine businesses that cater to real consumer wishes. This restaurant is a bubble activity that can survive only under the phony conditions of the circus boom. It needs to come to an end so that the resources it employs can be reallocated to more sensible lines of production.

One more point is important to remember: all firms are affected by the artificial boom, not just those that embarked on new projects or came into existence thanks to artificially cheap credit. Mises observed, “in order to continue production on the enlarged scale brought about by the expansion of credit, all entrepreneurs, those who did expand their activities no less than those who produce only within the limits in which they produced previously, need additional funds as the costs of production are now higher.”

Notice that the precipitating factor has nothing to do with the market economy. It is the government’s policy of pushing interest rates below the level at which the free market would have set them. The central bank is a government institution, established by government legislation, whose personnel are appointed by government, and which enjoys government-granted monopoly privileges. It bears repeating: the central bank’s interventions into the economy give rise to the business cycle, and the central bank is not a free-market institution.

But why can’t businessmen simply learn to distinguish between low interest rates that reflect an increase in genuine savings and low interest rates that reflect nothing more than Fed manipulation? Why do they not avoid expanding when the Fed ignites an artificial boom?

It is not so easy. Even businessmen who know that the Fed is keeping interest rates artificially low may still find it in their interest to borrow and launch new projects, hoping they can get out before the bust hits. If they do not react to the lower rates, their competitors surely will and might be able to gain market share at their expense. Someone will take the bait.

This does not, and is not intended to, account for the length of a depression. It is a theory of the artificial boom, which culminates in the bust. The bust period is longer the more government prevents the economy from reallocating labor and capital into a sustainable pattern of production. Government interference, in the form of wage or price controls, emergency lending, additional liquidity, or further monetary inflation—all aimed at diminishing short-term pain—exacerbate long-term agony. Malinvestments need to be discontinued and liquidated, not encouraged and subsidized, if the economy’s capital structure is to return to a sustainable condition.

There will always be those who, not understanding the situation, will call for more and greater monetary injections to try to keep the boom going, and their number has skyrocketed since the fall of 2008. In mid-December, the Fed set its federal-funds target at 0 to 0.25 percent, the Keynesian dream. Blinded by the same folly, Bank of England governor Mervyn King said he was ready to reduce rates to “whatever level is necessary,” including as low as zero—a move sure to perpetuate the misallocations of the boom and set the state for a far worse crisis.

Keynesian “pump priming,” whereby governments fund public-works projects, often financed by deficits, are another destructive if inexplicably fashionable course of action, based on the modern superstition that the very act of spending is the path to economic health. Take from the economy as a whole and pour resources into particular sectors: that should make us rich! Economic historian Robert Higgs compared plans like these to taking water from the deep end of a pool, pouring it into the shallow end, and expecting the water level to rise.

Additional public-works spending not only deprives the private sector of resources by taxing people to support these projects, it diverts resources toward firms that may need to be liquidated and drives up interest rates if the projects are funded by government borrowing, thereby making bank credit tighter for private firms. These projects are the very opposite of what the fragile bust economy calls for. It needs to shift resources swiftly into the production of goods in line with consumer demand, with as little resource waste as possible. Government, on the other hand, has no way of knowing how much of something to produce, using what materials and production methods. Private firms use a profit-and-loss test to gauge how well they are meeting consumer needs. If they make profits, the market has ratified their production decisions. If they post losses, they have squandered resources that could have been more effectively employed on behalf of consumer welfare elsewhere in the economy. Government has no such feedback mechanism since it acquires its resources not through voluntary means but through seizure from the citizens, and no one can choose not to buy what it produces. These projects squander wealth at a time of falling living standards and a need for the greatest possible efficiency with existing resources.

Neither can the state seem to resist the temptation to extend emergency credit to failing businesses. If their positions were sound, credit would be forthcoming from the private sector. If not, then they should go out of business, freeing up resources to be used by more capable stewards. Diverting resources from those who have successfully met consumer demands to those who have not serves only to weaken the economy and make recovery that much more difficult.

