I just can’t resist posting this! I don’t know what to feel about the current economic crisis and how the US Federal Reserve and the central banks across the world are going about trying to avert a complete economic collapse – by pumping in more and more money into the system. I do not know if I am feeling depressed or agitated, or both! Here is a simplistic way of describing what the Fed is trying to do; you can judge for yourself if this is all true “free market”.
Let’s say there are 100 people in a room and that all of them are going after 10 goods that are being traded. Out of the 10 goods in the room, 2 are essential commodities and the remaining 8 are just luxury. The money that can be used to buy these goods is the Government/Federal Reserve mandated currency, which in the case of the US, is the US Dollar. For whatever reason, most of the 100 people decide not to buy the luxurious goods – for now!
Here’s what happens next…
At the prodding of Nobel Prize winning economists like Paul Krugman, the Fed (feel free to substitute this with your country’s equivalent – its the same everywhere) appears on the scene and decide to, at random, pick 10 people in the room. Actually its not so random but is based on some unarticulated criteria which, for the purpose of brevity, I will not go into. Suffice it to say that people like Bernard Madoff would surely be one of the “chosen 10”. The Fed decides to stuff the chosen 10 with truck-loads of cash (US dollar in this case) so that demand for the 10 goods can be created!
Now, the 10 people who got the ‘new money’ buy some of the goods using the new money and also lend some of the money to, perhaps, another 20 people in the room – so that they can also pitch in to create demand for those useless goods that nobody really needs. Again, let’s not go into the details of how these 20 people are chosen. Amongst these 20 people would be people like Jeffrey Skilling, Bernard Ebbers, Sanjay Kumar, etc. The Government also chooses a couple of people from the ‘most incompetent people amongst the 100’. These people are given the responsibility of monitoring the gang of 30 and helping make the whole charade appear legitimate. This way, everyone’s focus is on how effectively the gang of 30 is being monitored rather than how the gang of 30 got the new money in the first place. Its an old trick; magicians call it ‘misdirection’
Lets now play out what will happen to the 10 goods in question…
There is more money in the hands of the “chosen 30” and they go and bid for the available goods and, in the process, they ensure that the prices of all these goods (unfortunately, including the essential goods) go up by an order of magnitude. Out of the 70 people ‘left out’ of the new money, many will work for the chosen 30 – producing more of the 10 goods. These ‘workers’ are satisfied with taking the crumbs left over by the ones with the ‘new money’.
However…
Since the prices for all the goods have gone up, most of the ‘ordinary 70’ can’t afford most things! Most of them would be satisfied with working hard for the crumbs. However, people being what they are, some amongst the ‘ordinary 70’ would compete to get into the first or second ‘chosen’ sets! Membership isn’t too difficult and can be obtained by sucking up to them (the chosen ones)- i.e. by directly eating from what’s drooling out of the mouths of the chosen 30 and cleaning their toilets in return – all so that they eventually can become part of the ‘chosen’ gang.
The “smartest” ones like Paul Krugman would become advisers to the chosen 30 and mathematically model the behavior of the 100 people so that they get to buy the goods without actually doing any work at all.
While the above may appear to be an over-simplification, I am absolutely certain that what the US Federal Reserve is doing is almost exactly what I have described!
The Politicians, the intellectuals at the Federal Reserve, the banking system, and the other ‘crooks’ everywhere – they all make us believe that this is “free market”. We also believe it because every one of us can choose to pledge our self respect and aspire to join the gang – provided we have the skills and the inclination to suck up. We also believe it because in the name of democracy we can also elect the crooks whose toilets we want to clean – and then aspire to be one of those crooks. Indeed, its a beautiful “free market” world we are all living in.
It’s left as an exercise to the reader to figure out what would really be a true free market. The clue here is to start with abolishing the Federal Reserve and abolishing the Government’s right to mandate what money people should use and, by extension, taking away from the Government the right to create money out of thin air.
Finally, if we, the ‘ordinary 70’ in the room do not wake up and stop the Federal Reserve from stepping in, there is no question that all of us collectively would eventually play into the hands of the Hitlers and the communists waiting in the next room. And by the way, the process has already started!
