Give Me a Shovel and Man, I'll Plant 'Em

Further tales of crashing banks and federal intervention:

The 28 branches of 1st National Bank of Nevada and First Heritage Bank [N.A.], operating in Nevada, Arizona and California, were closed Friday by federal regulators.

The banks, owned by Scottsdale, Ariz.-based First National Bank Holding Co., were scheduled to reopen on Monday as Mutual of Omaha Bank branches, the Federal Deposit Insurance Corp. said.

The FDIC said the takeover of the failed banks was the least costly resolution and all depositors -- including those with funds in excess of FDIC insurance limits -- will switch to Mutual of Omaha with "the full amount of their deposits."

On the larger topic of bubbles and bailouts: I don't have time to find the link right now, but the conservative writer Patrick Deneen -- not ordinarily a free-market guy -- made a good point a few months back about the notion that some institutions are "too big to fail." On top of the other moral hazards involved, he pointed out, the idea creates an incentive to become…well, too big.

Update: Here's that Deneen link. Thanks to Joe Leibrandt for passing it along.

Comments

[Not Mojo Nixon.]

Nice reference in the title. Jesse Walker (or the editor), you have my praise!

[Elemenope]

On top of the other moral hazards involved, he pointed out, the idea creates an inventive to become...well, too big.

One might imagine it also creates an incentive to become too big. 😉

[David E. Gallaher]

And your disincentives to become "too big" or "too rich" are looking back on the shit our handy-dandy government laid on Leona Helmsley, Martha Stewart, Bill Gates, not to even mention oil company executives.
Can we wait 'til McCain begins "trust-bustin'" lak his hero, Teddy R?

Ruthless
Should I be thankful I was never an "incentivisable" personality? It has to do with my hillbilly roots.

[Episiarch]

I'm too big to fail. Where's my bailout?

[David E. Gallaher]

Episiarch,
Have you, over the course of your still young life, consumed too many trans fats? Hang in there. Ah-nohld will save your buttery butt.

[Episiarch]

No, I meant my ego. But you already knew that.

[Jesse Walker]

Thanks, Elemenope. Apparently I didn't have time to proofread the post either.

[David E. Gallaher]

Here's a point--if you want to call it that--to ponder: If you had a buttery butt, would your ego still be too big?

[Episiarch]

My vanity would never allow me to have a buttery butt, which is fueled by my ego. It's sort of a chicken and the egg thing.

Of course, if my butt was buttered by Marlon Brando, there would obviously be ego issues.

[SIV]

including those with funds in excess of FDIC insurance limits

Is the FDIC backing the over-limit deposits?
Or Mutual of Omaha?

If it is the FDIC they are going to run out of money soon, or the Bureau of Printing and Engraving is going to run out of paper.

[PT Nerdino]

Jesse Walker,

Was your reference to Patrick Deneen as a conservative intentional?

While I think you are technically right--he favors what my goddess VPostrel would call "stasis"--the more typical designation for
Patrick Deneen's ideology would be communitarian.

[Jesse Walker]

Yes, it was intentional. I would call Deneen a conservative of a particularly un-libertarian stripe.

[David E. Gallaher]

Was just watching the ladies' opener of the MMA on CBS from Stockton, CA.
I love it when the mat is already blood-stained for the opener.
Anyhow, I sure hope both those delicate, prim and proper young ladies keep avoiding those vicious ol' trans fats out there in Cal-ee-fahrn-yia.

[David E. Gallaher]

Speaking of Mutual of Omaha, Congress could put many minds more at ease immediately at zero taxpayer expense by simply changing the name FDIC to the Marlin Perkins Memorial Trust Fund.
I'm just sayin'...
Do we want to stop runs on banks or what?

Ruthless

[Colin]

Too bad Marlin's dead -- he could've done a special Wild Kingdom episode on these banks.

