Wall St. Rises on Fed Official's Comments

Yahoo/Reuters ^ | 11/12/02 | Chelsea Emery

[LS]

Yah, I also overreact due to limited time. That's what happens when you're raised up a poor white kid in a black ghetto, beaten up on the way to school every day . . . oh, wait. That's Eminem. Never mind.

[LS]

First, the value question requires both a buyer and a seller. Any good, at any time, obviously can be valueless, or can be extremely expensive depending on demand. That may not speak to a company's productive capacity, efficiency, "profitability," or patent monopolies, but entirely to the demand side. We saw this in the Great Depression. There were plenty of hogs, sheep, goats, and wheat, but no one had money to buy them. It implies (but does not prove) that we need more cash liquidity, not less.

It seems a little odd that you say that now, in light of the stock market downturn (hardly a crash), all these studies should be discounted. A just as reasonable conclusion might be in the opposite direction---that these companies actually in the last two years LOST MORE VALUE than has even been reported, and I might go along with that. Frequently what "markets say" and what they appear to say at the time are totally different things. Virtually everyone in the Fed the 1920s thought that the "markets were overheated." We now know that just the opposite was true---they had much more room to grow, and by 1929 were being starved of cash.

At any rate, I'm pleased you've been reading my posts for ten years. (Have I been posting that long?) I'll convert you yet :)

[LS]

I give! I'm not going to post anything on economics for a year (lessee, that's Nov. 2003). By then, we will at least have some direction here, and have some clearer evidence. Talk to you guys then.

[David]

Reply to your #62 responding to my #56:

What you say in your first paragraph is just a denial of the free market economic system. Day one in Econ 101 is "human wants are unlimited and resources are limited". Economics is all about how we allocated limited resources to unlimited wants. I want lots of stuff I can't afford (my Porsche is old and has 250000 miles and would look a lot better if it were a Carrara4).

Problem with the absence of liquidity to buy the hogs, sheep, goats and wheat was that no one had the ability to generate that liquidty, either by borrowing it or by earning it. Could not borrow because no one had the income to pay loans back. Same problem today--liquidity is abundent (I get credit cards in the mail and bankers call wanting to loan me money just like everyone else). Fed could create sufficient liquidity today in the hands of the people who want to use it (just as it could have in 1931) but if it did that, it should destroy the dollar; and in fact, the risk that the Fed might do that is the principal reason that (notwithstanding today) gold is in an uptrend.

Because printing the money to give it to the guys who want to buy hogs, sheep, goats, and wheat will cause the value of the printed fiat paper to go down (MV=PT--when you increase the paper M, the value of the paper M will go down in terms of its exchange for goods and sevices at T).

"It seems a little odd that you say that now, in light of the stock market downturn (hardly a crash), all these studies should be discounted."

These studies, like the arguments Richard cited you to that the fundamental P/E valuation should be modified, are part of a continuing effort by the brokerage community to lead investors to believe that they should buy common stock because it will go up tomorrow. Those studies are all incorrect because the market action demonstrated that stocks were not going to go up for the reasons cited at all.

Instead, stocks went down. The studies were dead wrong.

"Virtually everyone in the Fed the 1920s thought that the "markets were overheated." We now know that just the opposite was true---they had much more room to grow, and by 1929 were being starved of cash." That's not true either. Now you may be able to find some one Fed governor who from time to time might have said words like what Greenspan said in 96 about irrational exhuberance. But the essential problem in the 1920-1949 period was exactly the same problem we have in the 1990-2020 period.

The monetary authorities created way too much excess liquidity in the 1920's which caused excessive prices in the stock market, as well as throughout the economy, just as the fed did in the 1990's. That excess liquidity was put in the hands of users the same way it was in the 1990's to the end that debt became unservicable out of income levels resulting in defaults and illiquidity. And it took a combination of substantial inflation in the 1940's and default liquidation from 1930 to 1949 to work out of the hole. Same future we face today.

The Liberal political establishment created this "starved of cash" analysis and promoted it in the Liberal economic community to refute the fundamental truth that the Fed's mismanagement of monetary policy in the 1920's was the root cause of the depression in the 1930's. The fiction continues that the Fed followed its limited liquidity mistake of the 1920's (which on the record did not exist) with failure to respond promptly to the economic crisis by printing money.

