Alan Greenspan, 1926-2026: 'The Undertaker' passes away

Alan Greenspan, dubbed by Ayn Rand as "The Undertaker."  
Ultimately, he took the job that John Galt refused: economic dictator

"Alan Greenspan died [earlier this week], and the man who spent two decades inflating bubbles will be eulogised as a maestro. Fitting, because he understood exactly what he was doing. 

"In 1966 a younger Greenspan wrote an essay called 'Gold and Economic Freedom.' [In it, he states that the gold standard is essential for economic freedom.] He laid out the case with precision. The gold standard protected savers from confiscation by inflation. Welfare statists hated gold because it stood in the way of their deficits. He wrote that the abandonment of gold made deficit spending a "scheme for the hidden confiscation of wealth." He was right. He knew it. Then he took the job running the printing press.

"From August 1987 to January 2006 Greenspan sat atop the Federal Reserve and did the opposite of everything that essay defended. After the 1987 crash he flooded the banks with liquidity and taught a generation of traders that the central bank would catch them every time they fell. They named the reflex after him: the 'Greenspan put.' He cut the federal funds rate to 1 percent by June 2003 and held it there, and you watched housing prices detach from any sane relationship to income. Mortgage credit gushed. He went on television in February 2004 and suggested Americans consider adjustable-rate mortgages, roughly eighteen months before he started hiking rates into those very borrowers. The man who warned in 1966 about the hidden confiscation of wealth engineered the largest credit distortion in postwar history. 

"Then came the apology that wasn't one. In October 2008, sitting before Congress as the wreckage smoked, Greenspan confessed he had found 'a flaw' in his model of how the world worked. He was 'shocked' that lenders [licensed to print money] had not policed themselves. You don't get to spend twenty years pricing risk at zero and then act surprised when men respond to the incentives you built. Any committee of economists cannot set the price of money better than a market can. 

"Greenspan knew the answer at 40 and spent the next half century pretending he'd forgotten it. The savers he warned about in 1966 paid for that performance. ..."

"Every Fed chair since Greenspan has discovered this truth the hard way. Bernanke cranked rates to zero after 2008, then Yellen kept them pinned there, then Powell printed $4 trillion more during COVID. Each crisis demanded bigger interventions than the last."

~ Handre

 

"Greenspan was the Dr. Robert Stadler of our age: the brilliant man who knew the right principles and betrayed them, certain his own genius could control the evil he agreed to serve. 

"He was a member of Rand's inner circle. His essay "Gold and Economic Freedom" appeared in Capitalism: The Unknown Ideal. He argued, correctly, that the gold standard protected savers from confiscation, that statists hated gold because it blocked their deficits, and that abandoning it turned deficit spending into a scheme for the hidden confiscation of wealth. 

"He even understood that Social Security was a Ponzi fraud that would help bankrupt the nation. He knew all of it. Then he took command of the Federal Reserve and did the opposite of everything he had written. 

"The 'Greenspan put,' rates held at one percent, the housing bubble, the very confiscation he had warned of, engineered by his own hand. 

"Here is the irony. Greenspan knew 'Atlas Shrugged' intimately. He watched Rand create Stadler, the genius who lent his mind to the looters' Institute believing he could outwit them, and who lived to see his knowledge weaponised as Project X. Greenspan studied that warning at the source, from the author herself. He understood the character completely. Then he walked the identical road and became the man the novel was written to expose. 

"When the wreckage came in 2008, he told Congress he had found 'a flaw' in his model. There was no flaw in the model. The flaw was in the choice to abandon what he knew. Some men meet the virus and are consumed by it. Greenspan had the answer at forty and spent the next fifty years pretending he had forgotten."

~ The Rational Animal

"Q: Alan Greenspan passed away [this week]. Alan Greenspan was a close associate of Ayn Rand for a while, and the Chairman of the Federal Reserve … these things did not overlap, as people familiar with Ayn Rand’s ideas wouldn’t be surprised to hear. So, Keith, I’m sure you’ve read [Greenspan’s essay] ‘Gold & Economic Freedom’ many times; so let’s get your thoughts on Greenspan’s passing…

"A: For anyone who’s read that essay, which was published in 1966 as part of [Ayn Rand’s] book 'Capitalism: The Unknown Ideal,' and therefore endorsed by Ayn Rand, he had to evade everything he knew in 1966 in order to take the job at the Fed. And ultimately, he took the job that John Galt refused, which was economic dictator.

"Now … everybody is confused about capitalism … but … there is no greater area of confusion than the concepts around money. Both the critics of capitalism and of gold, and the FANS of capitalism and gold will tell you that he was 'a Maestro' — and if you ask “a master of what?’ you’ll be told he was a master of central planning of our economy, and of managing our little lives for us. …

"They’ll say ... ‘he managed a sound money regime’— and the problem with the concept of sound money they use is an anti-concept, that is, [it’s a notion] that destroys and obliterates a legitimate concept in order to smuggle something else in. And what they mean by ’sound money’ is an irredeemable fiat currency jammed down our throats by the government forcing us to use it as if it WERE money, but ‘sound’ because it’s somehow managed to avoid consumer prices going up [by no too much].

"So I’d like people to think about a simple fact, that in every industry seeking greater efficiency, that is, they want to produce more with less — with less cost, with fewer inputs, with less labour, land, physical commodities etc. — and of course that’s happening relentlessly across the entire economy in every sector (unless regulation prevents it…).

"So suppose the average across the entire [economy] is a 2 percent gain in efficiency every year, all else being equal, you’d expect consumer prices therefore to be falling comparatively across industries, as costs are falling. SO your expect consumer prices tl be falling roughly 2 percent per year.

"So imagine it it were possible as the manager of the currency to debase the currency at a matching rate. Now, this is pure fantasy [hoho!]; this is only interesting as a thought experiment … but suppose it were possible to debase the currency at a matching rate so that every company from Intel to US Steel to Rolls Royce making aircraft engines is cutting costs at 2 percent, [while] you are debasing the currency at a matching 2 percent, and the nett result is CPI = zero. Would anybody call that SOUND?