[John-David]

I don't see any easy solution to the TBTF problem, unless we persuade the government to intervene to limit the size to which a bank can grow. I guess that's a little more palatable than endless bailouts. Is there a third way?

[tarran]

Is there a third way?

Yes, government officials announce loudly and repeatedly that they will never bail out anyone under any circumstances.

It won't help the morons, but will cause more peole to invest and bank conservatively.

Ergo, fewer failures and fewer losses.

Nothing is too big to fail.

[jimmy smith]

My wife never said that I was TBTF.

[Jim Woods]

Heck yeah dude toss me a shovel, I'll help!

JT
http://www.FireMe.To/udi

[libertymike]

F-for

D-dummies,

I-investment

C-counselling

[Occam\'s toothbrush]

PT Nerdino,

What Jesse said...and like it or not this fellow's version of conservatism is on its way to becoming the dominant one. Huckabee was just the herald of things to come.

[squarooticus]

Here's what makes me know it (the credit crunch) is bad:

Bush did a 180? on the bailout bill.

This means that someone who knows how seriously fucked our financial system is explained it to the chimp-in-chief, who decided he didn't want to be president during the second Great Depression.

The government is 100% unified behind a hyperinflationary "solution" to the credit crisis. You heard it here first, folks: the housing market will not be allowed to fall to its natural (bubble-free) equilibrium, which means instead of a 50-70% drop in home prices, you'll see 100-200% inflation over the next several years. You can already see it in food and energy; it's only a matter of time before it hits everything else.

You'll know it's really bad when Bernanke resigns to spend more time with his family.

[joe]

Remember back, before the Great Depression, when the financial institutions were so much more conservatives that we didn't see irresponsible investment and lending activity leading to financial collapses?

Yeah, me neither.

[squarooticus]

joe: point me to a system-wide banking failure/insolvency that wasn't the result of government legal tender laws.

I'll save you the trouble: it's never happened. Bank runs before the advent of central banking were the market's way of punishing banks that created more paper money than they had real money on hand.

Now, follow the money: who benefits most from centrally-controlled and guaranteed paper money versus real money?

Thanks for playing.

[joe]

Bank runs before the advent of central banking were the market's way of punishing banks that created more paper money than they had real money on hand.

And rather than happening less frequently than the recent troubles, they happened quite a bit more frequently, and with more severe consequences for the economy, owing to a lack of the very backstopping that we're always told will increase the frequency of such collapses, but hasn't, going on 70 years now.

It's cute that you can phrase your comment as if you just won an argument, but it doesn't make up for the fact-averse nature of your belief system, and the ease with which it can be disproven by anyone with a 9th grade history book.

[joe]

Shorter squarooticus: Bank runs that wiped out thousands of people and led to national depressions - which happened every decade or two throughout the first 150 years of our country's existence - are good because they're free market bank runs.

The absence of bank runs over the past 70 years, and the absence of depressions set off by them, are bad, because the ability to achieve a safer, more stable, stronger economic and financial system involved the government.

[squarooticus]

And rather than happening less frequently than the recent troubles, they happened quite a bit more frequently

You mean to say, "Instead of bank runs being local, isolated phenomena that punished only individual banks and their asleep-at-the-switch customers, bank runs are now "solved" by inflation (as seen in the S&L bailout and the increasingly frequent interest rate cuts by the Fed) that is beneficial to government taxation, bankers, and debtors, and detrimental to savers and earners. In other words, it's a massive transfer of wealth from everyone else to the already-wealthy, that occurs slowly most of the time but very quickly every few decades or so."

I usually hate putting words in other peoples' mouths, but since I'm sick of hearing ignorance emanating from yours, I've decided I need to step in.

It's cute that you can phrase your comment as if you just won an argument, but it doesn't make up for the fact-averse nature of your belief system, and the ease with which it can be disproven by anyone with a 9th grade history book.

It's not surprising to learn that your view of the world is limited to the sophistication of a 9th grade history book. I'll bet you think the cause of the Civil War was "slavery", too.

