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    Milton Friedman, libertarian economics and banks unravel

    by Sunny on 18th January, 2009 at 3:26 pm    

    The news that Barclays is about to unravel and may even have to ask to be partly nationalised made me chuckle a bit. I remember my friend Riz telling me while he used to work there that the reports he used to produce for the Forex markets were absolute shite, and yet people paid big money to read stuff a monkey could have put together. He said it was soul-destroying work and got out before they took his brain.

    Today, Will Hutton says the going is about to get a lot worse. That inspired me to pull out this short extract from a book I read recently.

    This is from Sidney Blumenthal’s: The Emergence of the Counter-Establishment (page 90)

    The origins of the [US Federal Reserve] can be directly traced to the panic of 1907, a Wall Street upheaval that almost triggered a general economic collapse Friedman assiduously presented numerous statistics about the panic. And he attributed the stemming of the crisis to the banks’ refusal to convert deposits into currency. His tone was dispassionate, but he was scoring points. To him, government intervention always destabilises the market. And the creation of the Fed is an ideal case study.

    In Friedman’s view, the Fed’s formation was precisely the wrong conclusion to be drawn from the 1907 experience. What was needed was not a central bank because, he claimed, market forces themselves achieved balance without outside interference. If the Fed had not existed, he continued, the Depression of the 1930s might have been avoided. The Fed’s policies worsened the crisis, which eventually might have been halted just as he insisted the 1907 panic ended: by the banks’ restrictions on withdrawals.

    He us so certain about his conclusion that he repeats it in Free To Choose:

    Had the Federal Reserve System never been established, and had a similar series of runs [on the banks] started, there is little doubt that the same measures have been taken as in 1907 - a restriction of payments… by preventing the draining of reserves from good banks, restriction would almost certainly have prevented the series of bank failures in 1931, 1932, and 1933, just as restriction in 1907 quickly ended the bank failures then… The panic over, confidence restored, economic recovery would very likely have begun in early 1981, just as it had in early 1908.

    [Some background on what created and alleviated the 1907 crisis]

    Friedman’s deficient history proved his own assumptions m at least to Friedman, the Fed, to him, was solely the device of big government; yet he unfairly slighted the bqankers. His history of 1907 incited him to dramatic claims about 1929. If the Fed had not been created, he asserted, we would have been spared the Depression. He insisted that its cause was the Fed’s imprudent reduction of the money supply. Unfortunately, on this point, Friedman suffers a shortage of facts, namely that from 1929 to 1932, the money supply fell by less than 3%, prices dropped by more than 30%, and unemployment rose to 25%. Leonard Silk, the economics columnist of the New York Times, wrote that it is, “difficult to see how such a catastrophe could have resulted from so small a decline in the stock of money.”


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    9 Comments below   |  

    1. flipside — on 18th January, 2009 at 3:47 pm  

      Peter Schiff Shrugged.Buy Gold.

    2. Riz — on 18th January, 2009 at 7:04 pm  

      Happy new year Sunny Jim…I come over to see if PP has anything on the blockbusting Bollywood films of late and see this interesting post…it’s so nice to some Pickled Economics on here!

      From what I have read, it does look like the liabilities side of the financial institutions way outpaced asset growth for too many years, and that recent gvt efforts are probably too small to plug the gap.

      Re Barclays specifically, I don’t think I phrased it quite like that Jimmy(!), but perhaps along those lines - I definitely felt that it was hypocritical to keep working in a function where my contribution and the teams overall contribution was questionable: working in research presented a major Catch-22 situation - on the one hand, if markets are efficient, then predictive research has almost no value, but on the other hand, if you truly believe in your analysis have value then you shouldn’t be giving it out free to clients!). The thing is, I don’t think I’ll ever be in such an intellectually challenging role again, but I questioned the system in which I operated and the answers came up wanting; thus, in order to be true oneself, I opted to travel and take up trading independently. There was a long list of pros and cons to be thought through when making this decision, and when it came to the crunch, if I had been motivated by money I would have stayed…as it was and as it is, I am not, and I didn’t. I guess they really did by your soul in the sense that they paid so much that it created an incentive not to ask such moral questions.