"I wrote an article called ‘Sound Money is Not What You Think It Is,’ and I had a picture that I took from Norman Rockwell [above, with customer and butcher both cheating] … and I asked if that would be considered a sound measurement of the weight of the chicken, and therefore a sound price to pay … And at best, that’s what Greenspan did."

~ Keith Weiner from Monetary Metals, interviewed on the 'Daily Objective'

"Of course you can 'speak ill of the dead' ...  After all, wrote Shakespeare, 'The evil that men do lives after them; / The good is oft interred with their bones.'

"Alan Greenspan, former chairman of the Federal Reserve System, just died at age 100. The general public wants to blame the United States president for the health of the U.S. economy, but the Fed chairman has much more influence over economic conditions. 

"Greenspan spent some time early in his career as an Ayn Rand acolyte, and in fact three chapters of Rand's book Capitalism: The Unknown Ideal, were written by the future Fed chairman.... Greenspan's opponents on the left therefore interpreted his whole career through a Randian lens, which serves to remind us how stubbornly they refuse to understand the world. 

"Had Greenspan wanted to run the Federal Reserve in such a way as to approximate a gold standard as much as possible, he could certainly have done so. Instead, he used it as an instrument for central planning, with disastrous results.

"Initially, Greenspan could do no wrong. He became known as 'The Maestro' ....  Meanwhile, Greenspan's contempt for the public was legendary: he confessed to Lesley Stahl of CBS that before congressional committees he would speak gibberish -- a tactic he called 'syntax destruction.' The next day the headlines would report two different things about what he had said, and for Greenspan that meant he had succeeded. Greenspan's policy moves (like arranging for a bailout of Long Term Capital Management in 1998) gave rise to the belief in a 'Greenspan put,' according to which investors could be assured that the Fed chairman was prepared to use the tools at his disposal to backstop the market if it should ever fall below a certain level. 

"And of course his monetary stimulus after the dot-com bust in 2000-2001, which looked to some observers at the time as a brilliant move, only delayed the reckoning, and transformed that bust into a real estate bubble (and eventual bust). When the lights of the economy should have turned red, Greenspan made them all green. That was the only recession on record in which housing starts rose rather than fell. 

"The Federal Reserve, like the government itself, has no real goods at its disposal, so while its various tricks can redistribute resources and simulate prosperity, it cannot generate real wealth. It simply arranges the economy into an unsustainable configuration that has to come apart. 

"Because of Greenspan's earlier association with Ayn Rand, and because the general public knows so little about the Fed, when the 2008 crash occurred, people generally went along with blaming 'capitalism' -- even though the Federal Reserve is a non-market institution created by act of Congress and enjoying a government-granted monopoly, and even though Greenspan's manipulations overrode what the market was trying to say. 

"Greenspan's legacy is 2008, and the undeserved reputational damage that the market economy suffered as a result."

~ Tom Woods

JIM GRANT: 'AI Is “One of the Greatest Bubbles of All Time”'

 

"Q:We heard a stat recently that if you combine SpaceX, OpenAI, Anthropic potential IPOs, inflation adjusted, these are so large, they're as big as all the IPOs in the nineties combined. What do you think about that?

"A: I think that the excitement surrounding the potentialities of artificial intelligence dwarf the excitement generated by the worldwide web and by the internet and by fibre-optic cables. And I think the dollars, of course, even when adjusted for inflation are larger today. And I think that the role of the Fed[eral Reserve Bank] is more intrusive, more problematical than it was then. And I think that a great deal is riding on the efficacy of the technology on which the world's hopes are hanging. And a great deal is also contingent on whether we collectively have correctly calculated (or miscalculated) the demand for tokens, for data centres, and for the rest of the capital that goes into artificial intelligence.

"So you know, you'd think that any technology with 'intelligence' in the very word would be up to date [on the] supply and demand [for it]. But I think there's reason to doubt that. I think there's a great deal of overbuilding, double ordering, just like there was in the late 1990s [with the Dot.Com bubble]. People thought, well, such is the high degree of organisation of all the information relevant to the marketplace that there will be nothing like the macro miscalculations of yesteryear. But it turns out that the human speculative spirit is a pretty wild thing and is not necessarily grounded by better technology.

"On the contrary, sometimes that can only incite it. So I think that [this] today is one of the greatest bubbles of all time. ...

"A guy from Uber, a COO of Uber, a CFO, was quoted the other day as saying, well, it's it's certainly a wondrous technology. We don't see it in our profit and loss. We can't really rationalise the expense just now. This is all kind of the jury's still out on this. It's wonderful -- it's not wonderful; it is hallucinating -- it is smarter than you ever dreamt ...

"What we do know is that the capital draw on AI is as great as it was on the [nineteenth-century] railroad [boom]. And the value proposition of railroads is very simple ...Now it is what? AI, augmenting human intelligence, planning it?

"We don't know. But the capital draw is immense, and there are dollars that are riding on the success of this and on the correct calculation of supply and demand for semiconductors, for data centres and the like. All this is terrifically important and also unknowable at the moment. So this makes it a time well worth living in."

~ Jim Grant interviewed on the Meb Faber Podcast on 'AI Is “One of the Greatest Bubbles of All Time”'

RELATED: 

 

What Defines an Asset Bubble? What Got Us Out of the Depression? - ROBERT MURPHY SHOW

"... some notion of irrationality or mania intrinsic to it is ... a required ingredient [of an asset bubble]. Because if you don't have that, it's not a bubble. And and that's how I use the term. 

"So, for example, as opposed to a boom. ...  like if they got rid of the IRS ... and we're sure it's not coming back. I think that would lead to an economic boom, but that wouldn't be a bubble. Okay, there might be a bubble involved if it overshoots ... I wouldn't call that a bubble because a bubble's going to pop. Like that's the whole point. That's why they call it that ...

