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Monday, December 22, 2008 12:04 PM

Fiscal Insanity Virus Rapidly Spreading The Globe (Part 2)

Mish Moved to MishTalk.Com Click to Visit.

This post is a continuation of Dangerous Virus Rapidly Spreading The Globe (Part 1).

If you have not yet done so, please read part 1. The symptoms of the FIV disease are complex. Part 1 addresses the symptoms and part 2 below continues with more symptoms and a discussion about preventative measures and cures.

Part 2:

Most In Congress Infected With FIV

Most Congressional member are afflicted with FIV, as is Paulson and president Bush, otherwise the reckless $700 billion bailout package would never have passed. True to form, those in the highest positions of authority, notably Speaker of the House Nancy Pelosi and Finance Chairman Barney Frank, show the most severe symptoms. President elect Obama shows signs of being in the late stages of FIV already.

Hair samples are not even required to make this determination, one can now reliably identify those afflicted with FIV by the symptoms alone.

Interesting enough, Congress is calling for more regulation of Fannie Mae and Freddie Mac, yet the first thing a regulator in his right mind would do would be to shut them down. Instead, Congress wants Fannie and Freddie to lend more.

Calls from Krugman and others scream for more regulation even though it is perfectly clear regulation in and of itself always fails.

Power Grab By Those Infected

Another distinguishing characteristic of FIV is those afflicted have a marked propensity to usurp power not caring whether it is legal or not.

I discussed this phenomenon in the Fed Uncertainty Principle.


Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

Corollary Number Three:
Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.

Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
Academic Wonkishness

Those with FIV are trapped in academic wonderland with no ability to see anything from a real world logical perspective. Instead they rely on formulas that imply free lunch theories and/or perpetual motion.

Here is a recent example of Krugman trapped in academic wonderland: European macro algebra (wonkish).

I’ve been on the warpath over Germany’s refusal to play a constructive role in European fiscal stimulus. But what does the math look like? Here’s a simple analysis — well, simple by economists’ standards — of the reason coordination is so important for the EU. ....

Consider the effects of an increase in government purchases dG. This will raise GDP directly, to the extent that it falls on domestic goods and services, and indirectly, as the rise in GDP induces a rise in consumer spending. We have:

dY = (1-m)dG + (1-m)(1-t)c dY

or dY/dG = (1-m)/[1 - (1-m)(1-t)c]

Since governments are worried about debt, it’s also important to ask how much the budget deficit is increased by an increase in government spending. It’s not one-for-one, because higher spending leads to higher GDP and hence higher tax revenue. We have

dD = dG - tdY

A crucial number is “bang for euro”: the ratio of the increase in GDP to the increase in the deficit. After a bit of grinding, it can be shown to be

dY/dD = (1-m)/[1 - (1-t)(1-m)c - t(1-m)]
It is impossible to argue against such wonkishness except with logic that an average 8th grader would understand.

Non-Wonkish Rebuttal

  • The average 8th grader understands that one cannot continually spend more money than he has.
  • The average homeowner who has been foreclosed on understands that buying more house than he could afford vs. wages earned was a very bad idea.
  • The average economics professor afflicted with the K-Virus thinks that it is possible to spend one's way out of a fiscal crisis.
  • The average economics professor afflicted with the M-Virus thinks that it is possible to inflate one's way out of a fiscal crisis by destroying the currency.
  • The average congressional representative believes in the free lunch theory of spending many multiples of what is collected in taxes.

Why is it that the average 8th grader has a better grasp of economics and fiscal sanity than the average economist and the average member of Congress?

Scientists are now in a race against time, attempting to figure out why economists and Congressional representatives are more prone to FIV than eighth graders. Preliminary results indicate immunity at birth that wears off as one ages.

The Economic Free Lunch

The problem with academic "wonkishness" is that it is tantamount to belief in perpetual motion free lunch physics.

Greenspan employed the very policies espoused by academia and all it did was create a bigger bubble. Now that the bubble has popped, the K's and the M's argue with each other how best to blow a bigger bubble.

Those afflicted with the K-Virus fail to look ahead to what happens once government stops building bridges, roads and whatever else they propose. What happens (in the absence of still more stimulus) is economic activity returns to where it was before, only more money was squandered in the meantime because of government graft and because schools, roads, and bridges will be repaired that did not even need repairing.

