Bretton Woods for the 21st century

mike65

The G7 (whatever happened to the G8?) and the leaders of other major economies are to convene to recast global fiscal and economic policies.

Clearly given the way the current "laissez-faire" evironment has unravalled some sort of order has to be brought to bear. There is already talk about such prickly issues as tax havens and alternative visions being proffered between, for example the US gov and Sarkozy.

What changes are likely and will a revised system damage the Irish economy (the IFSC has been home for what some (ie Germany, UK) have seen as dubious advantages/tax avoidence practices).

Mike

Flamed Diving

Interesting times. I think we need to return to a pre-1980's system of banking, where traditional banks are barred from trading in securities and mainly generate profit via their 'net interest margin', fees, etc. Investment banks need to be reigned in a bit, also. Although my fear is that whatever measures they conjure to tackle the problems in this market will simply lead to more exotic means of circumventing them (such as OBS activities). I find the field of banking regulation to be one of the most fascinating subjects in economics and I will be watching this one very closely.

silverharp

mike65 wrote: »

Clearly given the way the current "laissez-faire" evironment has unravalled some sort of order has to be brought to bear.

There is nothing laissez-faire about the current system, all the problems we are facing now are due to past gov./central bank intervention, clearly since 2000 the market has not been allowed to adjust, simply a bigger bubble was inflated to cover over the cracks of the previous one.

Here is an part of an interesting article on what the Austiran school approach would be, however fat chance of it being implemented



http://www.safehaven.com/article-11556.htm

In an essay first published in 1969 and recently re-published at http://mises.org/story/3127, Murray Rothbard summarises the causes and cures of economic depressions by drawing on the Business Cycle theory developed by the great Austrian economist Ludwig von Mises. Here's an excerpt from this essay:

"Mises, then, pinpoints the blame for the cycle on inflationary bank credit expansion propelled by the intervention of government and its central bank. What does Mises say should be done, say by government, once the depression arrives? What is the governmental role in the cure of depression? In the first place, government must cease inflating as soon as possible. It is true that this will, inevitably, bring the inflationary boom abruptly to an end, and commence the inevitable recession or depression. But the longer the government waits for this, the worse the necessary readjustments will have to be. The sooner the depression-readjustment is gotten over with, the better. This means, also, that the government must never try to prop up unsound business situations; it must never bail out or lend money to business firms in trouble. Doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease. The government must never try to prop up wage rates or prices of producers' goods; doing so will prolong and delay indefinitely the completion of the depression-adjustment process; it will cause indefinite and prolonged depression and mass unemployment in the vital capital goods industries. The government must not try to inflate again, in order to get out of the depression. For even if this reinflation succeeds, it will only sow greater trouble later on. The government must do nothing to encourage consumption, and it must not increase its own expenditures, for this will further increase the social consumption/investment ratio. In fact, cutting the government budget will improve the ratio. What the economy needs is not more consumption spending but more saving, in order to validate some of the excessive investments of the boom.

SoCal90046

Flamed Diving wrote: »

Interesting times. I think we need to return to a pre-1980's system of banking, where traditional banks are barred from trading in securities and mainly generate profit via their 'net interest margin', fees, etc. Investment banks need to be reigned in a bit, also. Although my fear is that whatever measures they conjure to tackle the problems in this market will simply lead to more exotic means of circumventing them (such as OBS activities). I find the field of banking regulation to be one of the most fascinating subjects in economics and I will be watching this one very closely.

I agree, I wouldn't be surprised to see that firewall reappear.

europerson

mike65 wrote: »

The G7 (whatever happened to the G8?)

The G7 and the G8 are different things, just for your information.

Stabshauptmann

What we need is a Glass-Steagall type solution; complete seperation of commercial and investment banking.

BenjAii

silverharp wrote: »

There is nothing laissez-faire about the current system, all the problems we are facing now are due to past gov./central bank intervention, clearly since 2000 the market has not been allowed to adjust, simply a bigger bubble was inflated to cover over the cracks of the previous one.

Silverharp, I don't quite get your logic here.

You appear to be saying governments are responsible for the current mess because they added to much to money supply at the beginning of the century & thus like mindless automans the market players as they are wont created a bubble.

And yet you seem to be calling for a self-correcting market (can there be such a thing ?) as if the market had some inherent common sense of its own, which on the evidence of your previous statement you would seem to deny it does?

Or am i picking up what you are saying the wrong way ?