"I would say for it to be a bubble where it unmoored from the fundamentals, and people kind of know it is. ...[that] at some point, this is going to crash hard, but as long as you think you can get out, it can keep going. And so, to me that's clearly a bubble. And again, I think a necessary ingredient of that is there some element that people know this is unmoored from reality.  ... 

" I'm going to say I don't think loose money or government interference or whatever is a part of the definition. ... [T]here could be a bubble even in An-Capistan if there could just be a mania. That could happen, but I think it would be relatively modest, other things being equal, for the same amount of irrationality and willingness to take a gamble or whatever ...

[H]aving a Federal Reserve Bank thrown into the mix is only going to allow that irrationality to get multiplied... So, the biggest bubbles are necessarily going to go along with a central bank."

"The AI era is one of mythology ... a dynasty of bullshit"

"We are in the dynasty of bullshit, a deceptive epoch where analysts and journalists who are ostensibly burdened with telling the truth feel the need to continue pushing the Gospel According To Jensen. When all of this collapses there must be a reckoning with how little effort was made to truly investigate the things that executives are saying on the television, in press releases, in earnings filings and even on social media, all because the market consensus demanded that The Number Must Continue Going Up.

"The AI era is one of mythology, where billions in GPUs are bought to create supply for imaginary demand, where software is sold based on things it cannot reliably do, where companies that burn billions of dollars are rewarded with glitzy headlines and not an ounce of cynicism, and where those that have pushed back against it have been treated with more skepticism and ire than those who would benefit the most from the propagation of propaganda and outright lies."

~ Ed Zitron from his post 'Mythbusters - AI Edition'

"This is [is this?] the sound of a bubble popping."

"Mark Zuckerberg had exciting news to share yesterday. His company Meta had finished a great quarter—and would continue to increase spending on AI.

"He said that yesterday afternoon. But when the market opened this morning, Meta shares dropped more than $80. That’s $200 billion in market cap wiped out in an instant. 

Meta’s share price this week 

"Why don’t investors like AI? Only a few months ago, companies saw their shares skyrocket when they made AI investments.

"In September, Oracle’s stock shot up 36% in just one day after announcing a huge deal with OpenAI. The share price increase was enough to make the company’s founder Larry Ellison the richest man in the world.

"But then investors changed their mind. Since that big day, Oracle shares have fallen $60. Larry Ellison is no longer the richest man in the world.

"This is [is this?] the sound of a bubble popping."

~ Ted Gioia from his post 'The Bubble Just Burst'

"Mark Zuckerberg’s Meta is spending untold billions on infrastructure and top talent for its AI ambitions.

"In fact, the CEO announced during the company’s earnings call on Wednesday, Meta will be spending between $70 billion and $72 billion on AI this year — up from its previous estimate of $66 billion to $72 billion, as CNBC reports.

"Unsurprisingly, that cash bonfire isn’t going over well with investors. Meta’s shares slid by more than 11 percent on Thursday, indicating widespread skepticism about the company’s ability to stop bleeding billions of dollars as it races to keep up with the AI industry’s ever-escalating expenditure commitments.

"That’s particularly striking because the drop comes in spite of Meta’s revenues exceeding Wall Street’s estimates. In other words, out of control AI spending is starting to rattle investors. 'The total dollar spend is just kind of what hangs us up a little bit,' [said one]...

"The AI industry is seemingly approaching a major inflection point, with Meta competitors Alphabet, and Microsoft tripling down on AI by increasing their planned spending to even loftier heights, fuelling fears of a growing AI bubblethat could take down the entire US economy with it if ever pops."

~ Victor Tangermann from his post 'Meta Stock Plummets as Investors Horrified at How Much Zuckerberg Is Spending on Misfired AI'

Moral Hazard + Bubble = ?

"The whole point of financial stability reports is to warn about stuff that might go wrong in the future but probably won’t. Even so, the latest missive from the IMF last week was bracing.

“'Valuation models show risk asset prices well above fundamentals, raising the risk of sharp corrections,' it said. ... Investors and policymakers should be alert to the prospect of 'disorderly' corrections and the potential for self-reinforcing doom loops, where a loss of confidence in the sustainability of government debt whacks the bond market, which in turn whacks risky assets priced for nirvana, which in turn hammers the banking sector, both traditional lenders and shadow banks that are locked in an embrace of 'increasing interconnectedness.' The Bank of England struck a similar tone, noting the risk of a 'sharp market correction.'

These things are extremely precisely worded. When such august institutions talk of valuations 'well' in excess of observable reality, and of 'sharp' or 'disorderly' corrections, they are very much switching on the fasten-your-seatbelts sign.

In the private sector, heavy-hitters are also urging caution, including JPMorgan’s Jamie Dimon, who observed that 'you have a lot of assets out there which look like they’re entering bubble territory.' ...

"And still, markets are humming along just fine. This is not complacency, as such. ... The foundation of this worldview is an unshakeable belief in the rescue squad — a sense that if markets do get seriously tricky, for any reason, the cavalry will soon arrive, in the form of large interest rate cuts or even asset-purchase schemes from central banks. Investors, both professional and retail, have become accustomed to this ever since the great financial crisis of 2008.

"Policymakers are keen to stress that the bar for emergency intervention is high, but investors are happy to call their bluff. ... The moral hazard is extreme here ..."

~ Financial Times from today's article 'Bubble-talk is breaking out everywhere'

AI's Bubble. Ready to burst yet?

While politicians here in NZ bicker about who should get credit for an Amazon data centre that either is (or isn't) opening, over in the States they're already wondering whether these data centres are part of an AI bubble that's starting to show clear signs of being about to burst. 

"Even Open AI boss Sam Altman is now talking about an AI bubble," notes Ted Gioia. "Of course, he knows better than anyone because he is seeing it up close—the disappointing release of ChatGPT-5 played a key role in setting off the current turmoil."

Consider this: 

AI buildout is contributing more to measured US economic growth than all of consumer spending.

