I’ve finished Manias, Panics, and Crashes, 5th edition. Some thoughts in addition to my previous ones (here and here). p. 55:
The Kipper- und Wipperzeit [according to Wikipedia, translates to tipper and see-saw time] of 1619-1623…got its name from the action of money-changers who took the debased coins that were coming from the rising number of princely mints and rigged their scales as they sought to exchange bad money for good with naive peasants, shopkeepers, and craftsmen. Rapidly rising debasement spread from state to state until the coins used in daily transactions became worthless.
Will that turn out to be a metaphor for contemporary government behavior?
More CPK below the fold.
p. 206:
One feature of many liquidity crises is that interest rates seem extremely high, especially beecause they are always expressed as a percentage per annum when they are really premiums for liquidity for one, tow, or at most a few days.
I remember that when risk spreads widened in 2008, someone wrote that the increase in the risk premium was not as bad as people were making it sound. The point was that if there is a 1 percent chance of default on a 10-year instrument and on a one-week instrument, the one-week instrument requires a much higher interest rate, because you earn the risk premium for a much shorter period.
In a chapter called “International Contagion,” CPK reviews the sequence of banking and currency crises in the 1930s, and concludes on p. 140:
This history does not lead to the conclusion that the 1930s depression originated in the United States.
p. 276:
The hallmark of the 1930s was a sequence of currency crises, first the Austrian schilling, then the German mark, then the British pound, and then the U.S. dollar; finally the speculative pressure was deflected to the gold bloc currencies–the French franc, the Swiss franc, and the Dutch guilder. By the end of the 1930s, the alignment of currency values was similar to the alignment at the end of the 1920s, although the price of gold in terms of the U.S. dollar and most other currencies was 75 percent higher.
p. 277:
since the mid-1960s…These decades have been the most tumultuous in international monetary history in terms of the number, scope, and severity of financial crises. More national banking systems collapsed than at any previous comparable period…In some countries the costs to the taxpayers of providing the money to fulfill the implicit and explicit deposit guarantees amount to 15 to 20 percent of their GDPs. The loan losses in most of these countries were much greater than those in the United States in the Great Depression
Remember, of course that this pre-dates the most recent financial crisis. p. 278-279:
There have been more foreign exchange crises than in any previous period of comparable length, beginning with the breakdown of the Bretton Woods system…The range of movement in the foreign exchange values of many national currencies …was much larger than in any previous period…the scope of ‘overshooting’ and ‘undershooting’ of currency values relative to the values inferred from the differences in national inflation rates was much larger than in any previous period
Finally, on p. 279:
There were more asset bubbles between 1980 and 2000 than in any earlier period.
This instability was fueled by money and credit. p. 280:
The financial tumult since the early 1970s resulted from the impacts of monetary shocks and credit market shocks on the directionn and scope of the flows of funds across national borders.
p. 286-287:
These manic-type shocks resulted from extensive changes in the preferences of investors for securities and other assets denominated in different currencies. Investors became concerned that the U.S. inflation rate would increase in the 1970s; they sold U.S. dollar securities to get the funds to buy securities denominated in the German mark, the Swiss franc, and the British pound, and the U.S. dollar depreciated much more quickly than would have been inferred from the excess of the U.S. inflation rate…Early in 1980 investors became convinced that the U.S. inflation rate would decline; they sold securities denominated in the German mark and other foreign currencies to get the funds to buy U.S. dollar securities and the U.S. dollar appreciated at a rapid rate.
A couple of other notes. First, CPK emphasizes how steep the Japanese real estate bubble was. We think that in the U.S., house prices were overvalued by, what, 30 or 40 percent? Japanese real estate was overvalued by several hundred percent. Suppose that, from an Austrian or PSST perspective, the distortion in the real economy (the creation of unsustainable patterns of trade) is proportional to the distortion in asset prices. Then it is no wonder that Japan had a long period of poor economic performance. Rather than view their problem as a “liquidity trap” or “insufficient stimulus,” you could view it as a really, really, painful adjustment to a really, really distorted real estate market.
Second, CPK suggests that flexible exchange rates are at best a mixed blessing. The virtue, according to monetarists, is that they allow countries to pursue separate monetary policies. In theory, this gives you a tool to manage your relative national wage rate without workers having to change their approach to wage demands. This should permit the central bank to stabilize GDP growth and employment. In practice, however, the reaction of markets to differential rates of monetary growth is so strong that for the world as a whole it seems that flexible exchange rates are destabilizing.
p. 291:
One of the patterns in the data is that the flow of savings to a country was associated with an economic boom;this was evident in Mexico and other developing countries in the 1970s, in Mexico, Thailand, and other Asian countries in the first half of the 1990s, and in the United States in the second half of the 1990s. The appreciation of the currencies of this group of countries reduced the inflationary pressures associated with a robust economic expansion
In some sense, when global savings flow into a country, asset prices are boosted while tradable goods prices are suppressed. If the monetary authority is following inflation as measured in the prices of goods and services, it gets a signal that things are just fine. But the inflation is taking place in asset prices, and maybe things are not so fine.