      Anyway, back to Barclays - I wouldn’t quite count them out yet, dude. The same Guardian article also says:

      ‘Barclays denied it faced financial problems and rushed out a statement to the New York stock exchange before trading closed. The bank, which is due to report its figures next month, said profits before tax for 2008 after all charges and costs should be well above forecasts of £5.3bn. The bank’s tier one capital ratio should be 6.5% at the end of the year and the total capital ratio will be 9.1%, putting it in line with many ‘of its peers.’

      And with the FT saying that on Friday, the entire mkt cap of Barclays dropped to £8.2bn, it looks like it it trading ridiculously cheap. Either the board doesn’t know something, in which case it would go to zero pretty damn fast, or, and I expect this is the case, short selling pressure from the expiry of the short selling ban may have conspired to a panic sell situation, in which case, we could get a monster rally on the open. Whatever the case, it is only one bank and in the grander scheme, the financial sector is in a hellish situation.

      More later, but for now I must watch Portillo’s documentary on Christianity of C4.

      : )

    3. MaidMarian — on 18th January, 2009 at 7:38 pm  

      I’m not altogether sure what Friedman would have made of bad debts, given that he essentially placed his faith in the rationality of markets.

      I suppose that he would have said it is a bank’s risk, but when those bad debts are at such a level where they need to be essentially socialsed to sustain I doubt he would have been so sanguine given that the market is harming individuals and crimping liberty.

      I also wonder what he would have made of UK style house price inflation. I doubt he owuld have thought of it as rational.

    4. Riz — on 18th January, 2009 at 8:42 pm  

      Over the years, despite a lack of interest in accumulating money and material possessions, I have developed a very strong appreciation for capitalism as an efficient allocator of resources, and an appreciation for the libertarian school of thought.

      Re libertarian economics, there have been some articles saying that the crisis is a slap in face for the libertarian philosophy, but those who count themselves part of the movement would say ‘Oh contraire, the current crisis is far from a crisis of libertarianism, but it the result of many years of government interference’. Of the top of my head, here are some examples of how the governments may have contributed to the crisis:

      - Since Thatcher and Reagan, the idea of owning a home has been promoted by the government. What makes them think they have the right to tell us what we should be buying? They pretended to be all free market, and then sold everyone the dream of one day owning their own house…so much for personal freedom.
      - Freddie Mac/Fannie Mae - still not sure about the exact roles of these institutions but these semi-gvt bodies played no small role in the crisis.
      - The Fed lowers rates every time a crisis occurs, effectively bailing out the financial sector each and the risk takers, creating a vicious moral hazard / ‘Greenpan put’ situation.
      - The world foreign exchange markets are rigged by the fact that the so many of the current account surplus countries have fixed exchange rates. This has led to a world where hundred of billions of funds get recycled back to the US in the form of Treasury purchases, pushing down rates along the yield curve, lowering mortgage rates, and other financing rates, etc.

      And how are we going to solve this mess? With more government intervention, bailing out the losers and making the innocent suffer? I don’t like it one bit.

      PS - Despite what Greenspan says, the many (perhaps most) libertarians I have come across do not count him amongst their own. The only well positioned libertarian with a public voice I can think of is Ron Paul. Youtube him to hear some wise words. (He may belong to the GOP but that’s by the by).

      A quote from the famous economist, Hayek: ‘the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.’

    5. Shamit — on 18th January, 2009 at 9:22 pm  

      Interesting points made by Riz. However, at a public policy and regulatory level, the worrying aspect lies in the fact that they failed to learn an iota from then the world’s second largest economy in Japan.

      The problem in Japan started to happen during 93-94 and it was due to dodgy inflated real estate prices not only in Japan but also in California. These real estate deals were backed by Banks through imaginary profits and money with collateral which were surely not half as valuable as they were deemed in the bank balance sheets.

      When the whole house of imaginary profits and money came falling down - - the response of the Bank of Japan and the politicians, driven by stalwarts such as Greenspan, Rubin, Summers were to first, reduce interest rates, then recapitalise the Banks - then more funding to get rid of the bad assets — and basically hope for the best. The result was the first major economy to come under deflationary pressure.