One argument has it that economic bubbles, sectors of the economy in which prices are artificially high, are caused by psychological factors that lead people to become irrationally committed to the production of particular kinds of goods. Such explanations may play a role in determining exactly which path the business cycle will take and which assets will be overvalued, but they cannot by themselves explain the bubble economy. Manias may steer overinvestment in one direction or another, but it’s the Federal Reserve pressing the accelerator.

Mises reminds us that a sudden drive for a particular kind of investment will raise the prices of complementary factors of production as well as the interest rate itself. For a mania-driven boom to persist, there has to be an increasing supply of credit to fund it, since investments in that sector would grow steadily more costly over time. This could not occur in the absence of credit expansion.

The best way to avoid bursting economic bubbles and to clean up the wreckage caused by artificial booms is to not initiate artificial booms in the first place. This would mean abandoning our superstitions about the expertise of Fed officials and their ability to manage our monetary system. But it’s about time we listened to people who have a coherent theory to explain why these crises occur, saw this crisis coming, and have something to suggest other than juvenile fantasies about spending and inflating our way to prosperity. The choice is stark: we can follow the suggestions that prolonged the Great Depression or we can try a different approach that actually accounts for what is happening.

That would be change we can believe in.

http://www.amconmag.com/article/2009/mar/09/00012/

Speculation on Banking Behavior

I recently spoke with a very astute and insightful friend of mine who has successfully invested in real estate for over 20 years. The topic of discussion was the seemingly strange behavior of banks. In particular, the questions were explored were:

1. Why are so many banks (that are financially sound) so reserved about loaning money to credit worthy, collateral rich individuals? We even know of landlords with 750 credit and solid income who cannot get a moderate line of credit.

2. Why are so many banks so reserved about negotiating with property owners who are on the verge of foreclosure. In particular, an associate of mine merely required a 3 month suspension of his mortgage to repair and rent his property, thus making his investment portfolio cash flow positive. This would have allowed him to catch up with mortgage and avoid foreclosure. Rather than undertake this strategic act of goodwill, the bank foreclosed on his severely depreciated property. The end result was that the bank had foregone a $600,000 loan and gained no more that $250,000 of property, a loss of $350,000 for the bank.

My friend pointed out that in the last 5 months the Federal Reserve more than doubled the money supply, which will inevitably lead to a spike in inflation. Inflation decreases the value of money, so it's hazards are felt heaviest by those who saved money and those who issued loans. Think of it like this: a landlord takes out a line of credit for $10,000 in 2009 dollars. And let's say by 2012 inflation lowers the real value of the dollar by 50%, which the landlord uses to pay back the bank. In effect inflation has wiped out half of the debt, initially to the bank's disadvantage.

So, perhaps one of the reasons why banks are so reserved about issuing new loans is that they anticipate a spike in inflation. In regards to the foreclosures, perhaps they anticipate that the value of repossessed property will increase while the value of the loan will decrease via inflation. Of course this is purely speculative, but it is worth considering. But what is clear and indisputable is the economic, political and social hazards of inflation.

http://www.freerepublic.com/focus/news/2199307/posts

A Wolf Shall Guard The Sheep?

Obama is pushing to grant sweeping authority to the Federal Reserve to regulate, restructure and even seize companies. While legitimate arguments can be made about the need for greater oversight of the financial system, the left and right alike should be deeply troubled about any proposals that greatly expands the power of the Fed.

To begin with, the Fed is not a disinterested party, it is a semi-private company whose stock is owned by member banks. So, there is a clear risk that the regulatory and confiscatory actions of these banks would be driven by self interest, not by public interest. This is an especial troubling prospect because it can be said that these very banks and the Fed itself played a major role in the unfolding of our current economic debacle. And at the very least this represents even greater collusion between the federal government and connected corporate interests - something that should be especially troubling to the left.

A frequent criticism of the Fed is that it lacks openness and transparency, so much so that bi-partisan efforts have emerged to audit the Fed and grant the government greater oversight over its actions. So, at the risk of engaging in hyperbole, Obama is asking a wolf to guard the sheep.