BenjAii

Fascinating article in the Irish Times today about this

http://www.irishtimes.com/newspaper/opinion/2008/1021/1224454424740.html?via=mr

Actually this G20 meeting the day after the US election might shape up to be of fairly historic proportions if some of the predictions about it come true i.e. replacing the dollar as a world reserve currency ...

eamonnm79

I think that one thing that would be very painful in the short term but would be common sence long run would be to make it illegal for banks to sell on mortgages.
If a bank gives you a mortgage they should have to stand over it unless they go out of business.

daveirl

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Flamed Diving

daveirl wrote: »

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That is exactly what they thought in the Great Depression. It took Keynes to show them that intervention was needed to get them out of it. I just don't agree with the style they chose this time.

BenjAii

daveirl wrote: »

This post has been deleted.

Dave you seem to be implying that the market has some inherent intelligence that means it can function perfectly if only it wasn't "interfered with" by government.

But the fact that it needs government to regulate money supply, or else it runs catastrophically out of control, would seem to negate your argument ?

SoCal90046

daveirl wrote: »

This post has been deleted.

It's an interesting perspective. On one hand, I think there's a lot of evidence to support the claim that government payments during a recession help to ease the extent of the downturn. I do agree that when it comes to some kind of major intervention on 'saving' the economy, I wouldn't necessarily agree that government always makes the correct move and could actually delay resolving the problem.

It's going to take some time to identify precisely what happened in the current crisis. Just like an airline accident (without the black box!) initial suspects may not turn out to be correct. It seems clear to me now that the problem was, as it almost always is, excessive credit, but I think it's important to remain open minded on the issue. As people examine the problem, other actors will likely emerge as having played a contributory role in creating the problem and the causes will likely be more arcane than is apparent now.

SoCal90046

BenjAii wrote: »

Dave you seem to be implying that the market has some inherent intelligence that means it can function perfectly if only it wasn't "interfered with" by government.

But the fact that it needs government to regulate money supply, or else it runs catastrophically out of control, would seem to negate your argument ?

I argue that government is the last entity you want regulating a money supply or it most certainly will run catastrophically out of control. The money supply should be controlled by an independent entity, a central bank, not beholden to party political whims.

Having said that, I think we all know that in the US, the Federal Reserve has been doing a less than stellar job recently with the money supply. I don't know if I posted the following link before, here it is; it charts the effective Fed Funds Rate and the target rate, I put the 28 day T-Bill in for good measure. Normally, the Fed Funds Rate doesn't deviate too much from the target rate, a small fraction of one percentage point, but as you can see in 2008, the Federal Reserve has lost control of the money supply. Well, it's a dramatic statement, but if you zoom in by changing the conditions of the graph (check out the boxes below the graph), you'll see that for the last few weeks, things were crazy.

silverharp

Basically I adhere to the Austrian economic approach and you will find this economic view point is popular with well known investors like Jimmy Rogers, Marc Faber, Hugh Hendry to mention a few. It comes down to the proposition that civil servants cant manage a monetary system, who the hell has the right or the ability to say what the correct interest rate should be, the correct level of monetary expansion or what the ideal inflation rate should be, central planning didnt work in Russia, why should it work anywhere else.
The market can set its own interest rate, any interference will create capital misallocation, and the property bubble this decade can be traced back to fed policy after the dot com collapse
Also the Keyensians here will have to answer why Japans stock market is still down 80% since 1990, if there was ever an exercise in keyensian intevention in the market, japan was it, textbook stuff but an utter failure, the term Zombie banks was created back then and it look like we will have our own version of them here.


extract from original link

The "Austrians" have considerable credibility because their basic theories have never been logically refuted and have been validated, time and time again, by real world occurrences. For example, in early 1929 the two leading Austrian economists of the day, Mises and Hayek, predicted that a great crash was about to occur. Mises, at the time, turned down a prestigious job with a bank because he foresaw a global banking crisis and did not want his name associated with any bank. After the crash the Austrians then warned that the large increases in spending and the various other government interventions implemented in order to stimulate the economy would turn a financial collapse into a very lengthy depression. They were again proven right. As an aside, it is often stated, as if it were a fact, that President Hoover employed a hands-off approach in response to the financial collapse of 1929-1932, thus sowing the seeds of the drawn-out depression that followed. However, nothing could be further from the truth. The fact is that Hoover was not a true believer in free markets and in response to the crash he ramped up the US Government's involvement in the economy, so much so that during the 1932 Presidential election campaign Hoover was labeled a "spendthrift" by F.D.Roosevelt, his opponent. Of course, the 16% increase in government indebtedness on Hoover's watch during 1931-1932 now looks miserly compared to the 1200% increase in Federal debt presided over by Roosevelt during 1933-1945, but at the time it was one of the largest peace-time increases ever.