Wonks fail to see that Keynesian spending to "prime the pump" is much like a heroin addict needing forever increasing amounts of dope to achieve the same high. The only solution for the heroin addict is to kick the habit. The only solution for governments to stop fiscal insanity.

Japan Model Revisited

The system collapses when a bigger credit bubble cannot be blown. This happened in the great depression, more recently in Japan, and again now in the US.

Please consider an Interview with Paul Kasriel from December 11, 2006.
Mish: Would you say that consumer debt in the US as opposed to the lack of consumer debt in Japan increases the deflationary pressures on the US economy?
Kasriel: Yes, absolutely. The latest figures that I have show that banks' exposure to the mortgage market is at 62% of their total earnings assets, an all time high. If a prolonged housing bust ensues, banks could be in big trouble.

Mish: What if Bernanke cuts interest rates to 1 percent?
Kasriel: In a sustained housing bust that causes banks to take a big hit to their capital it simply will not matter. This is essentially what happened recently in Japan and also in the US during the great depression.

Mish: Can you elaborate?
Kasriel: Most people are not aware of actions the Fed took during the great depression. Bernanke claims that the Fed did not act strong enough during the great depression. This is simply not true. The Fed slashed interest rates and injected huge sums of base money but it did no good. More recently, Japan did the same thing. It also did no good. If default rates get high enough, banks will simply be unwilling to lend which will severely limit money and credit creation.
The Debt Bubble And Its Root Cause

It is not falling prices that is the issue here as some seem to think. Rather it is the massive amount of debt (malinvestments) and inability to pay that debt back that is the problem.

That debt problem did NOT come about as Krugman suggests in The Bushies and the bubble.

"I’m also with Barry Ritholtz that Bush’s emphasis on homeownership was not the problem. Bush favored homeownership; I’m sure he also favored marital fidelity; his influence on homeownership and his influence on adultery were probably comparable. It’s Bush’s opposition to financial regulation that did the evil deed."

Ritholtz and Krugman are both wrong. Lack of regulation, notably the repeal of Glass Steagall Act, is nothing more than a scapegoat.

Time and time again Krugman, Mankiw, and others, even Ritholtz fail to take the problem back to the root cause: Government Regulation, Fractional Reserve Lending, and the Fed.

Let's Play A Non-Wonkish Game Of Q&A

Q: Do we need a regulator for Fannie Mae?
A: Of course not. Fannie Mae should never have existed in the first place. Fannie Mae should be dissolved.

Q: Do we need regulation of the rating agencies?
A: Of course not. It was government sponsorship of the ratings agencies (not lack of regulation), that created the ratings game scandal. (see Time To Break Up The Credit Rating Cartel for a complete discussion of this idea).

Q: Was regulation that removed leverage restrictions on the brokerages the problem?
A: Of course not. Citigroup managed massive leverage in spite of regulation. Citigroup did it by hiding assets off the books in SIVs. Had regulation explicitly not allowed Bear Stearns and Lehman to leverage up, they would have done so just as Citigroup did.

Q: Doesn't the above argue for tighter regulation?
A: Of course not. The above proves that corporations will work hard to get around such rules. The solution is to not allow fractional reserve lending. Without fractional reserve lending, such leverage would be impossible.

Q: Wouldn't abolishing fractional reserve lending go against Libertarian ideals?
A: No. Fractional reserve lending constitutes fraud. Government should preserve and honor property rights, not perpetuate fraud. There are no inherent rights to perpetrate fraud.

Q: If fractional reserve lending is fraud, who is the victim?
A: Inflation (increase in money supply and credit) benefits those with first access to money (the government, banks, and the wealthy). Inflation is a tax on the middle class and especially the poor who are last in line to money. The housing bubble and falling lending standards are proof enough.