Not Everyone Is Cheering Fed's New Role

JUNE 18, 2009

By SUDEEP REDDY

WASHINGTON -- The Federal Reserve would become the nation's most powerful financial overseer, an approach that is becoming a flashpoint as lawmakers and consumer groups attack the central bank for its role in creating and handling the financial crisis.

The proposal, if passed into law, would represent one of the biggest changes ever in the Fed's role. The central bank would win power to monitor risks across the financial system, and sweeping authority to examine any firm that could threaten financial stability, even if the Fed wouldn't normally supervise the institution. The nation's biggest and most interconnected firms would be subject to heightened oversight by the central bank.

President Obama said the plan would ensure "that lines of responsibility and accountability are clear" by placing authority in the Fed's hands.

Critics who wonder about the wisdom of the move say the Fed failed to use its authority to address loose lending practices and the housing bubble that pushed the U.S. into a recession. The Fed responded aggressively after the crisis began, but some argue those actions were overly secretive.

A movement is spreading in Congress to force the Fed to disclose the identity of institutions that borrow from the bank, a move officials say would discourage firms from seeking needed emergency funds. A large group of House members is pushing to audit the Fed.

"I don't have a lot of faith in the Fed being able to handle that big a universe," said John Taylor, president of the National Community Reinvestment Coalition, a group of 600 community organizations.

Senate Banking Chairman Christopher Dodd (D., Conn.) and House Financial Services Chairman Barney Frank (D., Mass.) both said Wednesday the Fed's role is the biggest potential source of friction in the plan.

Mr. Dodd said there is well-founded concern the Fed's responsibility for monetary policy, including setting interest rates, could conflict with its role monitoring systemic risk. Fed officials have said they can handle multiple responsibilities. "There's not a lot of confidence in the Fed at this point, and I'm stating the obvious," Mr. Dodd said.

Mr. Frank said most of Mr. Obama's proposals reflect a broad consensus on Capitol Hill. But "the interplay between the Fed and the rest of the regulators on systemic risk" will be a thorny issue.
Some lawmakers want an interagency council, another feature of the plan, to have greater responsibility for systemic risk, and the authority to act. Obama administration officials believe a committee approach would allow problems at financial institutions to fester without a clear regulator responsible for addressing them.

"How much power the Fed is going to have is going to be probably one of the most controversial issues about this plan," said Robert Litan, a senior fellow at the Brookings Institution. He said he thinks the Fed's role in the new regulatory framework is likely to be changed by lawmakers.

Treasury Secretary Timothy Geithner reiterated the administration's determination to make the Fed the systemic regulator. "I do not believe there is a plausible alternative," he told reporters.

Fed officials said they took action throughout the financial crisis because the central bank was often the only institution with the power to prevent turmoil. The regulatory overhaul would provide a mechanism for the government to unwind failing nonbank financial institutions, freeing the Fed of the need to act. The central bank has also taken steps to release details about its lending programs.

Despite a major conceptual change in the Fed's role, central bank officials believe perhaps only a handful of additional firms would fall under their supervision. They are also expected to make a case to keep the Fed's consumer-protection responsibility -- with some tweaks -- instead of giving up that role entirely, as envisioned under the plan.

The regulatory overhaul proposed by the Bush administration last year also would have given the Fed responsibility for financial stability. But that plan would have removed its role of supervising banks. Fed officials quietly objected, saying it would be hard to guard against systemic risks without also performing routine bank examinations. The proposal gained little traction amid an escalating financial crisis.

The Obama proposal would require the central bank to seek approval from the Treasury secretary before invoking emergency lending powers. It also calls for the Fed to work with the Treasury and outside experts to review the Fed's structure and governance, including the role of the regional Fed banks. A report due by Oct. 1 would be used to propose changes to the Fed's structure "to improve its accountability and its capacity to achieve its statutory responsibilities."
—Jonathan Weisman and Damian Paletta contributed to this article.

http://online.wsj.com/article/SB124525004449623489.html

Distribution of Wealth (Part VI)

One factor that I have neglected to mention is inflation.