There were many financial crises in the US prior to the 1930s. The main factor that differentiated the 1930s from earlier periods of crisis -- the thing that transformed a financial collapse into an economic depression lasting more than a decade -- was the government's response to the crisis. Never before had the government tried so hard to fight the contraction by ramping up its own spending, and never before had the US economy performed so poorly. Strangely, most economists seem incapable of linking the dismal economic performance with the large increase in government intervention, and, as a result, most economists still think that increased government intervention and spending is the answer (although they often disagree on the details). The Japanese thought it was the answer during the 1990s, and thus managed to transform what should have been a sharp 1-3 year adjustment into a 10-15 year period of economic stagnation. And now it's widely considered to be the appropriate response to the current woes in the US.

BenjAii

silverharp wrote: »

Basically I adhere to the Austrian economic approach and you will find this economic view point is popular with well known investors like Jimmy Rogers, Marc Faber, Hugh Hendry to mention a few. It comes down to the proposition that civil servants cant manage a monetary system, who the hell has the right or the ability to say what the correct interest rate should be, the correct level of monetary expansion or what the ideal inflation rate should be, central planning didnt work in Russia, why should it work anywhere else.
The market can set its own interest rate, any interference will create capital misallocation, and the property bubble this decade can be traced back to fed policy after the dot com collapse
Also the Keyensians here will have to answer why Japans stock market is still down 80% since 1990, if there was ever an exercise in keyensian intevention in the market, japan was it, textbook stuff but an utter failure, the term Zombie banks was created back then and it look like we will have our own version of them here.

I get the Austrian school's logic that it is an oversupply of money that leads to bubbles, which then lead to recessions. I'm less convinced by the arguement that governments can't stimulate the economy effectively afterwards.

Given that its broadly the policy of Western governments to want growth in their economies matched with low inflation, how else could it be manged if not through the quasi-governmental central banks ?

Anytime anyone proposes free markets behave optimally if left completely unhindered I can never quite understand what the are getting at.

In the first place, a free market is just a collection of human beings dealing with money, common sense would tell you a totally unregulated anarchic situation will not lead to that collective behaving optimally for the geater good of the market as an abstract entity.

Secondly, the government is the market too; there is no getting away from that. It is the lender of last resort and governments financial dealings & clout dwarf any company, not to mention the unavoidable role in regulation and law in both the market and the wider society that the market cannot be divorced from.

IMHO, people calling for completely unregulated capital markets just seems like a totally unrealistic proposition.

silverharp

BenjAii wrote: »

I get the Austrian school's logic that it is an oversupply of money that leads to bubbles, which then lead to recessions. I'm less convinced by the arguement that governments can't stimulate the economy effectively afterwards.

The Austrian response would be that you cant use the same medicine that caused the original problem, the recession would be the necessary cure so that savings and capital can be rebuilt, spending and borrowing cant create long term prosperity

BenjAii wrote: »

Given that its broadly the policy of Western governments to want growth in their economies matched with low inflation, how else could it be manged if not through the quasi-governmental central banks ?

I've no problem with central banks but they dont do what they say on the tin, as a group they have caused risk to be mispriced in the market to the point that they brought the whole system to the edge of a cliff.
Had the orignal Bretton Woods been maintained then we would not have the current set of problems.


it might not be realistic to expect but I can use "Austrian" standards to measure what is going on now

SoCal90046

silverharp wrote: »

I've no problem with central banks but they dont do what they say on the tin, as a group they have caused risk to be mispriced in the market to the point that they brought the whole system to the edge of a cliff.

I don't know if it's clear that central banks mispriced risk. There was a lack of transparency, at least in the US, that likely gave rise to the current problems.

silverharp

SoCal90046 wrote: »

I don't know if it's clear that central banks mispriced risk. There was a lack of transparency, at least in the US, that likely gave rise to the current problems.

more generally they did, the CB's that were holding dollar reserves were reinvsting in US bonds, this artifically reduced interest rates, this is one of the reasons that spreads between junk bonds and AAA got so low in the past couple of years. I dont believe interest rates would have gone so low in the absence of central bank action combined with the US gov. obsession with getting poor people in to the property market where they ought not to have been

Flamed Diving

The notion that markets solve themselves exists on a blackboard, nowhere else.

