Historian Steve Davies is one of my all-time favorite scholars. Here’s his recent take on today’s market turmoil.
My friend, the great monetary theorist and historian George Selgin, once wrote a pamphlet for the Institute of Economic Affairs entitled Less Than Zero, arguing that in times of economic growth the price level should be allowed to fall (as more goods being chased by a stable supply of money means that each unit of money will buy more goods). It’s an important point that is, sadly, too little heeded.
A shorter version of George’s pamphlet is published here, by National Review.
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Tyler Cowen brought up the main reason economists fear deflation in a podcast with Russ Roberts, namely, nominal wages appear to be nominally sticky. That is, if the cpi goes down, wages do not causing real wages to rise rather than stay the same.
So, um, not a single post on the corporate bail outs?
I'm a free-market guy, but I think many, many free-market economists confuse capitalism with corporatism.
I guess bailing out AIG is OK, but bailing out US tech workers, who's market has been destroyed by H-1b, is bad.
Whatever.
Allowed to fall? I have a hard time imagining my local grocer, eyeing the mortgage on his store, protesting that his prices haven't been allowed to fall.
What does "stable supply of money" mean anyway? Is some authority telling us how much money we have? If I can't lay my hands on gold, am I forbidden to use silver as a token instead? If I can't find silver, am I forbidden to use platinum? If not platinum, may I not use copper?
If I'm not fond of metals generally, may I not simply accept a grocer's credit for my gross of eggs, his contractual agreement that I may purchase $10 worth of anything else in his store, as marked, for my eggs? Does some lord of the "stable supply of money" forbid it?
If the mechanic down the street will accept this $10 credit in exchange for his services, am I to be shot for dealing this way without the permission of someone holding gold? Am I forbidden to increase the money supply by accept the grocer's credit for my gross of eggs?
No, this "stable money supply" is not the least bit liberal. I want no part of it. Maybe we can do without central bankers. That's a separate issue.
… accepting the grocer's credit …
The fundamental misunderstanding of money as some kind of durable good that can or should be limited is a major impediment to the acceptance of liberal principles. We create as much money as we need, and any of us may create it at any time by producing valuable goods.
AIG is nationalized, but the news may not yet have reached Cafe Hayek.
The market value of Morgan Stanley's stock varied between $11.70 and $24.72 today, but this is not noteworthy. Do you suppose it is just "the lower classes needlessly travelling about"?
This is an economics blog, not a tawdry stock-tout's sheet.
What I find dismaying is the editors' neglect to offer the free-ish market policy suggestion "Make credit available liberally at penalty rates" as an alternative to the nationalization and bail-outs that depend at root on agents with firearms extracting money from Martin Brock.
And Paulson may set up a new agency to nationalize even more of the economy. Apparently, our Fascist in Chief pondered the question for all of forty minutes today.
http://money.cnn.com/2008/09/18/news/economy/rtc_speculation/index.htm?postversion=2008091818
Morgan Stanley's perceived value is highly uncertain. What else can an economist say about it? I'm a software developer, not a financier. I don't really care how many stockbrokers at Lehman Brothers lose their jobs, any more than they care about me.
Well, they are making credit available to AIG at penalty rates, if I can trust what I'm reading about it. The Fed takes an 80% stake in the company in exchange for a two year line of credit to liquidate assets, at the LIBOR plus 8.5%. That ain't cheap credit.
But the problem is that the Fed doesn't know what the company is really worth, so it's possibly buying 80% of nothing (or worse) for credit that'll never be repaid. Why? So the People's Bank of China will continue becoming our national landlord? Maybe I should join the John Birch Society.
"What I find dismaying is the editors' neglect to offer the free-ish market policy suggestion "Make credit available liberally at penalty rates" as an alternative to the nationalization and bail-outs that depend at root on agents with firearms extracting money from Martin Brock."
I don't know if you don't realize what is going on or not, but the fed is giving them a loan at penalty rates. As a condition of that loan they are also taking 80% of the company. It is better for the tax payer not worse. Also, they haven't actually given them 85 billion dollars. They've basically given them a credit card with an $85 billion dollar limit on it. This changes their credit ranking and probably/hopefully will give them time to have an orderly liquidation.
