Wednesday, September 17, 2008

In case you don't read this all the way to the bottom, here's the conclusion

From The Fed Should Inflate to End the Financial Crisis? It Just Ain't So!
By Ivan Pongracic, Jr.

It's not surprising that Wall Street wants to be bailed out through inflation. They would receive the benefits of the increased liquidity while the rest of us would bear the costs. Their profits would remain private while their losses would be socialized and spread out among the rest of the society through inflation. It is exactly this kind of policy that contributed to the current mess. In 1998 the Long-Term Capital Management hedge fund was deemed “too big to fail” and was bailed out. In the process, the Fed created a severe moral hazard: by protecting some people from the downside of their risky actions, the central bank encouraged such actions. The Fed's bailout policy is at least partly responsible for the Wall Street excesses; the hedge funds came to expect that the Fed would not chance a failure of the financial system. The so-called “Greenspan put” is now clearly the “Bernanke put.”

Yeah, I never heard it called that before either.
If the Fed continues to inflate, as Makin recommends, it would simply postpone the day of reckoning. Rather than letting the bad investments be cleared out now, reflation would further distort relative prices, likely leading to significant errors down the road and more bubbles in other sectors (as may already be happening in the commodities markets). This is how one crisis begets a bigger one. We must allow the distortions introduced by the activist Fed to be discovered and corrected. The odds that the government will eventually nationalize the mortgage markets will be much higher if the current crisis is treated by planting the seeds for a much bigger one in the future.

Pongracic also wrote a review of Mark Skousen's Vienna & Chicago: Friends or Foes?, A Tale of Two Schools of Free-Market Economics which he titled Methodenstreit Comix
Just so that we are clear here — readers, please forgive the tedium — praxeology does not mean that the economist does no historical research. It means that theory itself is not generated and proven by means of historical studies. Theory is employed to understand history, and history to illuminate theory. (See Mises's Theory and History.) Doing history without theory answers no questions about causation, and ends in intellectual chaos. And although Skousen himself admits that empirical evidence can go awry, he proclaims at the end of the chapter that Chicago is the winner of the methodological dispute.


Worth mentioning is the chapter on gold and fiat money. After a rather thorough discussion about the pluses and minuses of the fractional reserve system, after declaring gold and silver "as honest money," Skousen seemed like he was going to pronounce the Austrians as winners. I became suspicious, however, when Skousen attacked Rothbard's The Case Against the Fed as too radical. The Fed, according to Skousen, cannot be that bad. After all, the Fed is a part of a serious system. "And most importantly, Fed actions are graded every day in the stock, bond and foreign currency market."

Is Skousen really that na├»ve? The Fed under the Greenspan leadership has been anything but graded in the financial market. It has been behaving like there is no tomorrow. There is now an increasing number of financial experts calling Greenspan the worst Fed chief ever. According to these individuals, Greenspan intentionally created a bubble over the last decade — several bubbles — that can only end in catastrophe. Preaching deregulation, he created a mountain of bad debt that will create a mountain of bankruptcies and a runaway inflation, with a high possibility of a deep recession, or even worse.

This review was written in 2005, not yesterday. Read the whole thing.

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