[squarooticus]

Bank runs that wiped out thousands of people and led to national depressions - which happened every decade or two throughout the first 150 years of our country's existence

[[citation needed]]

[joe]

Wow, squarooticus, you presume to talk down to me about economic history, you act like you have some insight into this question, and you aren't even familiar with the timeline of American depressions?

OK, lesson time:

American depressions prior to the Great Depression:

1. A depression began in 1819.

2. A depression began in 1837.

3. A depression began in 1857.

4. A depression began in 1873.

5. A depression began in 1893.

[jimmy smith]

Let me see now, the dollar I saved in 1953 is now worth 11 cents, not a bank failure? Quick, someone tell me how this helped me?

[joe]

Uh, you were able to put it in a bank which didn't fail, and which you knew wouldn't fail, thus earning interest, and your dollar is actually worth...um...carry the five...uh...a whole lotta dollars.

[BakedPenguin]

joe, in the depression, banks could have stopped some of the runs themselves. IIRC, JP Morgan and a few of his pals had plans to purchase up (certain) insolvent banks, which probably would have slowed or stopped the run on banks in general. However, the McFadden Act prevented interstate commerce in banking.

[BakedPenguin]

Yup. Morgan even saw stabilization of the banking markets as part of his role. Good thing those trust-busters kept him in his place.

[joe]

And also, hey look over there.

Since I'm not arguing "every action of government involvement in banking is good," I don't see the purpose of pointing out to me that there have been government interventions into banking that are bad.

[BakedPenguin]

When you finish looking over there, joe, let me know if you saw something that looked like a self-regulating market mechanism - that would have dealt with bank runs- was forbidden to be put in place by the government.

I wasn't arguing "joez a liberal, he likes gov't! LOLfag!", I was pointing out a historical incidence of a major market player wanting to act responsibly to prevent problems, and being stopped in doing so by regulation. You made a point upthread about hard money depressions and the bank runs that preceded them.

[Captain Awesome]

It may just be my bias from having worked in a bank, but the business is inherently risky. The Average Joe goes there under the impression that it's the safest place to keep his money (and it is a hell of a lot safer than the mattress alternative). And it is another situation in which we have more bad regulation piled on top of old bad regulation. Requiring insurance on deposits in order to call yourself a bank is not something that I get too worked up about. And banks do pay for it (I cut the FDIC checks myself) but it's a pittance. I'd rather see some sort of private reinsurance for deposits, and if your institution doesn't want to get it, then I have no problem disallowing them from being called a bank, perhaps "Big Gambling Pool" would be a more appropriate name.

[J sub D]

The FDIC said the takeover of the failed banks was the least costly resolution and all depositors -- including those with funds in excess of FDIC insurance limits -- will switch to Mutual of Omaha with "the full amount of their deposits."

How much is the FDIC paying Mutual of Omaha to expand their business? Maybe they're doing it out of the goodness in their hearts, but for some reason this cynical bastard doubts that.

How to package corporate welfare so the liberals will support it.

It's for the homeowners.
It's for the depositors.
It's to avoid a financial panic.
It's for the environment.

Fuck the 1st National Bank of Nevada and First Heritage Bank N.A. depositers of more than $100K. If fraud was committed. put some bankers in jail.

[Penn]

Squarooticus and Joe, your comments made me laugh out loud. But if I were honest, I'd cry. I think we're headed toward another Great Depression. Not *just* because high finance is crumbling like the WTC; but also because you can start to sense the panic on the nation's streets, in your car, in people eyes. A general eeriness.

But maybe I'm a full-blown paranoiac. Everything's probably fine, just as it should be, as it always will be.

"Americans are whiners," after all, and "technically we're not in a recession."

On the other hand, you can take George Carlin's advice and "save up money for the black market."

[joe]

BakedPenguin,

When you finish looking over there, joe, let me know if you saw something that looked like a self-regulating market mechanism - that would have dealt with bank runs- was forbidden to be put in place by the government.