Sekar, lighten up, my friend!
There MUST be monetary controls in today’s markets to keep them as “free” as we can. To be sure, it’s certainly not perfect; and a lot of people are suffering right now.
But THIS particular world crisis is our own fault, collectively, for losing confidence and slowing down the economies – not that of the officials we elected and to whom we gave the power to try to fix it all, even if that means doing things of which we don’t approve, like printing more money.
If we stop trying to “fix” it and just let the economies correct themselves, there will be far more trouble than we have now. We’ve elected smart people and enacted good laws and procedures. They’ll try some things that don’t work, and some that will. I have no doubt that the things that work will outweigh the things that don’t.
Rob Cosgrove
CEO, Remote Backup Systems, Inc.
Rob,
Thanks for your comment. I disagree with your “our own fault for losing confidence and slowing down the economies”. That is the Keynesian economists’ party line. The root cause of the problem is the Government mandated fiat money and the fractional reserve banking system which unfortunately is accepted as axiomatic. Until anyone has the power to create money out of thin air, these problems will keep coming backup. It will be bigger and nastier the next time around. Our children and grand children will pay the ultimate price. I consider it immoral and unethical for anyone to keep the power to print money knowing full well that it is a way of collecting a tax by stealth from the poor and gullible citizens.
As we see, at the height of the crisis everyone seems to agree that the Government should take more power onto itself and do whatever it takes to mitigate the effect of the crisis. That the US banking system is so close to being nationalized was unthinkable in the last few decades. The next time around the crisis will be worse and the Government will argue for even more power. This will continue until we lose all our freedom to the communists who will eventually take over our lives.
Please do read the following article: http://mises.org/story/3165
This article is much more articulate and powerful.
Thanks once again for taking the time to post your views. Though I disagree with your view I appreciate your comment.
Sekar
Sekar,
From what little I know about the great depression, I believe that we are in the same situation as then – credit contraction. The Fed then failed to take any action to back stop the financial system causing a tremendous number of banks to fail. Everybody agrees that we do not want episode 2 of the great depression. If the Fed were to do the same it would be foolish to expect different results. It has to do some thing to back stop the financial system and to reverse the credit contraction.
I do agree that they have selected a chosen few to “Give” a bulk of the money. But there is no perfect way to deal with this.
You talk about inflation being the gravest danger. Currently the threat is deflation and what it’s impact to the economy and the job market. If this continues unemployment could easily exceed 10 pct causing widespread pain that would make the recession even worse. The fed is doing the right thing to tackle the recession now and address the current deflation threat and worry about inflation when this hurdle is crossed.
I am not sure what to make of inflation — who is the biggest loser then? Is it the poor or the middle class? Is it the working class or the retired?
I guess for the really poor who do not have any assets but wages tied to inflation, I would not think it would make much of a difference. It is a whole another ball game for them if the wages are not tied to inflation. On the other hand in a deflationary enviornment if they lose their jobs I guess the situation is much worse.
Hi Hanumanth,
I think the mainstream economists and the mainstream media have brain washed all of us to believing what you have described. If we need to solve a problem we need to go into the root cause of the problem. The root cause is the fiat money, the Government’s/Fed’s power to create money out of thin air, and our fractional reserve banking system which can theoretically create credit ten times our real deposits. The main stream economists treat this as axiomatic which it is not. The current system of creating money out of thin air and giving it to a “chosen few” is criminal because it is almost like stealing money from the prudent ordinary people who saved. Those who were imprudent and excessively borrowed and lived on debt are being rescued here. In what world is this ethical and accepted behavior? By no means am I thinking of it like some revenge. I personally will like to help the people who lose their jobs and who are in serious debt. But what the Government is doing is not the way – we are made to think it is the only way. Please analyze it thoroughly, question the popular wisdom and you will ultimately come to the same conclusion as me. Why should someone have the power to create money? There are some brilliant articles on the web on what I am talking about. Please search for them and read it. For a start please read some of the articles at http://www.mises.org
Coming to the question of how to mitigate the effect of the current crisis the solution is not to lend more money to the same people who are already living on too much debt. That is the reason I say when the problem happens next time it will be much worse and there will be no possibility of any rescue. The only solution is for the people to reset their expectations and try and live within their means and try to save for the future. That is the real long term solution to the crisis. Again I am not so good at articulating all of this. You should look for articles who argue for what I am talking about. And then please come to your own conclusion what you think will be the best longer term solution.