I want you look long and hard at this chart, and consider the implications.

Another sign? Mark Zuckerberg just paid US$14 billion for a stake in Scale AI, the data-labelling startup that's never made a dollar.

Meanwhile in the real world, McDonald’s CFO told Bloomberg that the company is struggling because many customers are now too poor to afford breakfast. And this isn’t some isolated anecdote—it’s a data-driven report from the biggest restaurant chain in the world. ...

There’s a mismatch here between two visions of the emerging economy. So which one is real? Are we entering an AI-driven boom time like an out-of-control Monopoly game? Or will [Americans] be too broke to eat breakfast?

Several signs, maybe, that both are happening —many signs of businesses struggling, closing, unemployment and debt rising, customers at any price simply disappearing. And meanwhile, 

• half the gains in the stock market are due to betting on the shares of five companies, who are betting everything on their spending up AI data centres
• consumers however are spending so little that this "investment" spending on AI by just four CEOs (two of whose money is made mostly by selling ads) totals more in the last 6 months than all the spending by all those consumers
• the energy grid simply can't support this growth in AI data centres, and there’s no indication that consumers are willing to pay for the enormous infrastructure. 

That last is the biggest sign right there. 

Fewer than 1% of ChatGPT users are paid business accounts. That total is no larger than the number of paid Substack subscribers (but what a difference in company valuation!).

In fact, most of ChatGPT’s traffic disappears when students go on summer vacation.

That tells you how wide the chasm is between reality and the crazy claims of AI fanboys—but many of them (I bet) are also reluctant to pay for AI. ... The tech simply doesn’t live up to the hype. The more people deal with it, the less they like it. That’s why AI companies must give it away (or bundle it into an already successful product) in order to gain any reasonable usage.

So everywhere I go online, companies are touting free AI. That’s funny. It doesn’t fit the narrative of a transformative technology.

But even four billionaires can’t change reality," warns Gioia. 

Yes, they are spending like drunken sailors, but that just makes the bubble bigger. It can’t stop it from bursting. The crazy level of investment only makes the eventual fallout all the worse.

How much longer can it last? Maybe a few weeks or a few months or a few quarters. Billionaires often throw good money after bad. But the whole economy is fragile—or beyond fragile—right now. And that’s the bigger reality.

By any reasonable measure, the current trend is unsustainable. And there’s one thing I know about unsustainable trends—there’s a day of reckoning, and it’s not a happy one for the people who caused it. But, even sadder, they take down a lot of others with them when the bubble bursts.

Read the whole thing here. (NB: He's opened up the article from behind the paywall.)

PS: How is this AI capital malinvestment even possible? Because of absurdly low interest rates set by the state's economic planners at the US Federal Reserve — rates that are so "economically absurd" they are only made possible "because the monetary fraudsters on the Fed's Open Market Committee (FOMC) had their big fat thumbs on the scales in the bond pits."

And we do mean fraud: The Fed’s balance sheet rose by $1.2 trillion or 17% during the 12-month period ending on July 7, 2021, and at a time, as we will amplify below, when the Fed’s balance sheet should have actually grown by essentially zero.

That is to say, the FOMC was buying government debt and GSE paper hand-over-fist with fiat credits snatched from thin digital air, thereby starkly falsifying yields and prices in the bond pits. There is not a chance in the hot place that tax-paying, real money savers left to their own devices would accept such niggardly real yields.

David Stockman explains the Fed's fraud.

Ludwig Von Mises explains the inevitable results of malinvestment — "meaning bad investment in
lines of production that would not otherwise take place."

"Trump's policy, unveiled yesterday afternoon, is called a 'reciprocal tariff plan,' which is a bit like calling a hammer a 'reciprocal pillow'."

"There’s a fundamental problem with Donald Trump’s new trade policy: it fails a test that actual 5th graders can pass. I know this because I tried explaining his 'Liberation Day' trade plan to one last night. Here’s how that conversation went:

“Imagine you want to buy a toy at a store which costs $50. You pay for the toy and walk away with it. The President looks at that transaction and says ‘wait, you paid the store $50 and the store paid you nothing, therefore the store is stealing from you. To 'fix' this, I’m going to tax the store $25. From now on that same toy costs $75.”

"The 5th grader looked at me like I was crazy. 'Whaaaaaaat? None of that makes sense. If I pay for something, it’s not stealing. And taxing the store seems stupid, and then everything is more expensive. Why would anyone do that? That can’t be how it works.'
    "This is the core problem with Trump’s 'Liberation Day' trade policy: it fundamentally misunderstands what trade deficits are. And if you think that’s bad, just wait until we get to the part where this policy declares economic war on penguins and our own military base. ...

"The policy, unveiled yesterday afternoon, is called a 'reciprocal tariff plan,' which is a bit like calling a hammer a 'reciprocal pillow.' The premise is that since other countries have high tariffs on us (they don’t), we should have high tariffs on them (we shouldn’t). But that’s not even the weird part.
    "At the heart of this policy is a chart. Not just any chart, but what might be the most creative work of economic fiction since, well, Donald Trump launched his memecoin. Trump proudly displayed these numbers at a White House event, explaining that they showed the tariffs other countries impose on the US. He emphasized repeatedly that the US was being more than 'fair' because our reciprocal tariffs would be less than what other countries were charging us.
    "There was just one small problem: none of the numbers were real tariff rates. Not even close.
    "At first, observers assumed the administration was simply inventing numbers, which would have been bad enough. But the reality turned out to be far more stupid. ...

"All of this glosses over the fact that 'reciprocal tariffs' are not reciprocal at all. Trump’s team is making up fake tariff numbers for foreign countries based not on anything having to do with tariffs, but on trade deficits, which is just an accounting of inflows vs. outflows between two countries. It’s only reciprocal because the Trump team faked the numbers.
    "On top of that, Trump can only impose tariffs (normally a power of Congress) based on the International Emergency Economic Powers Act and the National Emergencies Act. Both laws require there to be an actual 'emergency.' The only emergency here is that nobody in the administration understands what trade deficits are....

