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View Full Version : Help me argue in favor of the Austrian Business Cycle?




yaz
11-03-2009, 09:51 PM
ME: I think that if you agree with the Austrian theory of the business cycle, http://en.wikipedia.org/wiki/Austrian_business_cycle_theory , then you have to think that abolishing the Fed is a good idea.

I'm not convinced that the whole system would collapse without our intervention. http://thecurrent.theatlantic.com/archives/2008/09/not-buying-it.php We're esentially trusting the same people who caused or helped to creat the crisis in the first place.

http://mises.org/story/3132

" The 1930's depresion was also funded by the fed the reason the money supply dropped was not because the fed did not supply liquididy but because the gov regulated prices; so they could not drop and no one would borrow money at to high of prices. We need to let prices fall to the right level (whatever that might be) so we can go on with good investments and let the bad ones go. If we bail out then we are just letting the fed remonitize the problem they already created and it will come back to bite us in the rear down the road. The fed created the bubble and is trying to create another instead of letting if pop. It does not matter if it was housing or dot.com or tulips, it was still a bubble and has to pop. What we realy need to get rid of is the fed so we can go to a natural business cycle not the big boom and bust of the fed."


Not Me: First, you would need to tell me why a "natural business cycle" is superior. Fact, in the era of non activist, no Fed, business cycles featured more frequent and more virulent recessions. Fact, the more recent period in history after governments chose to follow a more hands on approach we have less frequent and shorter lasting recessions with expansions that are a lot longer. Lets further look at two examples of countries in latin america with banking crisis with similar economies. Mexico formed Fobaproa to orderly close banks, to keep asset prices from free falling irritionally caused by over reactions due to irrational fear. Then there was Argentina, Argentina decided to keep their hands off, to let banks fail, to let prices free fall. Mexico recovered within 2 years, they started again on a growth path and saw a very prosperous decade. Argentina was not so lucky, it took them more than half a decade to see their situation improve and only marginally.

With regards to falling prices, one would have to closely examine the reason prices are falling. Price controls indeed were enacted, but those were for some goods and services and for some salaries and wages. None of those price controls existed for asset prices. What goes on with asset prices is a relevant story where rapidly falling prices are NOT a good thing. Let me explain, in the case of the great depression, as well as the case here recently many financial institutions had stocks, MBS, etc as their assets. Now, when an institution like Lehman with huge holdings of those instruments goes bust, they have to unload all those in the market place, rapidly increasing supply and forcing the price down. People holding the asset on margin see the value of their collateral go down and get margin calls, they have to unload. Fear sets in as everyone holding those assets wants to get out before price slides further down, nobody can find buyers, the traditional valuation models don't hold water anymore, there is uncertainty, and fear and over reaction set in forcing prices down adversely impacting the balance sheet of the institutions that hold them. the paradox is, evrybody is trying to unload their assets to improve their balance sheet and capital positions to prevent failure. the problem is, that since everybody is trying at the same time, no one can is able to improve their financials no matter how much they unload. traditional credit instruments such as the fed funds window, libor, etc... dry up as uncertainty increases with regard to the strenght of balance sheets. those institutions find themselves overnight beat up, without access to credit, with depositors running on the bank, undercapitalized. ALL at the same time.

Andrew-Austin
11-03-2009, 10:12 PM
First, you would need to tell me why a "natural business cycle" is superior.

There is no natural free market "business cycle" at all if we do away with fractional reserve banking. There can still be artificial credit expansion / creation of new money so long as you have FR-banking as opposed to 100% reserve banking. These cycles are less severe without the central bank lender of last resort, which allows the FR-banks to have and sustain much lower reserve ratios.



Fact, in the era of non activist, no Fed, business cycles featured more frequent and more virulent recessions. False. The boom bust cycles were dramatically strengthened with the creation of the Fed.

mtj458
11-03-2009, 10:18 PM
The FED wasn't there in the 1800's but there were still central banks. I really don't know enough about the history to comment on it but I remember reading something from Tom Woods about the Panic of 1837 and a couple of others in the 1800's which were caused by expanding the money supply. It is true though that since the Great Depression our recessions have been a lot more moderate then they were before the FED was created. It could be that central banking isn't inherently flawed but that politicians can abuse it so easily to create bubbles. You can have a central bank that doesn't create inflation like we are now, but who regulates the bank?