Over time wages have risen, but the problem for many workers is that wages increases have not kept up with the rise in prices. Milton Friedman and many other economist are correct that the burden of inflation usually falls heaviest on the poor and middle class. Furthermore, inflation discourages savings and production and encourages people to place their capital in high return, speculative ventures, all of which contributes to the increasingly unequal distribution of wealth.

Without a doubt the main culprit of inflation is the federal government via the expansive monetary policy it uses to fund its massive growth.

Ben Bernanke Refuses Transparency

http://www.youtube.com/watch?v=kUJIG3JNPk0

Inflation is on the Way

Children of the Weimar Republic stacking

Deutsche Marks rendered worthless through hyper-inflation.

Scroll down to view Glenn Beck's video in which he correctly points out that the Fed is greatly increasing the money supply, which will herald future inflation.

We will not see inflation for the time being, because of the drop in demand for goods and services related to the economic downturn. But, I am confident that Obama has laid the monetary foundation for major post-recession inflation.

Inflation not only is economically damaging, but it engenders political and social turmoil. In fact, most modern revolutions, from the bolsheviks in Russia, to the nazis in Germany and the coup against Allende, were preceded by acute inflation.

http://www.youtube.com/watch?v=lNS8IY_Td14

Crazy Talk from a Wacky Radical!

Here is some crazy talk that wacky radical Ron Paul (excerpts from his speech before a senate hearing on Fannie Mae and Freddie Mac) dating from September 2003:

Today, I will introduce the Free Housing Market Enhancement Act, which removes government subsidies from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the National Home Loan Bank Board.

This explicit promise by the Treasury to bail out GSEs in times of economic difficulty helps the GSEs attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital.

More importantly, the line of credit is a promise on behalf of the government to engage in a huge unconstitutional and immoral income transfer from working Americans to holders of GSE debt.

The connection between the GSEs and the government helps isolate the GSE management from market discipline. This isolation from market discipline is the root cause of the recent reports of mismanagement occurring at Fannie and Freddie. After all, if Fannie and Freddie were not underwritten by the federal government, investors would demand Fannie and Freddie provide assurance that they follow accepted management and accounting practices.

Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.

Despite the long-term damage to the economy inflicted by the government's interference in the housing market, the government's policy of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary, but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.

No less an authority than Federal Reserve Chairman Alan Greenspan has expressed concern that government subsidies provided to GSEs make investors underestimate the risk of investing in Fannie Mae and Freddie Mac.

Mr. Chairman, I would like to once again thank the Financial Services Committee for holding this hearing. I would also like to thank Secretaries Snow and Martinez for their presence here today. I hope today's hearing sheds light on how special privileges granted to GSEs distort the housing market and endanger American taxpayers. Congress should act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors who were misled by foolish government interference in the market. I therefore hope this committee will soon stand up for American taxpayers and investors by acting on my Free Housing Market Enhancement Act.

For the full transcript from Dr. Paul's speech:

http://www.lewrockwell.com/paul/paul128.html

Let's Counterfeit!

Economists are universally opposed to counterfeiting because it degrades the value and decreases confidence in a currency and causes inflation through the increase of the money supply. And history has shown that inflation is harmful because it erodes the purchasing power primarily of the working class and erodes any incentive to save and invest money. But, our savior Obama has decided to continue Bush's expansion of the money supply via the printing press, to help pay for his endless expansion of government programs.

So, I say if counterfeiting is good enough for our savior, it's good enough for us. Why bother expanding and improving production and human capital, when each American can end the recession by creating and spending counterfeit money. And when massive inflation occurs we can buy wheelbarrows to cart around money, like they do in Zimbabwe, which will of course stimulate our wheelbarrow industry. So write to Barack Obama and Ben Bernanke asking them to send you a printing press, so you can do your part to help foster change we can believe in!

http://www.brookesnews.com/082912obamanomics.html

http://www.theaustralian.news.com.au/story/0,25197,24949763-7583,00.html