Actually, I'm not looking over there at all, because rather than the subject being the general field of "government and market and banking," I've been addressing the specific point raised by the author of the post - the alleged increase in risky behavior by banks (and the consequences thereof) produced by government backstopping.

While it's nice, I guess, that earlier bank runs could have been contained through targeted acquisitions by larger banks, the fact that there were, in fact, more such failures with greater consequences (however they might have been attenuated) before that backstopping should put the "moral hazard" argument into perspective. Back when the risks of bad bets by banks was much higher for those banks, we still saw such actions as bubble-chasing and high margins.

The bankers who did so weren't ignorant of the risks; like every bad investor, they were pretty sure that they knew what they were doing and that things would turn out well for them.

[joe]

Penn,

There's a reason we haven't had any depressions since the Great Depression: there are (evil, anti-human, road-to-serfdom) government backstops in place, to keep financial-industry meltdowns from stalling the economy as a whole.

There is not way the American economy in 2008 is going to be starved for capital, all across the board, the way it was in the early 30s. That can't happen anymore.

Here's a question for people smarter than I: how did we manage not to have runaway inflation in the 30s, when the government was pumping fiat money into the economy? Other countries did. Did FDR just happen to get the balance just right?

[Penn]

"There is not way the American economy in 2008 is going to be starved for capital, all across the board, the way it was in the early 30s. That can't happen anymore."

Oh, I agree. My opinion is that the present economic arrangement will last well into eternity. The fate of capital is to stably spiral into infinity.

Would most people agree that the Great Depression started on Wall Street; and that it was caused by speculation?

Buying on margin, leverage, investment trusts. These are the watchwords of the 1929 collapse.

Traders still do much of their trading on margin, the banks are more leveraged than ever, and the investment trusts have renamed themselves hedge funds.

Leverage is what's going to be lethal. I heard it mentioned on CNBC that the Feds are requiring banks to deleverage before they go to the discount window. So what are the banks doing? Instead of borrowing capital from other banks (leverage), they're loaning money to themselves!! Where does the money come from. Why, from the deposits of course!

Margin, leverage, hedge funds. These are instruments of speculation.

[Charles]

It's not surprising to learn that your view of the world is limited to the sophistication of a 9th grade history book. I'll bet you think the cause of the Civil War was "slavery", too.

Almost every real historian, from those writing 9th grade textbooks up to those writing the most unreadable monographs, agree that slavery in some form caused the Civil War. There are disagreements over exactly how it happened -- if it had to do with slavery's disruptions of the party system, or the western expansion of slavery, or something else -- but few historians would disagree if you say slavery caused the Civil War (although almost all of them would say it's an oversimplification).

[Captain Awesome]

"Would most people agree that the Great Depression started on Wall Street; and that it was caused by speculation?"

I think many believe that wall street played an intermediate step in the Great Depression. It was a 3 step process (gross simplification).

1) Terrible fed policy encouraging overleveraging.
2) Wall street takes the bait and sets itself up for disaster.

while alone these could cause a depression, and a gnarly one at that:

3) Smoot-Hawley (and other congressional reactionary legislation)

is what made it great!

[jimmy smith]

Joe, I have a lot of dollars from my buck, but each is only worth 11 cents, Every thing above the initial dollar is taxable, I can get 11 cents worth of goods, before it is taxed. My second dollar of interest will buy about 8 cents worth of goods. I love inflation, I love taxes, it's what makes us civilized. I'm rich, I'm telling you. Mom, can we move to Zimbabwe?

[Mo]

in the depression, banks could have stopped some of the runs themselves. IIRC, JP Morgan and a few of his pals had plans to purchase up (certain) insolvent banks, which probably would have slowed or stopped the run on banks in general. However, the McFadden Act prevented interstate commerce in banking.

Was this Zombie JP Morgan? Because JP Morgan died in 1913.