"So to sum up where we are:The administration invented an economic emergency

• To justify a policy based on made-up numbers
• Generated by an AI formula that came with explicit warnings not to use it
• Which they’re now using to launch trade wars 
• against: 

• Penguins
• Our own military
• And presumably Santa’s Workshop (someone check for a North Pole entry)

"And while the penguins and military base make for amusing examples of this policy’s incompetence, the real damage will come from applying this same backwards logic to basically all of our actual trading partners — countries whose goods and services make American lives better and whose economic relationships we’ve spent decades building. And who, historically, welcomed back American goods and services as well. All of that is now at risk because someone couldn’t be bothered to learn what a trade deficit actually is. And the American electorate deciding that’s who we wanted to govern the country.
     "When your trade policy is so fundamentally misguided that you’re declaring economic war on flightless birds and your own armed forces, perhaps it’s time to admit that the 5th grader from the beginning of this story wasn’t just smarter than the administration — they were dramatically overqualified for Trump’s Council of Economic Advisers."

~ Mike Masnick from his article 'Trump Declares A Trade War On Uninhabited Islands, US Military, And Economic Logic'

 

Bring back the slow-news days ...

"A comedian asked today if his audience was getting bored from all these slow-news days. Let’s consider the tumult:
    "Over the weekend, President Joe Biden did what he said he would not do and quit his race for a second term as US president. He also endorsed Kamala Harris for the bid. Overnight millions and millions of mega-donor and celebrity donations poured in for Kamala and the Democrats now that their favorite fossil was out of the race. ..
    "Suddenly, former President Trump has a real campaign to run against veritable competition, and reports started emerging that his campaign people are now doubting hopeful VP Vance is up to the new job because he was supposedly picked to electrify the MAGA faithful, but with the new fight for independent voters, the race becomes a different beast. ... Democrats have swung from all-out despair to surging hope over the course of a weekend. ...
    "That graze by a bullet and deaths caused by the assassination attempt have finally united a divided congress to the task of dividing the Secret Service from its leader. ...
  
"This isn’t just the most tumultuous year of political chaos in the US, geopolitics has ramped up in the last couple of months to suddenly outweigh inflation as a concern for markets ... [with] the prospect of an increasingly fractious Europe, isolationist America and a slowdown in the pulse of world trade. ... after a roaring rally, money is rushing out of potential flashpoints - such as Taiwan's stock market - and into havens such as gold, which hit an all-time high last week….
    "'All of Trump's policies are likely to be inflationary - be it tax cuts, immigration, or re-shoring, and hence dollar bearish...so the [US] dollar is likely to depreciate against gold,' ...
    "China’s growth is slowing even more, resulting in rescue packages from the Chinese government. So is growth under Bidenomics. ...
    "At the same time more than $100 billion has been wiped from the market value of Taiwan Semiconductor Manufacturing Co in less than a week after Trump sounded equivocal about his commitment to Taiwan's protection and chip industry. ...
    "Things are also only getting hotter in the Middle East ... Israel bombing Yemen with F-15s in reprisal to a drone attack in Israel by the Houthis ... Russia [moving] ships out of Crimean ports due to decimation of its Black Sea navy by the Ukraine ... Meanwhile, in the West, the Paris Olympics look like a police state, while Europe is gearing up for more war with the introduction of military conscription … In fact, Paris now hosts the largest military camp inside of Paris since WWII so that soldiers (not police) can reach any part of the Paris Olympics, which are scattered around the city, in thirty minutes. ...
    "And, of course, on Friday we had the biggest global internet crash in history. ... part of the mad mix of events that have happened all around the world in less than one week’s time. ..."

~ David Haggith from his post 'The Year of Chaos Roars!'

This is not normal

Source: Liabilities data for 1916–2023 from the Board of Governors of the Federal Reserve System, statistical release H.4.1, Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks, via FRED; and M2 money supply data for 1959–2023 from the Board of Governors of the Federal Reserve System, statistical release H.6, Money Stock Measures, via FRED. Note: The solid trend line (1) is a curve fit to the data between 1965 and 2003. The solid trend line (2) is a double exponential curve fit to the data after 2003. The two world wars are indicated by arrows pointing to the pink regions. Recessions are indicated by sepia-colored strips.

"The world since 1900 has experienced two major world-encompassing wars. Wars cost a lot of money, and countries—even if they were once on a gold standard—usually start printing massive amounts of money to finance their wars....
    "[Yet i]f we take the real value of the expansion of U.S. Federal Reserve liabilities between 1934 and 1963 due to World War II, and compare this to the total liabilities from 2008 to 2023, we find [this most recent period] to be 2.3 times larger at its peak than it was in World War II!"

~ John Hartnett. from his post 'Has World War II Already Begun?' [emphasis mine]

INFLATION: Orr lies

"[T]he Reserve Bank Governor [Adrian Orr]... likes to make up stuff suggesting that high inflation isn’t really the Reserve Bank’s fault, or responsibility, at all....
    "Late last year there was the line ... that for inflation to have been in the target range then (Nov 2022) the Bank would have to have been able to have forecast the Russian invasion of Ukraine in 2020. It took about five minutes to dig out the data ... to illustrate that core inflation was already at about 6 per cent BEFORE the invasion ... It was just made up, but of course there were no real consequences for the Governor....
    "And then there was last week’s effort in which Orr ... attempted to brush off the inflation as just one supply shock after the other, things the Bank couldn’t do much about, culminating in the outrageous attempt to mislead the Committee to believe that this year’s cyclone explained the big recent inflation forecasting error (only to have one of his staff pipe up and clarify that actually that effect was really rather small)....
    "It is, of course, all nonsense....

See for example:

• INFLATION: A critique of the “crisis-push” doctrine
• INFLATION: The Elimination of "Less Supply" as the Cause of an Inflationary Rise in Prices
• INFLATION: "Under such a system, the increase in the quantity of money is limited only by the self-restraint of government officials."