Q: How is fractional reserve lending fraud?
A: Please consider Murray N. Rothbard and the Case for a 100 Percent Gold Dollar. Rothbard condemned fractional reserve banking as a violation of contract.
"In my view, issuing promises to pay on demand in excess of the amount of the goods on hand is simply fraud, and should be so considered by the legal system. For this means that a bank issues "fake" warehouse receipts — warehouse receipts, for example, for ounces of gold that do not actually exist in the vaults. This is legalized counterfeiting; this is the creation of money without the necessity of production, to compete for resources against those who have produced. In short, I believe that fractional-reserve banking is disastrous both for the morality and for the fundamental bases and institutions of the market economy...."
From an Austrian economic point of view, as Rothbard argues above, Krugman and Mankiw are sponsoring policies that constitute fraud. Sadly, sponsorship of fraud and other socialist policies is rampant at universities.

It is stunningly ridiculous to expect regulation to solve major problems when it is regulation that caused every major problem we have!

The Austrians Were Right

Inquiring minds are reading Ron Paul, one of the few in Congress still with a sound mind.

Please consider The Austrians Were Right.
Before the U.S. House of Representatives, November 20, 2008

Madame Speaker, many Americans are hoping the new administration will solve the economic problems we face. That’s not likely to happen, because the economic advisors to the new President have no more understanding of how to get us out of this mess than previous administrations and Congresses understood how the crisis was brought about in the first place.

Today, a major economic crisis is unfolding. New government programs are started daily, and future plans are being made for even more. All are based on the belief that we’re in this mess because free-market capitalism and sound money failed. The obsession is with more spending, bailouts of bad investments, more debt, and further dollar debasement. Many are saying we need an international answer to our problems with the establishment of a world central bank and a single fiat reserve currency. These suggestions are merely more of the same policies that created our mess and are doomed to fail.

At least 90% of the cause for the financial crisis can be laid at the doorstep of the Federal Reserve. It is the manipulation of credit, the money supply, and interest rates that caused the various bubbles to form. Congress added fuel to the fire by various programs and institutions like the Community Reinvestment Act, Fannie Mae and Freddie Mac, FDIC, and HUD mandates, which were all backed up by aggressive court rulings.

The Federal Reserve created our problem, yet it manages to gain even more power in the socialization of the entire financial system. The whole bailout process this past year was characterized by no oversight, no limits, no concerns, no understanding, and no common sense.

Similar mistakes were made in the 1930s and ushered in the age of the New Deal, the Fair Deal, the Great Society and the supply-siders who convinced conservatives that deficits didn’t really matter after all, since they were anxious to finance a very expensive deficit-financed American empire.

All the programs since the Depression were meant to prevent recessions and depressions. Yet all that was done was to plant the seeds of the greatest financial bubble in all history. Because of this lack of understanding, the stage is now set for massive nationalization of the financial system and quite likely the means of production.

Although it is obvious that the Keynesians were all wrong and interventionism and central economic planning don’t work, whom are we listening to for advice on getting us out of this mess? Unfortunately, it’s the Keynesians, the socialists, and big-government proponents.

Who’s being ignored? The Austrian free-market economists – the very ones who predicted not only the Great Depression, but the calamity we’re dealing with today.

Please read Ron Paul's speech in entirety. It is one of his best speeches. If Krugman and Mankiw could somehow escape academic wonderland, they are advised to read it as well.

FIV Prevention

An ounce of prevention is worth a pound of cure. FIV is highly contagious. It is best to avoid contact with anyone showing signs of the disease. This is very difficult to do for those taking economic classes, working at any university, or working for the government in any fashion (especially Congress).

Fortunately, there is a preventative measure. Those in frequent contact with gold bullion or gold bars and those even thinking about buying gold seem to have superior resistance to FIV.

This preventative measure was discovered by noted Dr. Au Buygold who suggests "Buy two ounces and call me in the morning" if you start showing any unusual symptoms. Preventative measures may work if the symptoms are addressed soon enough.

FIV Cures

Unfortunately there is no known cure for the later stages of FIV. Once infected, the virus progressively and irreversibly damages the brain, causing the victim to engage in increasingly reckless activities with no apparent concern that those activities may be illegal and/or a violation of the constitution.

Federal Reserve Chairman Bernanke is the classic example of someone clearly in the late stages of FIV.

Don't be an academic wonk, and don't let this happen to you. Take preventative measures against FIV today. Your brain and your financial well being may depend on it.

Mike "Mish" Shedlock
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