SoCal90046

silverharp wrote: »

more generally they did, the CB's that were holding dollar reserves were reinvsting in US bonds, this artifically reduced interest rates, this is one of the reasons that spreads between junk bonds and AAA got so low in the past couple of years. I dont believe interest rates would have gone so low in the absence of central bank action combined with the US gov. obsession with getting poor people in to the property market where they ought not to have been

That's a good point. When I go back and look at the numbers, it's hard to fault the Federal Reserve exclusively for the recent debacle. The Fed Funds target rate was low, but stable and there was no sign of inflation or any other signals of problems--at least the classical warning signs that the Fed has used recently didn't signal problems.

It should have been clear in the US at least that the housing market had problems. I have always looked at a very simple ratio: household income to average house price--that statistic was way out there from about 2002 to 2005. There were other indications of overheating, in fact, Greenspan himself gave signals of structural problems when he testified before Congress in '04 and '05. Warning signs were there, but aside from a few fringe writers, there weren't any serious warnings of the extent of the peril to come.

Aside from the monetary policy aspects to the problem there were fiscal policy issues and financial issues which were outside the direct purview of the Fed. I think that segregating the problem into components and analyzing each one independently isn't a bad approach. There's always a rush to judgment when problems like the one we have now occur. I think it's really going to take time to figure out what happened. Like the airliner analogy I mentioned earlier, problems in complex systems often arise from unanticipated interactions of two or more parts.

BenjAii

silverharp wrote: »

I've no problem with central banks but they dont do what they say on the tin, as a group they have caused risk to be mispriced in the market to the point that they brought the whole system to the edge of a cliff.
Had the orignal Bretton Woods been maintained then we would not have the current set of problems.

Given that, broadly speaking, it's the remit of central banks to increase money supply as much as possible to encourage growth, provided inflation is being kept in check, can they really be blamed for everything that goes wrong further down the line ?

Aside from the housing bubble, the true poison of the current crisis is that uncreditworthy debt products were given investment grade ratings and traded in an opaque system where nobody knows anyone elses exposure to what turned out to be bad debt.

The obvious blame there goes to a)rating agencies b)banks who should have known better.

So really this is not a failure of over-supply by central banks, its a failure of market players making very basic and stupid mistakes (as a side note, something else to cast doubt on an inherently intelligent, self-regulating market ? ).

Given central banks supply money to satisfy western economies constant demand for economic growth, what alternative would the Austrian model followers propose govern money supply ?

silverharp

BenjAii wrote: »

Given that, broadly speaking, it's the remit of central banks to increase money supply as much as possible to encourage growth, provided inflation is being kept in check, can they really be blamed for everything that goes wrong further down the line ?

Aside from the housing bubble, the true poison of the current crisis is that uncreditworthy debt products were given investment grade ratings and traded in an opaque system where nobody knows anyone elses exposure to what turned out to be bad debt.

The obvious blame there goes to a)rating agencies b)banks who should have known better.

So really this is not a failure of over-supply by central banks, its a failure of market players making very basic and stupid mistakes (as a side note, something else to cast doubt on an inherently intelligent, self-regulating market ? ).

Given central banks supply money to satisfy western economies constant demand for economic growth, what alternative would the Austrian model followers propose govern money supply ?

The main problem I have with central banks is that they dont understand or care about the ripple effects they create, by bailing out the market at every hiccup, LTCM, Y2K , 911........ the market has forgotten how to price risk, this distorts the market. And indeed the ratings agencies were asleep at the wheel or blatently corrupt but again this is part of my earlier point. Great for me though as I was shorting subprime debt when it was still valued at par.
Inflation is also a corruption of the system which sends out false price signals to the market. So I don't think a central bank can possibly know what is going in the market as everyone windsreen is blurry to say the least. For crying out loud they cant even measure inflation.
What is going on now is as big as 1929, and at this stage it is Margin clark 1 central bank 0 , when the dust settles on on this I would and wouldnt be surprised if the major economies went back to some kind of a gold standard. From a purely investment standpoint my next play is moving out of Treasuries and into gold and gold stocks, every other asset class s going to be a wasteland