READER COMMENTS
Matt C
Jul 24 2011 at 10:37am
> But the [monetary policy induced] inflation is taking place in asset prices, and maybe things are not so fine.
This is an idea I’ve read on investment sites, but I don’t recall reading it here before.
I’m not savvy enough to properly analyze this. But if the mechanism for pumping money into the economy is to lower prime interest rates, it sounds plausible to me that the new money could concentrate in investments rather than general prices, causing positive feedback and a bubble.
Matthew C.
Jul 24 2011 at 11:13am
Exactly right! FOFOA refers to this runup in asset prices of all types as “Credibility Inflation”. And it sets the stage for a grand collapse of the entire financial Ponzi. Here are a few choice quotes from the linked piece:
Most simply stated, credibility inflation is the expanding confidence in the fiat financial system to always deliver a higher payoff tomorrow than today. And through credibility inflation we ultimately destroy the currency structure by believing it can somehow deliver more than reality will allow. . .
. . .price inflation isn’t the only story that impacts us. Rising prices come and go, but money inflation continues to affect us without fail. So why do people feel better when price increases slow or stop, even as money inflation runs ever upward? The good feelings usually evolve from the effects that money inflation (increases in the money supply) has on financial instruments. These assets take on the very same characteristic that the rising prices of goods once exhibited. They run up in currency price. . .
Human nature has always dictated that we buy what we need now instead of holding someone’s IOU to receive it later. That nature is only changed through the “greed to obtain more.” Like this: “I’ll hold my wealth in dollars as long as my assets are going up. Later those increased assets will buy me a better lifestyle as I purchase more goods and services than I could buy now.”
This is the hidden dynamic we see today. Just as destructive as “goods price increases,” “credibility inflation” impacts our emotions to “hold on for the future, more is coming!” In every way, “credibility inflation” is just as much a product of an increase in the money stock as “regular price inflation” is. As cash money streams out to cover any and all financial failures, we begin to attach an ever higher credibility to the continued function of the fiat system. In effect, the more money that is printed, the higher we price the credibility factor. . .
And what sets the stage for hyperinflation is a period of high credibility inflation followed by the loss of credibility. During our period of high credibility inflation the dollar was invisibly hyperinflated in a near-monetary sense. This has already happened. We are already there.
When I say the dollar has already hyperinflated in a near-monetary sense, I am talking about the number of dollars people, entities and even foreign nations think they have in reserve. Not in a shoebox, but in contractual promises of dollars to be delivered more or less on demand by somebody else. . .
I think it is fair to say that we have finished our 30-year run of high credibility inflation and we are now in the early stages of credibility deflation. The real question now is, can the credibility of the financial system deflate without tripping a breaker, without causing a credibility waterfall in the currency in which it is denominated?
The difference between today and a few years ago is that a few years ago credibility inflation was being fed by private credit (debt) expansion. Asset values, like homes, were being sustained and driven higher with the arrival of new marks. But today the Ponzi cycle of credibility inflation has peaked, there are no more new marks, and its decline is being managed centrally with the government expansion of new base money to conceal the failures one at a time.
And as in any Ponzi scheme there comes a point when redemptions can no longer be financed by new marks. I think the tipping point of credibility must come once it is clear that Bernie Madoff, I mean Uncle Sam is writing redemption checks that can never be cashed. The point is, we are already past the tipping point. So timing isn’t really a question anymore. The credibility waterfall has already happened. But somehow we still have early marks continuing to stockpile rubber checks as if they are worth something. Does this mean credibility still exists? I think not.
I suppose this begs the question, is all that dollar debt out there in the world really worth anything anymore? If you answer yes simply because you cashed some of it in today for new underwear, then I say you didn’t answer the question. The question is, is all that dollar debt out there in the world really worth anything anymore? The answer is no, it is not. Only at the margin, where you reside, can it still be cashed in for new underwear. But in aggregate, it is worthless, even today.
Noah Yetter
Jul 24 2011 at 4:07pm
Years ago when I was an aspiring PhD student, this was the core of my tentative plan for a thesis. To this day, I believe it remains unexplored.
fundamentalist
Jul 25 2011 at 9:42am
Hayek warned about the dangers of floating exchange rates long before the end of Bretton Woods, but everyone thought Keynes was smarter.
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