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Bursting the bubble

The Origin of Financial CrisesPicked up The Origin of Financial Crises: Central Banks, Credit Bubbles, and the Efficient Market Fallacy, by George Cooper recently.

Yeah, I know … sounds really exciting doesn’t it. But in reality, from what I’ve read so far, the book seems to do a great job of explaining how the global economy has been pushed into crisis, and offers potential solutions … one of these being that “avoiding financial tsunamis comes at the price of permitting, even encouraging, a greater number of smaller credit cycles.”

In other words, Mr. Cooper is arguing that instead of staying out of the markets when the economy is growing, but jumping in and cutting interest rates when the economy is contracting, the world’s central banks should permit some short-term cyclicality in order to purge the system of excesses, which can be accomplished by preventing excessive credit creation (which he defines as credit growth far ahead of economic growth).

This doesn’t mean that Mr. Cooper is arguing that the central banks stay out completely; when things do reach crisis proportions, as they have currently, central banks do need to intervene, but they need to be careful NOT to inflate another credit bubble.

I need to finish reading the entire book to really give it a thorough review, but thus far it’s quite an interesting read.

5 Comments on "Bursting the bubble"

  1. Sounds like in forest management, where an occasional brush fire keeps the undergrowth down and the forest healthy. Put out all the brush fires and the tinder grows up to the point that when you do have fires, they cause real damage.

    • That’s a great metaphor. Small fires are healthy, but if one really does get out of control, you have to intervene and can’t just let it burn itself out, because the destruction that will be wreaked will take decades to recover, and if the people caught in its path panic, then it can take even longer to get the situation under control.

      The problem is that the laissez-faire proponents of the efficient market theory seem to want to let the current wild-fire in the economy burn itself out, rather than taking steps to control it and protect people caught in its path.

      Yes, there will be sacrifices … it’s inevitable that in the current economic climate, some jobs will be lost and some businesses will fail, just as certain neighborhoods and homes may be sacrificed in a wildfire to try to prevent the spread of the fire further.

      Pumping money into banks will do more good than pumping money into the auto industry. Creating jobs by spending money on infrastructure will do more good than tax cuts. The problem is that, like when fighting a wildfire, mistakes can and will be made … some good people will suffer, and some bad people will benefit from the efforts.

      What’s worse? Pumping money into a bank, the CEO takes a $25MM bonus, but the bank survives and 20,000 people get to keep their jobs? Or letting the bank fail, and 20,000 people losing their jobs?

  2. While, I don’t disagree with the general notion that many, but less intense, business cycles would be preferable to having a “great moderation” but then having to deal with a once in a lifetime downturn, I don’t know whether it takes pro-active interventionism to get that done. I know that when the economy was relatively “laissez-faire” and the banking sector decentralized, there were more booms & busts. Some of them were deep and long, and some of them were small & short. I believe basically all business cycles are caused by unnecessary expansion of credit, followed by the contraction of credit (or any policy really that affects capital flow I suppose). I also believe that the structure of production has to do with the cyclicality of the economy, and that even if the old policies were still in tact (we were to have no central bank etc.), there would be fewer booms & busts, and they’d be relatively quick & small because we’re much more of a consuming society as opposed to a producing society. So I’m basically saying that I believe laissez-faire would basically give us those small yet many business cycles. It’s hard to know though. Also, I believe banking in general, as practiced throughout most of history is misbegotten. What if the entire financial, banking & monetary system need radical change to get things right, instead just tinkering around with it?

    Anyway, I didn’t mean to post all that, but I did so I’ll just go ahead with it. What I wanted to do is disagree with your point that building infrastructure is better than tax cuts. Not that I’m ideologically for tax cuts (though I must admit I am), but building infrastructure doesn’t sound like a good idea. First, there are all the regulations (such as environmental) that one has to comply with before building the infrastructure, ergo, it takes considerable time to start up the actual building. It takes even more time to get the secondary effects of that infrastructure, if there will indeed be any. (I have to assume that at least some won’t be built because there is a demand for them in the market, but rather some will be built mainly for political reason, and some of these infrastructure projects are mostly costs because we’re just repairing/rebuilding stuff, we’re not necessarily creating something new). Furthermore, the construction for these projects require more skills than ones of 80 years ago or whatever. I don’t see how it will be extremely beneficial to the economy as whole.