"Bottom line: all those stories trying to distract people ... with tales of the evil Russian or the foul weather or whatever other supply shock he prefers to mention, really are just distractions (and intentionally misleading ones ...). The Bank almost certainly knows they aren’t true, but they have served as convenient cover ... We are now still living with the 6 per cent core inflation consequence. It is common – including in the rare Bank charts – in New Zealand to want to compare New Zealand with the other Anglo countries. But what the Bank has never acknowledged – and just possibly may not have recognised – is much larger the boost to domestic demand happened in New Zealand than in the US, UK, Canada or Australia. And domestic demand doesn’t just happen: it is facilitated by settings of monetary policy that were very badly wrong, perhaps more so here than in many of those countries."

~ Michael Reddell, from his post 'Excess Demand'

'The Most Important Factor in The Economy Is Flashing A Huge Warning Sign'

Source: TheChartStore.Com, and the post: 

'The Most Important Factor in The Economy Is Flashing A Huge Warning Sign'

"The wavelike movement effecting the economic system, the recurrence of periods of boom which are followed by periods of depression is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion.”

~ Ludwig von Mises, from his chapter titled 'The Monetary or Circulation Credit Theory of the Trade Cycle,' quoted in the post 'The Most Important Factor in The Economy Is Flashing A Huge Warning Sign'

Source: Board of Governors St Louis Fed, and the post: 

'The Most Important Factor in The Economy Is Flashing A Huge Warning Sign'

"This year’s banking crisis was never going to be 2008 redux — more like 2008, the sequel...."

"This year’s banking crisis was never going to be 2008 redux — more like 2008, the sequel....
    "In one respect, the collapse of both Silicon Valley Bank and Credit Suisse were isolated, one-off events that have now been contained.... Nevertheless, the runs on these banks are better seen as symptoms of an underlying disease that continues to fester.... the edge of a coming economic storm whipped up by a decade of geopolitical fragmentation and cheap money. Now, the overdue attempt to reverse this course has slowed the global economy, possibly to the point of recession.
    "Unlike the 2008 crash, this does not follow an era of prosperity, but rather 15 years of monetary chaos....
    "Central banks now find themselves trapped in a stop-start course of withdrawing money with interest-rate rises, and putting it back at each sign of stress ... And this hair-of-the-dog treatment may soften the hangover but only prolong the addiction of the financial system to cheap money."

~ John Rapley, from his post 'The Next Financial Crisis Will Get Ugly'

What did you expect?

"As long as we keep expecting politicians to give us something for nothing, we should also continue to expect financial crises…."

~ Thomas Sowell, from his 1987 essay collection Compassion Versus Guilt [hat tip Cafe Hayek]

Is it an LOLR? No, It’s a Trap. And you should be mad.

Pic from AIER

Banking regulators set a trap for bankers, depositors and taxpayers back in 2008 into which they're all falling, explains Michael Munger in this guest post. And now the trap is sprung, we're up to our pocket-books in moral hazard and "too big to fail." What those regulators failed to fully understand is the proper role for the Lender of Last Resort (LOLR) ...

Is it an LOLR? No, It’s a Trap

by Michael Munger

In the 1983 film Return of the Jedi, Admiral Ackbar turns to the officers on the bridge and says what everyone already knew: “It’s a trap!” It had seemed a little too easy to be able to destroy the main threat, permanently and with no risk. Of course that turned out badly for the Alliance; they shouldn’t have been fooled.

Dodd-Frank and other post-2008 banking regulations were supposed to have fixed the banking system, permanently and without risk. But once again that was too good to be true. Turns out that all that new regulation did was to set another trap, Not intentionally (although the benefits to large firms are at least partly intentional). The solution to effective banking regulation however is to understand the role of the “Lender of Last Resort,” and to commit to doing nothing more, no matter what. As Richard Salsman and I argued more than a decade ago, the alternative, “Too Big to Fail,” has proven disastrous.

The Way to Regulate Banks: The Lender of Last Resort

Banks, and many other financial institutions, are brokers, mediating transactions between people who have money — depositors — and people who want to secure loans to do things with the money — borrowers. Brokers generally don’t hold on to the money that is deposited with them; the value of brokerage is connecting that money with an investment. In fact, the banking business was long described as a sleepy-but-safe activity, one that followed the “3-6-3 rule”:

• 3 percent — the interest you pay on deposits
• 6 percent — the rate you charge on loans
• 3 pm — your daily tee time on the golf course, because this business runs itself

Banks package and sell a product called “liquidity.” Liquidity is a measure of how quickly and cheaply an asset can be used to buy something else. Importantly, liquidity is not money, but a measure of the demand to hold cash balances, rather than holding wealth in some other form. Still, cash is liquid. It is easy to agree on a price, and transferring ownership is cheap. Loans are (usually) illiquid. Loans (such as mortgages) are contracts that bind one party to another, requiring payments that are secured by an asset. In the case of a mortgage, for example, the loan is secured by the value of a home, meaning that it is possible to negotiate a much-lower interest rate than on an unsecured personal loan, because the risk to the lender is smaller.

It is possible to buy and sell loans, or stocks, or other equities, but it is much more expensive than paying cash. (This illiquidity was part of the reason that mortgage-backed securities seemed like such a good idea back pre-2008, because in theory at least those were liquid; in fact, it appears that mortgage-backed securities were pretty liquid, and held their value better than is sometimes described). Another form of loan is called a “bond,” which is a promise to make periodic payments for a term of time, and then repay the full amount of the loan, the principal, at the end of that term. Ten-year US Treasury bonds, for example, have a face value and an implied interest rate paid to the buyer of the bond.

As I said earlier, banks are brokers. They take in deposits, and then use those deposits to “buy” loans. The bank might be the originator of a loan, as in the case of many mortgages. Or the bank might literally buy bonds or other securities, financial instruments that generate a higher rate of return than just holding money.

