Tuesday, January 6, 2009

Controlling monetary levels

2 articles in FT today touch upon the same topic from different angles. I have been talking about monetary levels since the August 07 panic.

First article argues for control of debt levels by central banks. The invisible hand did make a mess of things because the investment banks and their hedge fudge clients only had interest in increasing leverage taking too much risk and reaping the rewards of taxing the flow, and when it blows up, you blow up. Reader Arthur B calls this asymetric risk. The great depression saw the introduction of legislation limiting the leverage and fraction the commercial banks could have between debt and capital/deposit. Investment banks were, unfortunately, free of that constraint. They went up to 50x leverage. 10 is not enough, 50 is too much, it doesn't take a genius to say "so what about 35 for the ibanks, 2 for the hedge funds?" Controlling debt levels is the key, as when it goes in reverse it WILL kill capital. Too much debtism kills capitalism. By the same token, uncovered CDS, or speculative CDS where you do not own the underlying bond should be banned: it demultiplies the effect of bad debt, and this is systemically dangerous as it increases the debt levels in the case of default.

The second article is a gold-bugs dream. The gist is simple, under fiat money politicians and bankers, the unholy pair, will print themselves money to get out of trouble. It is called quantitative equilibrium right now in the US. Gold prevents this as the government cannot create gold. Hard money proponents distrust governments but forget as reader Army Nova reminded us taxes on wealth had to be raised to 90% during the depression. Before taxes reach 90%, I will be long gone. Reader barry kelly also pointed out that fractional banking still exists under gold. Me, gold-bugs piss me off, sound money can be achieved with sound government, so gold bugs are by definition wary of any form of government and are usually libertarians or anarchists.

I want to be more optimistic. Articles like this one, in a publication like the FT just piss me off. There is one reason gold was abandoned: Keynes and depression economics. At the end of the day it is about money levels, through debt creation in the system. It should be transparently regulated and this is what both articles really talk about: the need for sound money.


Anonymous said...

Money sufficient to fuel commerce = balanced, but how to grow?

Money insufficient to fuel commerce = deflation occurs as money is scarce, value increase. Growth difficult.

Money in surplus = inflation, plus growth.

Money in overwhelming surplus = 2002-2007.. economy goes haywire.

So where are we now? With the Fed 'buying' assets, even if bogus - is that creating 'money' or balance sheet legerdemain?

Love your blog, enjoy very much the commentary that you & your wife both share. Thanks for effort and time you put into it. Warm regards from Northern California. Wish I was in Madrid.

Marcf said...

Hey anon,

thanks for the kind words.

I believe there can be a better equilibrium of money/inflation/growth. To me, most of the increase in housing prices was nothing but inflation. I have this theory that if you look at DOW in linear mode (not exp) you see these 2 humps in the growth representing money inflows, not real growth. Real growth was linear, which would sound about right for a mature economy. Ping me when you are in Madrid :)

Arthur B. said...

There is one reason gold was abandoned: Keynes and depression economics

Gold was abandoned under Nixon, in 1971 by severing the link between the dollar and gold.

What happened in 1933 was that the government confiscated the gold, giving people paper dollars. This was achieved using special presidential power granted during WWI, the "War Time Powers Act" of 1917.

The purpose was not to enter a Keynesian paradise or to apply depression economics, but to prevent a run on the banks and ultimately the federal reserve, which would have severed the government control on money.

This is a fact, this is what they acknowledged they were doing. You do not need to be a libertarian or an anarchist to see that this is fundamentally wrong.

The day the government produces good money, it will not need to outlaw competition.

Marcf said...

Yes, the free banking thing... I am still thinking through that. It seems a little flimsy... like ripe for abuse and scams.

Arthur B. said...

It is indeed susceptible to scams, but so is government's handling of money.

The alternative is imperfect markets Vs imperfect government, not imperfect markets vs perfect government.

That being said, the consequences of a few scams are tame in comparison to the catastrophes brought by the printing press.

A big fish like Madoff took 50B, a world record. Leeson brought down Barrings down for a couple of Billion. Now compare that to other world records, like Zimbabwe inflation who brought cholera epidemics and widespread famine or Weimar inflation which helped Hitler rise to power.