I am sympathetic to the Austrian critique, but there's a big problem with refusing to print any money and just letting the debt pyramid collapse. M0, the actual amount of green dollar bills in the world, is at $750 billion. MZM ( Money Zero Maturity, all the money in bank accounts and money market funds) is at $8.5 trillion. If the Fed refuses to use the printing press - ie it refused to print money or give loans to bail out the FDIC, and refused to bail out the money market funds - there will be a giant bank run as everyone with dollars in a money market fund rushes to redeem the holdings with actual green dollar bills. We're not talking about a couple big Wall St. banks going out of business. We're talking about every startup that has VC funding in a money market fund losing everything. We're talking about every mortgage in the world defaulting. Every bank account will vanish.
Of course, this won't happen, but only because Bernanke has guaranteed the assets of money market funds and the FDIC by promising to print money. Now, I think it is awful that MZM grew to be 10X the size of M0. The Austrians are right to condemn the fractional reserve policies that caused MZM to get so big. But the only thing the Fed can do now is to print money to make the two match, and then make sure it never happens again.
The Austrians are right to condemn the fractional reserve policies that caused MZM to get so big. But the only thing the Fed can do now is to printing money to make the two match, and then make sure it never happens again.
To even have that discussion, there has to be acknowledgment from academia & the Fed that their policies led to this. Right now, the intellectual climate is far, far from any such acknowledgment. In fact, the Nobel for Krugman signals exactly the opposite. It has conferred on him a degree of economic credibility (and perceived infallibility) that, frankly, he does not deserve - that was the point of my post.
Without that Nobel prize, he was easy to ignore as just-another-commentator. Not now. Yet another Keynes quote seems appropriate, why this debate is important:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.
I don't expect much intellectual truth and reconciliation from academia. What will actually happen is the Fed will continue to informally create money ( via guaranteeing debt MZM rather than actually printing greenbacks) to get through the crisis, and we'll either end up with prolonged stagnation or a return to "the great inflation". As non-optimum as this is, I'd rather have Bernanke at the helm, than say Ron Paul. The Austrians don't realize that you can't just let MZM collapse and have everything turn out hunky dory after a bit of pain.
The article has some good points, but Paul Krugman does too. The modern "keynesian" view that the Great Depression was caused by very bad policy of the Fed (keeping very high interest rates and desperately clinging to the gold standard) seems very close to the truth. But, on the other hand, the people running the Fed now, trying to avoid the mistakes of that era, might be going to the other extreme of keeping interest rates too low and printing too much money.While that might make the current recession relatively short and mild, it will prepare the ground for further bubbles - people, worried about their cash losing value, will invest like sheep into the next big thing, until it bursts again. So, maybe the right balance is somewhere between "keynesian" and "austrian"?
Artificial debt inflation is like heroin. The Keynesians correctly pointed out that going off of heroin causes you a heck of a lot of pain. Therefore, their solution is to never stop shooting heroin. Their cure for withdrawal is more heroin. This is good in the short term, but fatal in the long term. Unfortunately, the Keynesians deny that shooting heroin can even be a problem.
The Austrian position is that 1) we should not start using heroin in the first place and 2) if we find ourselves on it, we should quit cold turkey. This may be a good idea for a mild debt (heroin) dependency, but after the inflation of World War I and the 1920's or the inflation we've had the past few decades, going cold turkey causes a great depression. Therefore, I'd prefer we'd check into a methadone clinic, gradually wean ourselves off the heroin, and make sure to never shoot up again. Not very likely to ever happen.
Part of the problem is that the central bank only measures inflation by consumer prices, and not investment asset prices. As long as consumer prices rise slowly, central bankers feel no hesitation in following loose monetary policy. This is true even as stocks and real estate prices take off into the stratosphere, causing potential instability.
Recently, Bernanke seems to have come around to accepting that asset prices are important to monetary policy, breaking a long-held Fed orthodoxy, dating back to Greenspan. Contrast his speech in 2002, where he outlines the"don't burst a bubble but clean up the aftermath" philosophy:
One key piece to remember is that in true austrian theory, the central bank has no place as that is an attempt at free market regulation which is utterly impossible (see book "I, Pencil" as an example of the difficulty in truly understanding and regulating a free market). The bad policy of th Fed itself was NOT within austrian theory but caused by the introduction of the Fed in 1913 to "quelch" financial instability (what good that did, as expected).