Another thing is that we are also brain washed into thinking that deflation is bad. During a deflation the people who saved do well. And that means they can also invest and create jobs. You do not have to only borrow and create jobs. And by the way, if the economic progress happens through real savings we probably will not have these big bubbles and busts. The current “skewed capitalism” makes it happen through fictitious credit created by our fractional reserve banking system. I also think with what the Fed is trying to do the US will end up with a massive hyper inflation – the question is really when it will happen and not if it will happen.
Finally, if you forget for a moment the economics question and think deeply, do you really accept that the Government can have the power to print as much money as it thinks is required so that the real savers are all screwed and the borrowers are all rescued. Don’t you think it is immoral? For this reason alone we should abolish the fiat money system and get the Government out of mandating what money people should use.
Writing in a hurry. So pardon any mistakes.
Sekar
Rob & Hanumanth,
Please consider this.
Long ago Thomas Jefferson has said this:
“If Americans ever allow banks to control the issue of their currency, first by inflation and then by deflation, the banks will deprive the people of all property until their children will wake up homeless.”
Even Keynes whose prescription is what the Fed and the mainstream economists follow has said this:
“The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
Note that Keynes has also famously said “In the long run we are all dead”. Thinking through this I am sure he probably knew full well that his solutions were only quick fixes to economic issues and it will have some devastating effect in the long run. So the only way he could justify it is by saying “in the long run we are all dead”.
Unfortunately, most of us are seduced by these quick fixes because all of us feel comfortable only if we believe we are in control. If we are not, we tend to look up to others who pretend to be in control. No wonder most of us go after some “Guru” to guide us through our lives. In this case we accept the central banks as our Guru.
Sekar.
Guys,
Please read this.
http://www.pbs.org/wgbh/commandingheights/shared/minitext/ess_inflation.html
To quote:
“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
It’s obvious that Keynes himself understood the devastation that can be caused by inflation (growth in money supply). This was in 1919. I have no idea why, in the later years, he then advocated interventionist government policy through fiscal and monetary measures. Either he must have gone senile or he was possessed by some evil force.
Sekar
I agree with Rob. Free markets need controls so that they don’t go into bubble/burst cycles. The current crisis is a result of some controls that were lacking in the credit market. I don’t have an opinion on the right fix now, but I’m sure we can do better than leaving it to the market to correct itself. I hope we learn from this crisis and move on from the “unregulated free market” myth.
Hi Madhav,
I seriously suggest you read the links I have posted in the comments. Please do some more investigation with an open mind. We are escaping from analyzing the root cause of the problem by blaming deregulation because it appears obvious to us that putting enough controls in place will mitigate the problem from happening again. But the regulation process will never end because the problems will keep coming back bigger and bigger and then finally….
I will quote from the article link http://mises.org/story/3165 I posted in my comment above.
“The logical stopping point of this process is that one day everyone will end up being shackled to a wall, or at the very least being compelled to do something comparable to living in a zip code that matches his social security number. Then the government will know who everyone is, where he is, and that he can do nothing whatever without its approval and permission. And then the world will be safe from anyone attempting to do anything that benefits him and thereby allegedly harms others. At that point, the world will enjoy all the prosperity that comes from total paralysis.”
Once again, Madhav, please take this seriously and analyze it and then come to a conclusion on your own.
Sekar.