[joe]

Surely this undead industrialist will devour us all!

[Travis]

"Was this Zombie JP Morgan? Because JP Morgan died in 1913."

If you had clicked on the provided link you would have read about the banking runs of 1907. JP Morgan was trying to stop the runs by buying up failing banks.

[Mo]

In my defense when I, and probably most people, read "the drepression", my mind immediately thinks of the Great Depression. If you're talking about depressions in US history other than that one, you have to specify a year. It's like saying "the pill" You can't come back later and say, "No, I meant Zyrtec. That's technically a pill."

[James Anderson Merritt]

Squarooticus wrote, "Instead of bank runs being local, isolated phenomena that punished only individual banks and their asleep-at-the-switch customers, bank runs are now "solved" by inflation..."

Thank you for saving me the trouble of pointing that out. We traded "natural" bank failures that severely punished bad investment and management locally, for the pretense of national financial "stability" that didn't end the losses, but spread them out (via inflation and other mechanisms) across the entire population, routinely "punishing all." Unfortunately, the downside for this devil's deal is a steep one: If financial system instability becomes too great even for the national "stabilization" (i.e., tactical wealth-transfer) mechanism to handle, the ensuing depression will be deeper and longer-lasting than anything that might occur "naturally."

Inflation eats away at the purchasing ability of responsible, frugal people's cash savings, transferring the purloined purchasing power to those who get their hands on government's bogus new money first -- usually the recipients of bailouts or other welfare or pork; that's a serious form of theft, and those who knowingly participate in it should do serious jail time.

[Mo]

lation eats away at the purchasing ability of responsible, frugal people's cash savings, transferring the purloined purchasing power to those who get their hands on government's bogus new money first -- usually the recipients of bailouts or other welfare or pork; that's a serious form of theft, and those who knowingly participate in it should do serious jail time.

No it doesn't. Unless your hypothetical responsible, frugal person hides their money under their mattress, they'll get an above inflation RoR in stocks and bonds. The Japanese have virtually 0 inflation, which has hindered their economy because it leads to deflationary periods, which is a killer to the economy.

[Heinrick]

"Buying on margin, leverage, investment trusts. These are the watchwords of the 1929 collapse."

I have been thinking for a while that these pay option ARM mortgages are alot like buying on the margin.

[The Angry Optimist]

Mo - I'm not buying that. It is seriously obscene that the act of lending money to a private institution (which is what you do with deposits to a bank) still yields you a negative return. There's something broken with a system that virtually mandates that in order to make money you have to go above and beyond deposits. Banks make money hand over fist with the capital you lend them, but the lender sees almost none of it thanks to inflation.

[Sean Healy]

Banks make money hand over fist with the capital you lend them, but the lender sees almost none of it thanks to inflation.

So buy bank bonds instead. Or shares. They often pay a dividend, you know. Oh, you don't want any risk? Well, adjust your expectations of reward.

[Sean Healy]

[Sean Healy]

Fixed?

[alisa]

Okay.
Squarooticus:

One of the best natural experiments that shows countercyclical monetary policy works happened in the early years of the Great Depression. Ben Strong was then head of the New York Fed, and he independently conducted open market operations until his unexpected death; as a result, New York was, at first, spared the bank runs and panics occurring in the rest of the country.

Penn: what you are talking about (buying on margin, leverage, speculation) are characteristic of many recessions, from the "panics" of the 1880's and '90s to the dot-com crash. They don't always lead to 25% unemployment. The Great Depression was Great in part due to mismanagement. Roosevelt's administration artificially kept wages high so employment couldn't return to normal. Also, the Fed doubled the reserve requirement, causing a second recession in '38. There's more: it was a kind of perfect storm of bad policy. I'm not saying it couldn't happen today, but we'd need some singularly ahistorical folks working at the Fed and the Treasury.