We don't know this. When the assets are liquidated, what's left? If the company's net worth is negative, it could the credit persuading buyers to take its positive assets, as its net worth becomes more and more negative. Then it's even more bankrupt and hasn't the assets to repay the credit. And what sort of sweetheart deal will the chairman's college roommate's sister in law get out of it in the meantime?
If the company has positive net worth, why couldn't it find a buyer? What does Bernanke know that everyone else on Earth doesn't know?
Martin
I'm not sure what you are saying. Maybe you are not understanding what I am saying. I am saying that between two contracts: one with a line of credit at penalty rates and another with a line of credit at penalty rates and 80% equity, the latter is better than the former for tax payers. If you are worried that as the companies assets go negative that creditors get claims on the US gov't now, then you just don't understand bankruptcy law. The whole point of a corporation is that its a separate legal entity, if its net worth goes negative then the creditors are SOL.
"If the company has positive net worth, why couldn't it find a buyer? What does Bernanke know that everyone else on Earth doesn't know?"
The problem is that no one has $85 billion dollars laying around. A liquidity crisis by definition is a shortage of liquidity. Even a stable company couldn't borrow the money, because people are too skeptical to lend it. They don't really know how the companies balance sheet looks. So it is quite conceivable that the Fed is making a good investment that no one else can make. Of course, it is also possible that the Fed will lose $85 billion dollars on the deal. But let's at least get straight what we are talking about, on this specific deal, it can't lose more than that.
Charlie
>> "arguing that in times of economic growth the price level should be allowed to fall (as more goods being chased by a stable supply of money means that each unit of money will buy more goods)."
I'm very glad you posted this. As a layman, I've wondered for years why there is such a wide assumption that the money supply needs to grow, no one seems to question that assumption.
I think we are pretty confident (thanks to Hazlitt and Friedman) that inflation is purely a monetary phenomenon. Assuming that we we have enough cash in the system, and I would argue that we have plenty, why should the money supply grow? As more things are produced and produced more efficiently I would expect prices to come down over time, given a fixed money supply.
The only nit in this idea is that of falling wages, I wonder if the psychological effects of that might be problematic?
No. If the net worth goes negative, its equity holders are SOL, because the creditors are paid first. A bond is a contract between the corporation and another party. The equity holders are the corporation, contractually obligated to pay principal and interest due on bonds they have sold. If a company buys mortgages and sells mortgage backed securities, its equity is the value of the mortgages (its assets) minus the value of the securities (its liabilities).
So what if this equity is negative? If I own 80% of the shares of a corporation with negative equity, I own less than nothing. If I then lend the corporation money, I become simultaneously a shareholder and a bondholder, but my loan lowers the corporation's equity dollar for dollar, because it's another liability of the corporation.
Can I be sure that the corporation will repay my loan? Ordinarily, I couldn't, because no bankruptcy court liquidating the assets of the corporation would pay me first. It would pay the other bondholders first. It would sell the mortgages and abandoned houses that are my assets, and it would pay the brokers involved in these sales, and it would pay my attorneys, and it would pay the holders of my securities, and if it had anything left, it would repay my loan to the corporation, and if it still had anything left, I'd get 80% of that too.
But if the court runs out of value before fully repaying my bondholders, I don't get my loan back.
No one has $85 billion and is also willing to lend it to AIG. The Fed could lend you $85 billion and let you buy an 80% stake in AIG, thus providing this cash infusion and allowing AIG to liquidate its assets. Why wouldn't it do that? Why wouldn't you take the deal? Maybe because you don't think AIG is worth $85 billion.
It's also quite conceivable that they aren't, and it's not true that no one else can make the investment. I could make it, if the Fed would extend the credit to me. Bill Gates could leverage $10 billion of his own capital with a $75 billion loan from the Fed for this purpose, but would he? Apparently not.
Duh. Who said it could lose more than $85 billion? But what the hell. That's chump change to the Treasury, right?