In fact, there are books which contain interviews with individual Fed governors of the 1930 period where they tell you exactly how they were trying to create and deliver as much liquidity at as cheap a price as possible and it did not work. Same result today even though the Fed has started the printing press much earlier in the econmic cycle.

Only possible change in result is that the Fed is effective and manages to destroy the monetary system by creating runaway inflation.

None of this is any surprise to anyone who has studied any modicum of economics and economic history.

[imawit]

It implies (but does not prove) that we need more cash liquidity, not less.

Ya know, I completely agree with this. And in my way of emphasizing this I say the same thing. But more liquidity does not and should not be stuffed into the system thru credit. It ain't goin to happen with every one getting a salary increase or a brand new job either.

Where the bullit needs to be bit is in government where taxes need to be lowered, eliminated, etc.

This is very efficient because the dollar doesn't get inflated in qty, devalued against an interest number or other foreign dollar. The economy can suddenly have more dollars to save AND spend all at the same time. And these dollars can buy goods that have been or can be produced and it's in the right hands that are going to save and spend it.

The government makes a huge mistake when it takes a billion dollars and every man woman and child gets $4ea. If 10 million citizens got to keep $100ea and if this were true for every other week of the year, that would be tremendous buying and saving power. And that kind of power would but all industries back into heavy volume & profit.

Just don't hold your breath for the selfish politicians to put this into effect. They think taxes are a birth right and obviously their power to tax an undeniable gift of the Gods.

[imawit]

Missed seeing your #64 before I posted my #65

Are we in agreement. Money into consumers hands is the solution.

The question is....How do we get that money there. I propose that it's already there and in stead of confiscating it, the consumer needs to be allowed to put it to work.

Savings, debt reduction and spending using money that is already there. Wow is this a novel idea or what ?

Actually this is just a very natural market & economy function and a powerful one at that. Taxation reduces this natural function, succinctly taxation reduces and can destroy natural functions. Taxation is (although no one will admit it) an unnatural, restriction on the economy and markets. It is also a prime factor in economic and market decisions.

As long as we have arbitrary non natural factors placed in the market, to a lesser or greater degree, the market will disfunction.

[LS]

Certainly lower taxes will help. I think, though, the quickest things would be changes in depreciation schedules (involving taxation) and capital gains tax cuts, which are key.

But I think we can't overlook the significance of continually growing regulations, which is what is causing the boom in "microbusinesses" that I discussed earlier. The more I think about this, the more I think David is wrong here: remember in the USSR how much of a "black market" and underground economy there was? I think some (not as much as Libertarians believe) of our economy is already underground, hiding from the IRS, the BATF, and other concerns, especially in the area of microbusinesses. Therefore I think perhaps this sector is even understated, not overstated.

[LS]

This is response to your earlier post, and I am in substantial agreement. I DO think the Fed can open the money spigots more.

But no question the place to point is taxation. You are a little more pessimistic than I, mainly, I think, because you are focusing on the Feds. But consider this: new taxes and bond levies (which in a way are the same thing in that they suck money out of the private sector) have been failing at HUMONGOUS rates. Here in my sector of Ohio---in "kiddie ville" where all the soccer moms are---TWO new school levies failed. I think a fireman/cop levy failed too, even after 9/11! A couple of years ago I kept track of the big sports-related tax/bond issues. I think only two of them passed---Cincinnati and Houston. Many others were defeated. This gives me hope that at the state level citizens are DEMANDING that the spending be contained, and that taxes be at least locked in, if not reduced.

[LS]

Sorry David, but Milton Friedman and a generation of economists whom I greatly respect COMPLETELY disagree with you that the Fed produced some sort of credit boom in the 1920s. Again, all the studies that you willingly disregard suggest that a) stock values were appropriate, and generally accurate; b) people knew what they were investing in---it was not "spekulatin' "; and c) the commercial banks were not funding some massive speculation.

Friedman also debunks your theory that the people couldn't earn the money to buy the products.

Amazingly, your arguments are re-hashes of the old John Kenneth Galbraith/Keynesian "liquidity trap" concepts that very few (and I emphasize VERY) accept any longer. So if that is your world view, we must once and for all disagree.