Joe: my best guess, in response to your question, is that we weren't really pumping fiat money into the economy early in the Depression. Roosevelt was still worrying about balancing the budget. By the time we started to combine Keynesian fiscal policy and dropping interest rates, we were nearly in WWII, when production could keep pace with inflation.

[Bill Woolsey]

Purchase and assumption is the most common FDIC practice. A new bank takes over the old bank, receives all of the assets (or maybe just the good assets plus cash) and takes responsibility for all of the deposits, insured and uninsured.

The alternative is liquidation. Then FDIC takes over the bank, pays off the insured deposits, sells off the bank's assets, and pays off the uninsured deposits partially.
(With Indy-mac, the uninsured depositors will immediately given 50% credit for their deposits.)

FDIC says that it chooses between options based upon cost. And so, the key issue is whether there are other banks who want the assets and deposits of the insolvent institution.

In either situation, the stockholders of the failed institution lose everything. The bank isn't bailed out, but the depositors are bailed out.

There is nothing inflationary about this activity. It does mean that the deposit insurer (FDIC) must make insurance conditional of safe lending practices. The key one is capital requirements. The stockholders (who lose everything in insolvency) are required to finance a substantial fraction of the bank's assets. The rules are complicated, but commerical banks have 10% capital on average at this time.

With deposit insurance, there is little motivation for depositors to monitor bank lending practices, or capital, or anything else. So, the system is very dependent on the quality of bank regulation. The S&L crisis
and some of the subprime mortage crisis relates
to that problem.

Before deposit insurance, depositors didn't directly monitor bank lending, but they refused to put their money in institutions with little capital. A small balance sheet showing assets, deposits, and capital was placed on the door of banks. Right where today you see, "fdic insured."

The alternative to deposit insurance is having the Fed serve as lender of last resort. This doesn't protect depositors from insolvency. If a bank is solvent, however, the central bank can lend newly created currency to the bank,and a large proportion of the depositors can withdraw a large proportion of their money without this impacting the total money supply or any part of the banking system.

A central bank, like the Fed, can also cause inflation. Traditionally, severe inflation has been the result of using central banks for public finance. But, it sometimes happens because the central bankers think the policy is good for the economy.

Before FDIC and the Federal Reserve, banks generally suspended cash payments when there was a run. In the earliest days, the banks placed an option clause on their banknotes (they were issuing currency more than deposits at the time.) If the bank couldn't pay off the notes on demand, they would pay interest on them. This did nothing for depositors of an insolvent bank.

This practice was banned to try to get banks to hold more gold reserves. The result, in the U.S., was that banks suspended currency payments anyway, but the practice was illegal and there was no bonus interest to depositors. Bank clearinghouses, illegally printed currency, lent it to the banks, who paid it out to depositors. It was a private lending of last resort system. The Fed replaced it.

The Fed failed to act as lender of last resort during the great depression. It wasn't that it was unable to do so, it just failed to do so. And so FDIC was instituted.

[Bill Woolsey]

While a policy of "too big to fail" does create an incentive to deposit money in large banks, giving them a competitive advantage, small banks have been an artifact of regulation.

Before deposit insurance and before central banks were doing anything more than exacerbating runs, large multi-branch banks dominated the market wherever they were permitted. This is because they were safer for depositors because of geographic diversification. Local economic problems were not a problem for a geographically diversified bank with dispersed branches.

A local, community bank, on the other hand, would easily fail when faced with local economic problems. Depositors, saving for difficult times, would need their money. Borrowers would have trouble paying back loans at exactly that time.

In the U.S., branch bank was greatly resticted, sometimes to the absurd degree of requiring "unit banks"--single office banks. These regulations varied by state.

National branch banking has been allowed in the U.S. for nearly 30 years. However, because of deposit insurance, depositors don't have to worry whether or not their banks are geographically diversified. So, small, local banks, have survived. But, they are almost certainly an artifact of government intervention--deposit insurance.