    Lastly, I wanted to disagree that it’s justifiable to pump money into banks, because otherwise people would lose their jobs. Who says the only way for them to keep their jobs is keep their banks as zombie banks? Also what if it’s better in the long run that they not keep their jobs there? Yes, temporarily they’ll lose their jobs and suffer a hard time (of course, there is still some help from government and other sources, so they’re not entirely on their own), but it’s not like the situation is permanent. Second, pumping money has always been justified by politicians, policy makers, pundits etc. saying that if we didn’t pump money into these institutions, that civilization would collapse. How do we even know if that’s true? I heard that in Russia 95% of the banks failed (I don’t know if this is true or not, and I don’t know what time period this applies to). I’m not suggest we should go through that, but at any rate, they still recovered. Perhaps employees should keep their job at banks, but at least change the management, and not let the same CEO that ran the business into the ground take millions or billions in bonuses.

    Anyway, sorry for my rambling, but I still have more to add. Mostly, I want to know what you say to the people who think all the intervention is what causes us to go through decades long of “recovery.” The Japanese tried intervention to get out of their stagnation/recession. They still aren’t out of it (although the recent downturn is not the fault of their own, since all economies are tanking pretty much.) Hoover couldn’t stop the deflation/depression through his actions. Roosevelt at first had some success, but during the last years of the 30’s things got bad again, and FDR’s treasury said that they tried spending their way out of it, couldn’t and all they had to show for it was comparable unemployment as during the beginning of the decade, and much more debt to boot. Doesn’t seem like intervention is the be-all-end-all.

    • It’s way too early in the morning to give a full response, but briefly:

      The infrastructure projects being discussed are “shovel-ready”, meaning that they’ve already been planned, environmental studies completed, etc … essentially projects that were just waiting for funding to be started. These are projects that can put people to work sooner, rather than later. Repair/maintenance of infrastructure is still a necessary expense that too often gets pushed back due to lack of funding. The bridge collapse in Minneapolis a couple years ago is such an example. I don’t know where you live, but the state of the roads/freeways in Utah is horrid. We’ve been focussing on widening I-80 recently, but there are many other projects that need to be completed. Much of the funding that Utah is receiving from the ARRA’09 will be going towards that, and will be putting people to work.

      As for banks; going forward it appears that only banks that can pass stress tests will be getting additional funding, while those that cannot will be allowed to fail. This will weed out the weaker banks, but allow the stronger ones (which in the current state are still pretty weak) to survive. Time will tell how Geithner’s plan will be implemented.

      Many economists believe that the reason why Japan’s problems stretched on so long is because government intervention was stopped too soon; essentially at the first signs of economic upturn, rather than continuing it for several more quarters to ensure that the recovery had a solid footing. Hoover didn’t do much to intervene; most of his views were based on public/private volunteerism, rather than massive government intervention. This is why many have accused him of being an adherent of Treasury Secretary Andrew Mellon’s “laissez-faire” ideology. He was also a trade protectionist, and his policies of raising tariffs on imported goods after the 1929 crash sparked a trade war that actually hastened the Great Depression, rather than slowing it down. The “Buy American” clause in the ARRA’09, while understandable, is not a good idea. I think it should be “buy American when feasible”, not “only buy American”, but that was Congress, rather than President Obama … again, we’ll see how it’s actually implemented.

      No, intervention isn’t the be-all-end-all, but neither is do-nothing-laissez-faire-let-the-markets-work-it-out.

  3. Fair enough. I still disagree with infrastructure spending being a boom to the economy, whether shovel-ready or not. And I’m not convinced by your point about Japan, but I’ll have to look into that. Anyway, have a good life.

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