[rohry]

Sorry David, but Milton Friedman and a generation of economists whom I greatly respect COMPLETELY disagree with you that the Fed produced some sort of credit boom in the 1920s.

I know you don't like the Austrian School but they are just as respected as Milty:

America's Great Depression By Rothbard, Murray N. Item #B161 Your Price - $29.00

Quantity:

Applied Austrian economics doesn't get better than this. Murray N. Rothbard's America's Great Depression is a staple of modern economic literature and crucial for understanding a pivotal event in American and world history.

The Mises Institute edition features, along with a new introduction by historian Paul Johnson, top-quality paper and bindings, in line with the standard set by The Scholars Edition of Human Action. 

Since it first appeared in 1963, it has been the definitive treatment of the causes of the depression. The book remains canonical today because the debate is still very alive. 

Rothbard opens with a theoretical treatment of business cycle theory, showing how an expansive monetary policy generates imbalances between investment and consumption. He proceeds to examine the Fed's policies of the 1920s, demonstrating that it was quite inflationary even if the effects did not show up in the price of goods and services. He showed that the stock market correction was merely one symptom of the investment boom that led inevitably to a bust. 

The Great Depression was not a crisis for capitalism but merely an example of the downturn part of the business cycle, which in turn was generated by government intervention in the economy. Had the book appeared in the 1940s, it might have spared the world much grief. Even so, its appearance in 1963 meant that free-market advocates had their first full-scale treatment of this crucial subject. The damage to the intellectual world inflicted by Keynesian- and socialist-style treatments would be limited from that day forward. 

Read Johnson's Introduction. 

[LS]

No, rohry, I don't accept the Austrians' explanation of the Great Depression. Rothbard is NOT respected, nor has most of his work been substantiated by any other research.

That is not true of OTHER Libertarian/Austriahs' work, which HAS met the test of academic rigor, so you can't just blame "bias" in the academy: Larry White, George Selgin, Don (?) Mullineaux, and many others who subscribe to "Austrian" principles have published in mainstream journals and their arguments have stuck. But the principle group to look at for the best work on the Great Depression includes one-time Keynesian (who has severely adjusted his positions) Peter Temin, Charles Calomiris, and Eugene White.

Moreover, not one "Austrian" has substantially attacked or discredited Friedman's main points in any credible journal. Believe me, enough people would like to see Uncle Miltie dethroned that they would embrace anyone capable of doing so.

[imawit]

Not pessimistic, just like to be as dramatic as I believe the tale needs to be to get the impact.

I see the IRS comissioner is resigning and the Senate is getting a pay raise. These bureaucrats live in a world all of their own.

[David]

"Are we in agreement. Money into consumers hands is the solution. The question is....How do we get that money there. I propose that it's already there and in stead of confiscating it, the consumer needs to be allowed to put it to work."

I am not so sure. If this were a variation of LS's argument which reduced to its simpliest form is that the government should find some way to print the money and hand it to consuming spenders, no.

However one of the main structural causes of our problems is that taxes are too high--way too high; at every level. Further, the government wastes a large portion of the money. So If you reduce taxes, that obviously is a step toward a solution.

Observe also that the collapse of the Soviet Union resulted from governments control of an estimated 76% of the total economy. If you include actual tax financed spending at all levels plus spending that results from government control dictates; and spending (like houses and house construction; lake the auto industry) that results from controls related to government financing, you might conclude that we are over 50%, maybe 60%.

Another principal cause is our monetary system--we don't have a stable monetary system--my own personal view is that collapse of the derivative markets may well result in destruction of the value of our currency.

[David]

"the studies that you willingly disregard suggest that a) stock values were appropriate, and generally accurate; b) people knew what they were investing in---it was not "spekulatin' "; and c) the commercial banks were not funding some massive speculation."

I tend to weight the merits of these kinds of studies on the basis of their accuracy. You have generally described pretty clearly what they say with one exception--for the most part they were based on the fundamental premise that we are in a "new economy" in which we will never again have recessions; income, employment and GDP will simply continue to grow forever--and in part that is why stock valuation should continue on up to unheard of historical price levels.