      Any first year student of economics knows what happens when an economy has deflationary pressure — the impact on overall economic growth, production will fall drastically. What partially saved the Japanese economy is its R&D and mega multi-national corporations with global markets, especially in the US and Western Europe and in the emerging tiger economies of South East Asia. Then countries such as India and China by consumption saved Japan’s bacon. But it barely survived… and the welfare society is almost non-existent in comparison to US/UK. Therefore, Japanese Government did not have to shell out as much as these Governments would have to.

      Fifteen long years later, our policy makers are going through the exact same cycle and doing the exact thing. One of the most cardinal rules of free market capitalism is maintaining the confidence of the consumer not only in the market but also regulators and government doing their jobs.

      That is where the entire Western system has failed and to be fair, the US is in a far better situation to get out of it. The US system of Governance enables a President to appoint technocrats, respected academics and researchers and other authoritative figures to run Government departments and programmes and they need not be politicians. And, their politicians usually have more broader experiences than just working for a party or party based think tanks before they get in office of any sort. And, the political appointees go far down the ladder and its not just the top two positions in any department. Not only that they still have the most expenditures on r&D in the world and remains first in patenting and taking ideas to commercialisation with the least amount of time.

      Sadly on this side of the pond, we have exactly the opposite — where most of our cabinet ministers have done nothing but work as interns or professionals in think tanks or advisors to other senior politicians and very little outside experience. For example, look at our cabinet - Miliband Brothers, Douglas Alexander, Ed Balls (reporter for Financial Times for a couple of years dont count for much), Yuvette Cooper, and our current DWP secretary. None of them have any real experiences outside of the small world of labour politics. And, they did not win their seats because of massive mass support but rather because of patronage. Not because they took up a challenge for a community and moved ahead. Those that did are still languishing in junior posts such as Sadiq Khan — a successful lawyer who is regarded as an expert of Human Rights law.

      While many critics have said that Obama has very little hands on experience compared to other American politicians — he has tons of experience in campaigning, community organising and earned his spurs as he made his way through the very combative American political landscape when you compare him to our politicians.

      So, I am not surprised Gordon Brown is claiming to have novel ideas when the Japanese Government tried the same things 15 years ago and they did not work. So much for the claim to save the World —

      We need to find ways to restore credibility and confidence. One of the reasons the Japanese crisis did not affect the entire Global economic system is the media was not global yet. Good news travels fast and bad news travels even faster and it is difficult for the consumer to have confidence when they all hear is doom and gloom all day long.

    6. Zak — on 19th January, 2009 at 12:47 am  

      sooo translation we’re doomed?

    7. Shamit — on 19th January, 2009 at 1:03 am  

      Zak - I actually don’t think so.

      I think finally we are going to see some infrastructural investments — albeit it would be difficult for Britain as we don’t have much in the kitty - but we would borrow to do so.

      Infrastructural investments have two fold advantages — a) it helps is bringing about employment across the socio-economic backgrounds -

      b) it helps us prepare to be more competitive in the future.

      Do we need changes? Heck yeah but not the non thinking I know best ones that this Government has espoused.

      Interestingly, providing guarantees to SME loans from Banks is a good thing as well — the Tories have been calling for it and finally the Government saw the light. Its sad for someone centre left to agree but I think Tory policy actually made more sense than Mr. Brown and his cabal.

    8. shariq — on 19th January, 2009 at 11:49 am  

      Excellent comment Shamit - agree with everything that you say about the experiences of cabinet members and mp’s more generally. btw, do you know much about the Swedish model of getting out of a financial crisis? Was it the same as the Japanese one or different?

      Also agree on infrastructure. Although again, the mismanagement by the government is awful. The problem in America is that they don’t have many infrastructure projects ‘ready to go’, especially on stuff like high-speed rail which will help reduce carbon emissions in the future.

      What excuse does the labour government have? Given the fiscal deficits being racked up right now and the need for belt-tightening when the economy picks up, I’d say the government’s ability to invest in reducing emissions will be very limited.

    9. Shamit — on 19th January, 2009 at 1:19 pm  


      What I know of the Nordic crisis in 1993-1994 was that each country went in different ways but the basis was same.

      In |Sweden, what I know is that they created an agency to take over all the bad assets and basically took over the banks and held on to them. The shareholders in the bank lost completely for a long time but the depositors were safe.

      And at the same time, they put measures in build up credibility - thats what they say but I haven’t found much examples of exactly what policy tools they had used. If you find any do let me know.

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