NightOwl
11-03-2009, 10:46 PM
Fact, in the era of non activist, no Fed, business cycles featured more frequent and more virulent recessions.

The least activist period we've had was the period of the Independent Treasury, from around 1840 to the Civil War. That was probably the healthiest monetary period in American history.

All other periods are heavily "activist." Currency panics occurred after the Civil War when the regulation requiring currency to be backed by government bonds caused all sorts of problems -- as government paid off debt, there were fewer bonds to back the currency, thus leading to crises. How would that be the fault of the free market?

There has always been a fiduciary (fractional-reserve) aspect to American banking, and that, as Jesus Huerta de Soto argues in his treatise Money, Bank Credit, and Economic Cycles, is the root cause of the problem. And that, he argues, is not a free-market phenomenon, properly understood.

As for how wonderful things have been since the Fed, well, I'd say the Great Depression, the 1970s, and right now are pretty bad. Surely worse than 19th-century panics, which were shorter lived and affected fewer people.

yaz
11-04-2009, 06:28 PM
This was before my latest reply:
Him: I read this link you gave me ( http://mises.org/story/3132 ) I already had an idea of what that said. Makes sense. A period of low interest rates and rapid credit creation may indeed be th result of mistakes at the Fed. I will give them that. However, those cycles would occur without the Fedas well. Think of the famous animal spirits idea spoused by Adam Smith. A period of euphoria, will lead to overinvestment and low interest rates. It is just in the nature of how we make financial contracts, and how we set the capital discount rate. if we are overly optimistic we will tend to discount the future less heavily causing us to demand a lower required rate of return on capital. that is, lower interest rates are demanded in return for future cash flows. If such optimism, maybe caused by a new technology like the internet and overly rosy forecasts about their potential, takes hold then such a business cycle as described by Von Mises and Hayek will occur. The proper role of the Fed in that case would be to manage risk by actually putting a break on overinvestment by decreasing the money supply and bringing back risk taking from society to more desirable levels. Greenspan tried with his rational exhuberance speech. Then other concerns at the Fed caused them to abandon those warnings.

I copied and pasted what you both of you said to him because he's interested.

Joe3113
11-04-2009, 08:03 PM
http://mises.org/Community/forums/

Is your best bet. Since they, well - specialize in the area.

yaz
11-05-2009, 05:44 PM
I know theres a lot of you on this site too though.

Him: 100 percent reserve banking means such a society would have NO credit. Such a society would have a really hard time allocating capital to it's most productive uses. Indirect financing would cease to exist. Direct financing would still be available, but due to economies if scale, asymmetric information problems such as adverse selection, free riding and so on, only few major big players would have access to the pool of savings. Moreover, all the capital sitting at the bank would remain idle, not earning interest. The bank as a holder of your money would have no way to earn revenues except for charging hefty fees for holding your savings. You would indeed rid society of the risks of euphoric credit expansions and malinvestmens. You'd also limit good investments.

Reserves are set in the system, for the whole system at 10% of demand deposits. Central banks do not cause for lower reserve ratios in the system to be lower than the 10% except for cases of extreme distress in which the fed opens the discount window.

NightOwl
11-05-2009, 10:28 PM
I know theres a lot of you on this site too though.

Him: 100 percent reserve banking means such a society would have NO credit. Such a society would have a really hard time allocating capital to it's most productive uses. Indirect financing would cease to exist. Direct financing would still be available, but due to economies if scale, asymmetric information problems such as adverse selection, free riding and so on, only few major big players would have access to the pool of savings. Moreover, all the capital sitting at the bank would remain idle, not earning interest. The bank as a holder of your money would have no way to earn revenues except for charging hefty fees for holding your savings. You would indeed rid society of the risks of euphoric credit expansions and malinvestmens. You'd also limit good investments.

Reserves are set in the system, for the whole system at 10% of demand deposits. Central banks do not cause for lower reserve ratios in the system to be lower than the 10% except for cases of extreme distress in which the fed opens the discount window.

Absurd. Demand deposits aren't the only funds that can conceivably be lent. Time deposits can be lent under a 100% reserve system.

yaz
11-08-2009, 09:33 PM
can you explain that more?