Problem with those studies is that they were wrong--it didn't happen that way. The stock market is not going straight up forever; employment is not going straight up forever; the only reason the stock market continued up in the face of declining investment merit was the speculative view that someone would pay more next week than this week; and in part because management, through fraud and sloppy accounting practices misrepresented earnings. Stock prices in the entire decade were not "appropriate" at all--they were grossly excessive; as a multiple of earnings, prices were higher than they have ever been before at any time in history.

Facts are that the commercial banks were funding a massive speculation. The evidence is in the default losses they are incurring from a wide range of published bankruptcies like World Com, Enron, and others. There is more evidence developing as we write--and there are more bankruptcies coming that will have an adverse impact on the banks themselves like Citi and JP Morgan to name to obvious candidates.

You may love all these studies but they were simply wrong.

Now the stuff about Friedman and the generation of economists you respect takes a little more effort to refute--because the evidence is now burried in 80 years of history.

Friedman is nothing but a commited monetarist--and the discrediting of most of his views is the reason you seldom hear him quoted in knowledgable economic circles today. He, like most of the scholar economists, are Liberal, supporters of the government controlled money system and will say anything to rationalize continuation of that system.

Unless you are going to do a research project on your own to find out what the real data is, the best information probably is from Mr. Prechter--the data is relatively clear that the money supply in the 1920's increased significantly; much of the excess liqudity found its way into the stock market, bidding the price of common stock to unsustainable levels of excess valuation, far above values justifiable by p/e ratios or any other reasonable historical test; much of which excess liquidity was in the form of bank credits which defaulted when borrowers could not pay (resulting in the bank holidays and demise of the banking system); and in the aggregate resulting in the long term recession that did not end until after the end of War II as a means to liquidate the excess debt. (Same situation we are in today except that the magnitude of the problem today is much greater.)

The argument about insufficient liquidity was concocted to defend the Fed's continued existence--"the Fed simply made a mistake in the 30's in their response"--there is in fact a historical study in someone's doctrial thesis done in the 1940's where he went around and looked at meeting notes and talked to the principals and looked at the number--additional bank reserves provided by the Fed in the 1930's to solvent banks went nowhere because nobody borrowed--the origin of the "pushing on a string" concern.

That is the position that Greenspan is parroting now. However as to Greenspan today, that argument will be proven wrong over course of the next 18 months to two years because although he continued to create great amounts of excess liquidity, and there is no argument that he did it too late; all he has done is make the problem bigger and defer the day of resolution.

In the 1930's it is undisputed that incomes were down and that people did not earn enough money to get the economy turning. So your "debunk's your theory" position is just another monetarist argument in support of the Fed. The evidence is that it didn't happen. Reason it didn't happen is that the kind of productive activity resulting from capital formation enterprises did not occur so the people did not have the jobs in which they could earn income.

To the contrary, Keynes and Galbraith would have had the government print the money and give it to people who wanted to buy products--that would not work as an effective means to solve the problem and would create the further problem which we have today of decline in the value of our currency unit. That doesn't work either.

[LS]

Ok, now I know where you stand: Friedman is discredited, Greenspan doesn't know what he's doing; a generation of good scholars with good evidence were concocting "defenses" after the fact; and that only your assessment of what is happening now (and what happened then---but which is, can be, and has been, disproven) is right.

I see.

Over and out.

[imawit]

I am not so sure. If this were a variation of LS's argument which reduced to its simpliest form is that the government should find some way to print the money and hand it to consuming spenders, no.

Not a variation of LS and I agree with what you say. The main argument that I put forth is not to print money but to take away functions restricting and eliminating actual consumer cash and the arbitrary and artificial mechanisms of Gov & Fed that further schew and destroy the natural economic forces.

I believe we all agree that the Fed caused the bubble and in trying to now reinflate is causing further problems, deflation, more debt. They are printing money and that is not inflating anything but the qty of dollars through more debt which obviously is creating more debt, dropping the interest rate, creating a bigger spread on rates which is hurting corporate bonds and their ratings. What we are getting right how is lower rates, lower dollar exchange rates, dollar devaluation, lower confidence in the dollar and deflation (no one has any cash they feel is discretionary nor are there any places to confidently invest).

The only sector the Fed is enhancing is real estate which has an inverted direct effect with respect to interest rate.

[rohry]

"Rothbard is NOT respected, nor has most of his work been substantiated by any other research."