A few related comments…
By the time we put this current crisis behind us, we will see a dramatic change in lifestyle and attitude in society (at least in US/Europe). The nature of the change will depend on whether the perverse measures taken by the Fed will be successful in helping the easy-credit addicts (the majority) at the cost of decimating the responsible savers (a minority). All said and done, the previous 4 years and the coming 4 years will leave a mark in our collective psyche. We might all come away from this crisis with the same idea as behind this precious one-liner from our Bapu (Gandhi)- “There is enough to satisfy every man’s need, but not every man’s greed”.
Sekar,
it is OBVIOUS that we live in a skewed free market world for the simple fact that, ultimately, the control of the reserve currency of the world is under a public-PRIVATE institution (the Fed). How much confidence would one have in a stock as a store of value if that corporation kept diluting it to save themselves from any screw-up. This is the most fundamental counter-point to the “free-market” theory. I don’t even have to bring up the ‘old boys network’ or the ‘capitol hill-wall street’ nexus or protectionist tariffs counter-points.
On a lighter note, these are some interesting times. Thanks to globalization, the internet and some fantastic blogs and wikipedia, for the first time in history, anyone with access to an online computer can keep current of what is unfolding and be informed of the complex inter dependencies in the modern world.
Suraj,
Thanks for reading the blog post. You make some excellent points. I am glad that lot of people are trying to understand these fundamental issues instead of just hoping “A GOD” (Government/Fed) would take care of it. No God in this world is qualified to fully comprehend the complexities of life driven by fundamental human nature. Any centralized planning and intervention, however good the intention is, does not work in the long run. That is why someone long ago said “The road to hell is paved with good intentions”.
But I am worried about one statement of yours “This is the most fundamental counter-point to the “free-market” theory”. I hope you do not mean to say free market does not work because of human greed or because by nature most of us are crooks and hence we all need to be controlled and restrained by some “Centralized God”. Most probably you do not mean that. But I am still pointing it out because this flawed argument combined with the fundamental immorality of the current “skewed free market” is what is mostly used as slogans by the socialists to position themselves as the “Equitable Central God”. It is a very seducing argument and appeals to the masses instantaneously. That is the reason practicing this immoral skewed capitalism will eventually lead to communism and dictatorship in the long run.
Finally, even assuming most of us are greedy crooks it is much better for the crooks to be in the private sector with limited power, where we can cause only limited damage, than the crooks ending up as the central god with lot more power, where we can cause damage to whole societies.
If you haven’t already, please do read the links I have given in the comments in the blog post.
Sekar.
Now the wall street journal runs a piece
Is the Medicine Worse Than the Illness?
http://online.wsj.com/article/SB122973431525523215.html?mod=todays_us_nonsub_weekendjournal
I think I will stop with this before people pounce on me to stop all this pontification.
Sekar
Yo Sekar,
when I mentioned “free market”, I did not mean the one advocated by Austrian economists. I put in quotes to signify the “free market”; that all of us are made to believe the current market as (so, part sarcasm, mostly disagreement).
Anyways, I try not to focus too much on what kind of markets (Austrian, Keynesian etc.) are most suitable primarily because even if I do have a strong opinion, there is not much I can do about it. I am more interested in finding out how markets work and take precautions/advantages. That is why I was hoping that friends and others take required measures and stay safe in the years to come.
I understand the points you are making. Those are straight from the Austrian economics textbook. For those interested, “Road to Serfdom” by Fredrick Hayek is a wonderful book for the un-initiated on this topic.
later,
~suraj
Hi Suraj,
Thanks for the clarification.
I have seen the book “Road to Serfdom” but as usual never read it. I specifically did not quote “Austrian Economics” etc. because I am against any branding or blindly following any particular ideology. Because a “crooked guru” will appear as practicing Austrian Economics and take us all to hell by his own branding of the Austrian school. Also, if we just brand and give a name to an ideology it will eventually dilute into mere sloganeering which again is very dangerous. Most of the time I am driven by intuition and common sense. So I tend to read at random to pick up arguments and reasons to verify my intuition. I wish I had the brain power to logically prove everyone of my thesis. I am quite aware of my limitations and hence rely on other giants to verify my thesis – it does not matter the giants subscribe to Austrian schools or is a Keynesian etc. I am sure even Hitler has said some good things but he being Hitler would have used it to exploit the human vulnerability for his own advantage.