Who knows what the future will bring, but if one travels the path towards a deregulated banking system, the most likely scenario is a relatively small number (10? 20?) of banks, with branhes of some of those banks in every community. A small balance sheet on the door of every bank showing the bank's capital (net worth.) Expect to see a list in the financial section of the paper (and online) of more current capital data, including the stock market valuation of the bank's net worth. And runs ending rapidly with promises of bonus interest in compensation, which, of course, will never be paid by an insolvent bank. Because depositors would receive only partial payment in an insolvent bank, they will avoid poorly capitalized banks.

[The Angry Optimist]

So buy bank bonds instead. Or shares. They often pay a dividend, you know. Oh, you don't want any risk? Well, adjust your expectations of reward.

There's sufficient risk in depositing your money in the first place that there *should* be reward enough to at least cover inflation. The fact that there isn't signifies that there is something broken.

I love being condescended to by being told that higher risk = higher possibility of reward while simultaneously having the condescender miss my point!

[Mo]

There's sufficient risk in depositing your money in the first place that there *should* be reward enough to at least cover inflation. The fact that there isn't signifies that there is something broken

If your deposits are FDIC insured then there isn't a lot of risk. You can always deposit in a credit union or alternative bank with high yield savings/checking plans, which are greater than the spread between TIPS and T-Bills (i.e. expected inflation). Or you could deposit your money in a money market fund. By the way, if the inflation rate was zero, the real interest rate would be unchanged and your yield on deposits would go down accordingly. It's not like banks would still offer you the same interest rate if their expected return went down accordingly.

[squarooticus]

Boy, I'm glad I missed the rest of this discussion.

Joe, regardless of how widespread geographically panics in the 1800's might have been, they couldn't have been *system-wide* unless government was making people accept bad money through legal tender laws. For example, if you know or suspect I.P. Freely's bank is issuing lots more Bollars (redeemable in gold on demand) than it has gold on hand, then in the absence of legal tender laws you simply refuse to accept Bollars, or you accept them and redeem them for gold immediately. Even if Freely has a branch in every city in the US, you will not have your savings wiped out when there is a run on his bank, because you have the ability to reject his mismanaged currency.

No such safe harbor exists today: you must accept dollars, and take the mismanagement (in the form of moral hazard, political interests, and inflation) that comes along with it. Instead, you have several choices:

* invest in gold: the stability in the value of gold-that is, the amount of "stuff" that trades for some fixed amount of it-that would exist were it widely used as money doesn't exist in the 100% fiat reality we live in today.

* invest in bonds: these don't even pretend to keep up with inflation nowadays, given the existence of TIPS, which also don't keep up with actual inflation because of the cooked CPI numbers.

* invest in stocks: too volatile for savings

* invest in mutual funds: unless you manage your money actively during periods of market instability, these are still too volatile for savings; and the whole point of having a safe store of value is not to have to manage it actively!

There is no safe store of value anymore. None. And that's the reason why bank runs are more of a problem today than they were in the 1800's: because you can't avoid them even if you want to.

[Penn]

Alisa,

You said, "What you are talking about (buying on margin, leverage, speculation) are characteristic of many recessions, from the "panics" of the 1880's and '90s to the dot-com crash. They don't always lead to 25% unemployment."

No doubt, high finance is always a game of speculation. But speculation passes through stages, the last stage spelling disaster for al. What makes this economic crisis so worrisome is that it may be the last stage in a bout of speculation that has lasted the century, dating back to the end of WWII and the formation of the first hedge fund in 1949.

The Federal government may have in various ways prolonged the Great Depression. But I don't accept the historical revisionism that holds government responsible. The Great Depression was several times more severe in Germany; and it was felt all over the world. Why should that be true if it was the U.S. government's peculiar reaction that turned it into a Depression. Additionally, governments had never dealt with a crisis on the Depression's magnitude, and economics was a fledgling 'science'.