I'm not an academic and I know nothing about how academics rate his views. I do know that when I was in school there was a couple of revered books out by J.K Galbraith (The Affluent Society and the New Industrial State) that were wrong in almost all their predictions. Public and academic alcolades are fleeting and temporal.

At least we all know where we stand. I'm convinced that Austrian economic thought is analyzing our present situation properly, you think the Chicago School does. It's like we are all on different islands wathing a couple of large ships under sail. From one island it looks like they are going to collide, on another they look like they are proceeding in a safe manner. I guess we'll have to wait and see.

[David]

Response to your #75: Let us try again. All your studies and experts developing during the 90's argued the stock market was straight up forever; profits increase forever; employment goes only straight up; consumption is straight up; stock prices are fair and reasonable at 50 times (reported) earnings (which later prove overstated because of fraud and sloppy accounting).

Turns out stock prices are trending down; employment is trending down; there are no profits; GDP is declining; Fed can't get the capital formation economy going again even with the lowest interest rates of the century.

Seems to me these guys are simply wrong.

On the narrow issue of what happened in the 1920's and 1930's, we are dealing with a politically contentious set of issues. Those of us who have studied the question without a predetermined bias to the outcome have generally concluded that the fed created a bubble in the 1920's with an oversupply of liquidity much of which wound up in the stock market through margin debt; all in a similar setting as the 90's with an expectable result in 2000 not unlike the result in the 1930's. Still think that.

Don't know of any good scholars with any good evidence in support of the "short liquidity" defense--what do you think the data is that constitutes evidence in support of this position? I don't think there is any.

As to Dr. Greenspan, I still view him as best known for his assurance to Gerry Ford in 1974 that he (Span) could jawbone inflation down ("Whip Inflation Now") far enough to get Ford elected in 1976--which also proved wrong. History will judge the effectiveness of his term at the Fed because the evidence is going to be much fresher in the historical record than the data in defense of the 1930 Fed.

However his policies so far don't show any sign of success. They look like the same policies the Japanese have been pursuing for the last 12 years with absolutely no success. I expect the same results here.

[LS]

Here is the problem: "Those of us who have studied the question without a predetermined bias to the outcome have generally concluded that the fed created a bubble in the 1920's with an oversupply of liquidity"

This preumes that a) you don't have a "predetermined bias" (certainly not apparent from your posts) and b) that the scholars do. Yet KNOWING as I do some of these scholars, who are from a wide variety of ideological and methodological backgrounds, that is purely false and conceptually stupid. The ones I know personally are genuine geniuses, and I certainly trust their judgment more than anyone whose posts I have read on FR.

Likewise, the more recent studies MIGHT be "proven wrong" if we stop today (although already the markets are coming back--I know, I know, some giant phoney liquidity bubble). But we don't stop today. Things could be just as different in two years as they are today from five years ago. When you use trend lines, the magic is all in where you start, and where you end.

I'll say again: there is no reputable scholar since Keynes and Galbraith who argue for a "liquidity bubble" in the 1920s. I'll say again: your positions, whether you desire it to or not, place you suspiciously in line with the liberal wing of economists in the Democratic Party.

Need I really post price data for the 1920s to show the lack of inflation, the absence of a growing money supply? Or will you explain that away also?

[LS]

I didn't say the Chicago school analyzes the everything correctly. You might be surprised to learn that I debated Uncle Miltie on a boat going down the Danube about the benefits of government control of any money supply---I was opposed. I do say that Friedman had the 1920s pretty well pegged, but should be modified by Barry Eichengreen's analysis of the weaknesses of the gold standard and Wanniski's study of the Smoot-Hawley Tariff.

The same scholars you mildly denigrate, though, are the VERY people who exposed Galbraith and blasted them out of the water. What is interesting about these scholars is that they generally agree on the Great Depression, yet they come from a pretty diverse ideological and political background. My more important point, though, is that if the Rothbardian/Austrian notions are sound, they could be presented and debated and, more important, proven by scholarship. Economics, ultimately, can be reduced to numbers. What should concern you is that these people don't even get in the arena. There is a "Journal of Austrian Economics," but there is also a "Journal of Marxist Economics" (or some such title). The Marxists cannot debate with evidence their positions, thus they create their own little sandbox. That is what I'm afraid the Austrians have done.