Sunday, March 1, 2009

Boom, Bust

"The world has gone from the greatest synchronized boom in history to the first synchronized global bust since the Great Depression. How we got here is not a cautionary tale of free markets gone wild. Rather, it's the story of what can happen when governments ignore market signals and central bankers believe in endless booms. ... But the interest rates during this time [2004 to 2006] continuously lagged behind nominal GDP growth as well as cost of living increases, the Fed never truly implemented tight monetary policies. Indeed, total credit increased in the U.S. from an annual growth rate of 7% in the June 2004 quarter to over 16% in early 2007. It grew five times faster than nominal GDP between 2001 and 2007. The complete mispricing of money, combined with a cornucopia of financial innovations, led to the housing boom and allowed buyers to purchase homes with no down payments and homeowners to refinance their existing mortgages. ... Consequently the U.S. trade and current-account deficit expanded--the latter from 2% of GDP in 1998 to 7% in 2006, thus feeding the world with approximately $800 billion in excess liquidity that year. When American consumption began to boom on the back of the housing bubble, the explosion of imports into the U.S. were largely provided by China and other Asian countries. ... Another unique feature of this synchronized boom was that nearly all asset prices skyrockected around the world--real estate, equities, commodities, art even bonds. ... Sadly, government policy responses--not only in the U.S.--are plainly wrong. It is not that the free market failed. The mistake was constant intervention in the free market by the Fed and the U.S. Treasury that addressed symptoms and postponed problems instead of solving them", Marc Faber, WSJ, 18 February 2009, link:

I agree with Faber. Net, the Fed creates more problems than it solves. Milton Friedman said that about 40 years ago.


Anonymous said...

IA... I forget what the purpose of the Fed is? Is it making profits for the primary dealers and owner banks?

Printfaster said...

Until federal debt is limited to currency in circulation, the result will be major boom and bust cycles.

The fed's job is to constrain currency in circulation to prevent the dollar from collapsing, and at the same time allow the federal debt to float in the private credit markets.

If federal debt were not allowed as bank reserves -- I do not believe that federal debt is a suitable asset -- federal debt would not disintermediate private debt. Federal debt should be limited to being a private asset. After all, these same people will need to be taxed to pay back the debt. Look at WWII bonds and the like.

It is this schizophrenic role of pushing federal debt into the private credit markets, and trying to keep private debt from collapsing that creates booms and busts.