The problem is obvious. There can be a mismatch in liquidity between the bank’s liabilities (depositors put in cash, and they want to be able to take cash out) and assets (loans, bonds, other securities of various kinds). It is easy to imagine situations where a bank will be technically solvent — i.e., the total value of all its assets exceeds the value of all its liabilities — but the bank can’t convert enough of those valuable assets into cash fast enough to let everyone pull out their money right now. And when everyone does want their cash, right now, that’s called a bank run.

A bank run is dramatic, and has been used in movies from It’s a Wonderful Life to Mary Poppins. (It can be fun to use these movies in class, as illustrations!) The reason folks hurry to get their money is that there isn’t enough, and if you snooze you lose. The policy problem is that there is enough value, there just isn’t enough cash, today. That’s why the Lender of Last Resort (LOLR) function is so crucial. All that is required is a short-term loan so that there is enough cash today.

The cool thing about the Lender-of-Last-Resort solution (and note that the Lender of Last Resort could be either a private central clearinghouse, or a store of cash that maintains value in liquid form for immediate disbursal) is that if people believe the Lender of Last Resort will act immediately and effectively, then the Lender of Last Resort entity never has to act at all. If I know that I can get my money out, today, or for that matter tomorrow or the next day because the bank won’t run out of money — it cannot run out of money — then I don’t try to get my money out in the first place.

Walter Bagehot (Lombard Street, 1873) made the very sensible argument that many financial crises are not problems of insolvency, but only of illiquidity. And illiquidity is only a problem if literally everyone wants to take their money out of the bank at the same time. That problem is that “everyone wants to pull their money out at the same time” is literally the definition of a bank run, where depositors rush to get their cash while there is still some cash left.

Bagehot (pronounced “BADGE-uht”) claimed that the Lender of Last Resort must be fully committed to do three things, and never to do more than these three things:

1. Lend as much money as necessary directly to troubled (temporarily illiquid) banks; 
2. At a penalty rate (far above the market interest rate) 
3. But only against good collateral, as offered by a technically solvent bank.

Since there is immediate, unlimited cash available, there will be no bank runs. 

Since the interest rate is high, loans that are made will be very short-term. 

And since the bank has sufficient assets to cover its liabilities, there is no problem securing longer-term loans if that is necessary. Loaning to provide liquidity is cheap and effective, but it is not a bailout, because the bank has equity, it just lacks liquidity.

The Way NOT to Regulate Banks: Become the Insurer of Last Resort

The drawback with relying solely on Bagehot’s Lender-of-Last-Resort solution is that it does nothing to address “financial contagion,” when problem banks suffer not just from a liquidity shortage but from full-on insolvency. I learned about “contagion” as part of my professor Hyman P. Minsky’s theory of “fragility” in a financial system, so I tend toward his definition of contagion as a cascade of failures, animated by one or more financial institutions failing to make good on its commitments. When these assets become worthless, other banks immediately become technically insolvent also, though they were solvent an hour ago. The failures propagate like falling dominoes, quickly causing massive financial failures.

The reader will likely notice that the US has abandoned the Bagehot rules in favour of trying to limit contagion. Our present-day Lender of Last Resort, a composite of the Federal Reserve and the Treasury Department, routinely and wilfully misuses the discretion afforded central bankers. In their defence, though, the Bagehot criteria are not politically viable, because failing banks that lack good collateral are just as contagious, and maybe more contagious, than banks that have good collateral.

If the job of the Lender of Last Resort is to prevent contagion — and that is how the regulatory authorities describe their job — then it is logically impossible to hold to Bagehot’s third rule, lending only to banks that are solvent but need liquidity. But that changes everything. Without the constraint of requiring good collateral, the Lender of Last Resort becomes instead an insurer of last resort — a backstop for depositors who have no reason to consider risk when deciding where to place their funds. This problem has been massively exacerbated by the “deposit insurance” guarantees, which have now been extended far beyond the statutory $250,000 limit for despite protection, to have become essentially unlimited.

And that’s what happened for the depositors of Silicon Valley Bank, and Signature Bank (and, by the time this appears, possibly more banks). All of the deposits were guaranteed by taxpayers, even though the banks were insolvent, not illiquid. The usual story has been that the deposits were guaranteed by “the government,” but that’s nonsense. Money is being taken from taxpayers and used to support depositors who made a bad bet about where to put their money.

Since our regulatory practice has gone beyond making loans to illiquid-but-solvent banks, to paying back all the deposits of insolvent banks, the result is that there is no reason for depositors to care about whether their bank is taking excessive risks. This is called “moral hazard,” because it encourages the very risk-taking that regulators are later asking taxpayers to pay for.

The problem of moral hazard sounds arcane, but it’s a trap. In the case of Silicon Valley Bank, the risks in the bank weren’t even intentional, but revealed an astonishing lack of knowledge of basic financial principles regarding the capital value of bonds in times of inflation. To be fair, the stockholders of the bank itself have been punished by market forces (maybe, unless the Treasury loses its nerve, and succumbs to political pressure from union and state pension funds. Stay tuned!), because their equity is worthless. But the depositors should have been more careful. And they would have been more careful, except that deposits are insured by taxpayers who have no say in rewarding foolish risks. Worse, the fact that deposits of greater than the $250,000 statutory limit are now being covered by taxpayers means that the signal to all other depositors is that they need not look at their own banks, because taxpayers will cover those deposits, too.

The reason this is infuriating is that we are being told that taxpayers should be willing to double down, to reimburse even-more-careless depositors for their negligent inattention to risk. And I suppose you can see why, given that this dangerous assumption is now baked into expectations about how regulators will behave.

As Obi-Wan said to Luke, also in Return of the Jedi: “What I told you was true, from a certain point of view.” But Luke was mad that he had been lied to, and you should be mad, too.

 

Michael Munger is a Professor of Political Science, Economics, and Public Policy at Duke University and Senior Fellow of the American Institute for Economic Research.
His degrees are from Davidson College, Washingon University in St. Louis, and Washington University.
His research interests include regulation, political institutions, and political economy. he is the author of the 2021 book Is Capitalism Sustainable?
His post first appeared at the blog for the American Institute for Economic Research.

