{"id":112,"date":"2009-09-13T22:37:26","date_gmt":"2009-09-14T02:37:26","guid":{"rendered":"http:\/\/civilsocietytrust.org\/blog\/?p=112"},"modified":"2009-09-13T22:43:22","modified_gmt":"2009-09-14T02:43:22","slug":"professor-krugmans-bias-by-omission","status":"publish","type":"post","link":"http:\/\/civilsocietytrust.org\/blog\/2009\/09\/13\/professor-krugmans-bias-by-omission\/","title":{"rendered":"Professor Krugman’s bias by omission"},"content":{"rendered":"

From his soapbox at the NY Times, Paul Krugman delivers a lengthy and entertaining history<\/a> of the views of “saltwater” and “freshwater” economists, and laments how neither side really saw our recent financial debacles coming.\u00a0 Most troubling for this writer, he describes how Keynesiansim, rightly or wrongly interpreted but in either case a theory custom-made for big government, seems to be falling back into favor, although (encouraging to this writer), he surmises that the fields surrounding behavioral economics may hold better promise.<\/p>\n

But nowhere in the article is the school of thought that did<\/em> largely see this financial tsunami coming, but whose repeated warnings were largely ignored — the entire school of Austrian economics<\/a>.\u00a0\u00a0 It’s too bad, because we have a lot to learn from Ludwig von Mises, Frederick Hayek and others.<\/p>\n

Krugman describes the gigantic mind struggle of the Keynesian and Monetarist camps, as he says “clad in impressive-looking mathematics”, each trying to out-gun each other with explanations of which levers in the economy the government should be pulling and pushing on to smooth out the business cycle.\u00a0 Meanwhile, the Austrians make the compelling case that it is exactly the government<\/em>, mostly now via the Federal Reserve’s attempts at controlling the price of money, that causes the business cycle in the first place.<\/em> There are doctoral-level tombs that get into this in great detail, such as von Mises’ “Human Action”.<\/a> For an entirely more accessible version, complete with its application to recent events, check out Thomas Wood’s recent bestseller, “Meltdown”<\/a>.\u00a0\u00a0 Acknowledging the Austrian’s perspective on things would have changed the article considerably.<\/p>\n

Years ago I spent time developing software in the fixed income departments of several major investment banks.\u00a0\u00a0 Occasionally, the trading floor would explode in a sudden commotion like of a bunch of panicked extras in some cheesy disaster movie, with bond traders and salespeople yelling and screaming frantically. \u00a0 The Fed had unexpectedly cut the discount rate! (or had taken some equally earthquake-like action).\u00a0\u00a0\u00a0 Like seismologists, many players in the market would try to anticipate when these events would occur, but with some regularity, “big ones” would hit with little notice.\u00a0\u00a0 If you happened to be positioned incorrectly, property damage (to a trader’s book) could be severe.<\/p>\n

Since blogs are such a great place for thought experiments, why not ponder the repercussions of not having a Federal Reserve at all, as Jim Rogers<\/a>, Thomas Woods and others have at one time or another?\u00a0\u00a0\u00a0 Imagine that those bond traders, salespeople and their managers were collectively the bottom line of our interest rate structures, and that were was no big Federal daddy to run home to for whatever reason.\u00a0\u00a0 My guess is that they’d be at least a little (if not a lot) more careful with what price they put on capital, and the manner in which it was transacted.<\/p>\n

Which brings me to another great omission in Professor Krugman’s article, that being the role of failure.\u00a0\u00a0 Continuing the same thought experiment, if every bank knew it was NOT too big to fail, that there was no backstop for their potential mismanagement and recklessness, that would necessarily introduce an additional heap of caution into their lending practices. \u00a0\u00a0 When your trading counterparty is deemed “too big to fail”, it sets off an entire chain of relaxation in information gathering. \u00a0 The mutual knowledge of needs and equally shared costs and benefits between trading partners that is required by free trade is rendered increasingly phony and precarious.\u00a0 Would some borrowers, who under the recent overly-lax regimes got loans (what the Austrians might refer to as “malinvestments”), no longer get them? \u00a0 Absolutely.\u00a0\u00a0\u00a0\u00a0 But we now see that perhaps that would have been a good thing, and there is no reason to extrapolate into a scenario where lending stops entirely.\u00a0\u00a0\u00a0 Would some customers fear doing business with a bank that could fail?\u00a0\u00a0 Absolutely.\u00a0\u00a0 Therefore, a bank would have every reason to conduct themselves in a way that would assure their customers that they could not.\u00a0\u00a0 This could even spawn a market for private<\/em> banking insurance, the price of which would be determined by the insurance companies’ assessment of the likelihood of failure.<\/p>\n

In 2005, WalMart scared many potential competitors and special interest groups<\/a> by drafting plans to enter the banking industry.\u00a0\u00a0 Suffice it to say, they eventually withdrew their plans.\u00a0\u00a0 The point is, in a truly free market, driven by the profit motive, firms will always arise to meet the unmet wants of potential customers.\u00a0\u00a0\u00a0 At the same time, excess profits will always be kept in check by enabling and encouraging complete competition.\u00a0 “Excess profits” simply open the doors for a hungrier competitor to steal customers through better pricing.<\/p>\n

At the height of the recent banking crisis, nearly one year ago, there were cries of bank lending potentially shutting down completely.\u00a0\u00a0 But just because some lenders might be having trouble does not mean the need for borrowing permanently disappears.\u00a0\u00a0\u00a0\u00a0 Might the extra cross-industry diversification of a “WalMart in the banking business” have influenced “banking” for the better at the margin?\u00a0\u00a0 Would the Citibanks and Bank of Americas of the world have been forced to tweak their business models for the better?\u00a0\u00a0\u00a0 We’ll never know.<\/p>\n","protected":false},"excerpt":{"rendered":"

From his soapbox at the NY Times, Paul Krugman delivers a lengthy and entertaining history of the views of “saltwater” and “freshwater” economists, and laments how neither side really saw our recent financial debacles coming.\u00a0 Most troubling for this writer, he describes how Keynesiansim, rightly or wrongly interpreted but in either case a theory custom-made […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[8],"tags":[],"_links":{"self":[{"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/posts\/112"}],"collection":[{"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/comments?post=112"}],"version-history":[{"count":15,"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/posts\/112\/revisions"}],"predecessor-version":[{"id":127,"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/posts\/112\/revisions\/127"}],"wp:attachment":[{"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/media?parent=112"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/categories?post=112"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/civilsocietytrust.org\/blog\/wp-json\/wp\/v2\/tags?post=112"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}