Your statement about the Internet “for the first time in history, anyone with access to an online computer can keep current of what is unfolding and be informed of the complex inter dependencies in the modern world” is very valid at least in my case. Internet has been a big boon for me. I do not think I have the natural curiosity or enthusiasm to go to a library and read some of these works to verify my thesis. Internet has made the job easier for even someone like me who has very minimal natural curiosity but a natural rebellious tendency to question all authority.
Quoting you, “I am more interested in finding out how markets work and take precautions/advantages”
I think this is what most of us are trying to do all the time. We cannot escape from this system. But I feel all of us can make a small difference by talking about it and doing our bit to influence others who want to continue to believe in this “fantasy world” because many of us are uncomfortable accepting reality and would better look up to some Guru to solve all our problems. These small things will hopefully eventually add up and bring the change we all seek.
Sekar
A friend asked me by email the following:
“can you express your thoughts on what we as individuals (with families to look after) should be doing with our money/assets at this time? I want to make sure my understanding of ‘defensive position’ is what it really is.”
Here is my response to him:
With the Government intervention etc. all bets are off. Since there is a “Central God” who has the power to meddle with everything any logical reasoning to predict a short term trend is not possible. Since the Fed is creating money out of thin air, there is a very good possibility that your money (US Dollar) will significantly lose its value in the future. The only problem is that it is not easy to predict when that would happen. It can happen next year or even after 5 years. Because it will depend upon what happens in other parts of the world. If investors feel investing in Europe or China or India is safe (better than the US treasuries they are all buying now and helping the dollar appreciate in the process) then there will be run on the dollar. If this happens, commodity prices (Gold, Oil etc.) will shoot up significantly There is also very good possibility asset prices in the US will crash even more in the next few years.
So follow a portfolio approach. Invest a bit in Gold (physical gold too by the way) and related commodity stocks. If the money loses value you will be protected. Keep some in cash in safe banks because you may need short term liquidity and also if Gold/Commodity loses value then dollar will be appreciating.. Do not invest in real estate yet. But if you already own some property etc. do not sell it. In the long term these real assets will always have some value. Also in a dooms day scenario these real assets are the only thing that will matter. That is the reason, I think, in our Indian culture we are always told never to sell the family ancestral properties. You can also invest in stocks (obviously the safest ones) provided you do it for the very long term because in the short term stocks will most probably go down even more. Reset your expectations and follow a frugal life style and live within your means. If you feel psychologically comfortable then I would even advocate borrowing some money to invest as a portfolio because when the money loses value savers are screwed and borrowers look smarter.
Philosophically, if we can, we should really strive to free ourselves from the materialistic world. That does not mean we just live a life of a hermit. Rather, do not be enslaved by the comforts you have. Only then we get psychologically affected when we have to lose everything. If we are free from this enslavement then we do not have to fear anything and we will have the real confidence to survive any dooms day scenario.
Do not ask me if I follow the above. I do not. I have some property which I bought 6 years ago. The rest of the money is in public sector banks fixed deposits. Ideally I should be buying some Gold and investing in other commodities. And I just do not feel comfortable borrowing money. Lethargy is preventing me from acting. But I feel I have freed myself from most types of enslavement. Only time will tell if it is true.
Of course, take all advice with a pinch of salt.
Sekar
Much of the historical economic recession and depression information we have available to us is not apt for use in todays situation. The world is far smaller today and therefore real worldwide economic depression is far more likely a situation (as is worldwide boom)
In addition, while many regions have been left behind (and indeed far behind), the differences in education and ambition of high achievers in first and second world countries are not starkly different.
The information economy may now be tapped in to on an individual basis allowing an intelligent and resourceful individual in a remote region to participate in a high cost economy given intelligence and connectivity.
I think this alone leaves us in a very new situation from the perspective of the global economy.
You can argue all day guys. Someone may in time be proved right but that may be because of altering circumstances rather than having a correct picture now.
John