"Moral hazard played no role with Silicon Valley Bank"? Nonsense.

"I am continually amazed at the amount of nonsense that I’ve been reading on the subject of moral hazard. Here are a few examples:

1. Moral hazard played no role with Silicon Valley Bank because the shareholders and bondholders were wiped out. (nonsense)
2. Moral hazard isn’t an issue because average people don’t think about the safety of a bank when making deposits. (nonsense)
3. Moral hazard isn’t an issue because average people are unable to evaluate the risk of various banks. (wrong)
4. A run on bank deposits could cause a recession. (wrong)

"If you see anyone making the first two arguments above, just stop reading. They literally do not know what moral hazard is....
    "Some other misconceptions:

“Federal Deposit Insurance Corporation (FDIC) fees are not a tax on the public.” Yes, they are.
“We aren’t bailing out bank executives.” No, [they] are not bailing out Silicon Valley Bank executives, but [they] are (implicitly) bailing out their competitors."

~ Scott Sumner, from his post 'The Wrong Way to Think About Moral Hazard'

The triumvirate of fools at the US Federal Reserve Bank, US Treasury and Federal Deposit Insurance Corporation (FDIC) have abandoned any idea of a limited bailout for depositors in the two recently failed  banks, explains Thos Bishop in this Guest Post. Apparently there is now a new standard just made up by the banking bureaucrats: Too Mid-Size to Fail.
Welcome to the new economic paradigm where laws are broken, the rules are made up and the dollars don’t matter....

A Bank Crisis Was Predictable. Was the Fed Lying or Blind?

by Thos Bishop

Welcome to Whose Economy Is It, Anyway?, where the rules are made up and the dollars don’t matter. Or at least that seems to be the view of the Yellen/Powell regime.

As Doug French noted last week, Silicon Valley Bank (SVB) was the canary in the coal mine. Over the weekend, Signature Bank became the third-largest bank failure in modern history, just weeks after both firms were given a stamp of approval by KPMG, one of the Big Four auditing firms.

While some in the crypto community are suggesting that the closure of Signature Bank has more to do with a larger war on crypto, the regulatory action was enough to push coordinated action from the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and the Treasury to do what they do best, ignore clearly established rules to flood a financial crisis with liquidity.

Out: FDIC insurance limits on bank deposits lower than $250,000, haircuts for the largest bank depositors, and Walter Bagehot’s golden rule to lenders of last resort, “Lend freely, at a high rate of interest, against good collateral.” In: emergency financing to secure all deposits, accepting collateral at face value (rather than its current diminished market value) with no fee.

Don’t worry, the government promises this is only a year-long programme. It definitely won’t become a standing policy. They promise.

It is poetic that Barney Frank was serving as the director of Signature Bank at the time of its capture. This emergency action from the feds signals the failure of Frank’s key legislative accomplishment, the 2010 Dodd-Frank Act. The bill designated large financial institutions as “systemically important financial institutions,” with an additional layer of regulatory scrutiny as a means to end “too big to fail.”

Instead, the bill consolidated community banks into larger regional banks and empowered financial regulators that have now proven to be blind to the underlying risks of the banks. After all, it was state bank regulators, not the feds, that raised the flag on both SVB and Signature. Meanwhile, the hyper-fragile environment of the post-2008 financial crisis has created an environment where most financial institutions are treated as too big to fail, with no one too small to bear the costs.

Federal bank regulators and KPMG auditors aren’t the only ones blind to the underlying problems facing these large regional banking institutions. Just last week, Jerome Powell said that he saw no systemic risk in the banking sector from the Fed’s aggressive rise in interest rates and signaled confidence that they would continue in the near future. Less than a week later, few buy Powell’s projection.

While Powell deserves a level of credit for his willingness to take inflation risks more seriously than many of his peers, the instability we’re witnessing was predictable. As is repeated regularly on the Mises Wire, the decade-plus reign of low interest rates didn’t only incentivize financial risk but necessitated it. The benefactors were tech firms, the real estate market, and a variety of other financial markets. The consequence has been corporate consolidation and the creation of numerous overly leveraged, unprofitable zombie companies that depend upon refinancing at low interest rates to function. The Fed’s rising interest rates have always been a threat to these parts of the economy.

In defense of Powell, lying about the state of the economy is a necessary part of the modern financial system. Regardless of one’s opinion about the virtues of free banking, state intervention has created a fractional reserve banking system saturated with risk and moral hazard. Since no bank is equipped to deal with a significant increase in demand for deposits, even relatively conservative banks can be brought down by a confidence crisis fueled by the instantaneous communication of social media.

The Feds have signalled a bailout for all because everyone is at risk.

It doesn’t have to be this way. Caitlin Long has been fighting the financial regime for years in her quest to create Custodia Bank, a full-reserve bitcoin bank in Wyoming. There has been a coordinated attempt to stop her efforts, ironically including voicing concerns that Custodia could fuel “systemic risk.” Honk honk. [And despite all the interest-rate chicanery and money-printing Keith Weiner continues his efforts at Monetary Metals to remind everyone that the ultimate money is still a precious metal.]

The short-term question is whether the efforts of the Fed and the Treasury are enough to prop up confidence and prevent escalating pressure on financial institutions. However, these are not solutions to the underlying systemic problems that these bodies have created.

Unfortunately, the consequence of the complete politicisation of the economy is that financial policies are necessarily focused on the short term at the expense of the long term.

There is no serious solution until there is the political will to deal with our monetary hedonism.

Author: Tho Bishop
Tho is an assistant editor for the Mises Wire, and can assist with questions from the press. Prior to working for the Mises Institute, he served as Deputy Communications Director for the House Financial Services Committee. His articles have been featured in 'The Federalist,' the 'Daily Caller,' and 'Business Insider.'

His post first appeared at the Mises Wire.