In any case, the solution to a Depression, as is well known, is militarization and war. Germany came out of the Depression thanks to Hitler's war mobilization, and the Soviet Union thrived during this time. In fact, in the 30s, while America had a negative immigration rate, more than a hundred thousand Americans emigrated to the Soviet Union.

[Mo]

invest in bonds: these don't even pretend to keep up with inflation nowadays, given the existence of TIPS, which also don't keep up with actual inflation because of the cooked CPI numbers.

What would you use instead to measure inflation? PCE? You have no problem using CPI to note the loss of value of a dollar, but you have a problem with it for value conservation. WTF? You bitch about not being able to safely store money and there are numerous safe places. You completely ignored money market funds and high yield savings account.

Also note, prior to the establishment of the Fed, there were periods of inflation as well as 4-5 year stretches of deflation, which completely freezes up an economy. Better to have inflation at about 2%, where there's some wiggle room.

0% inflation, like 0% unemployment, is one of those ideas that looks good on paper, but is horrible for an economy. Pretty much the only people that support both have no understanding of economics.

[Captain Awesome]

"In any case, the solution to a Depression, as is well known, is militarization and war."

This may be the common knowledge, but it is simply not true. It's not until the private sector is sufficiently confident in returns that it starts investing in capital that a recession can end. Germany turned around it's recession through war only because somewhere on the order of 70% of its GNP was war plunder. That's not a sustainable way to grow an economy, is morally reprehensible, and when viewed on a scale larger than national(as it should), is a massive broken window fallacy.

@Bill Woolsey. That's some nice historical perspective you've got there. I agree that the artificial prevention of branch banking and regional banking requirements made local banks necessary and unstable as hell (our CRA is a weaker modern version of this mess). But capital can flow so smoothly over geography these days, that I could imagine local banks existing today, even in a free banking atmosphere. Furthermore, a private deposit insurance could conceivably facilitate this. If FDIC had been a private insurer and arranged this deal that cost them less money, and covered the uninsured depositors, be assured that Reason and the Hit-and-runners would be praising the efficiency of private insurance (and rightly so).

[Sean Healy]

I love being condescended to by being told that higher risk = higher possibility of reward while simultaneously having the condescender miss my point!

Well, it seemed to me like you were overlooking the fact that variable bank bond coupons linked to Euribor or Libor are far more attractive than deposit rates right now because of unusual wide spreads, but you're essential taking the same risk on both types of 'lending'. When you factor in price rises on the bonds' face value, yields are even more attractive. Again, for virtually the same risk (i.e. that the bank will fail).

I'm curious: where do you get the idea that a deposit *should* cover inflation? Don't interest rates work like other prices? In other words, if there were a profitable opportunity to be exploited at higher rates, surely some bank out there is offering them.

[squarooticus]

What would you use instead to measure inflation? PCE?

How about inflation as it was calculated under the early Clinton administration? None of this "core" crap, which excludes exactly the things people cannot delay purchasing: food and energy.

You have no problem using CPI to note the loss of value of a dollar

Actually, I note the loss in value of the dollar with M3 (or, if you don't believe shadowstats.com, MZM, which is a reasonable proxy) along with $DXY and trade-weighted dollar indices. The increase in the money supply doesn't directly decrease the value of each dollar, but the rate at which the government is creating dollars directly affects the willingness of people to hold those dollars, which directly determines how much each of those dollars is worth. This is pretty basic supply-and-demand stuff.

Despite the name, CPI does not measure inflation: inflation is the rate of increase of the money supply, whereas CPI is a delayed reaction to that increase as the dollar is revalued by the marketplace.

You completely ignored money market funds and high yield savings account.

Money market funds are typically not insured, and I'm sure they're not backed by gold. 😉 Bet it would suck to have a few hundred large in an uninsured money market when the bank goes bust after a run.

What rate does a "high-yield savings account" pay? If it's less than about 10%-which I'm guessing it is-then you're losing purchasing power over time.

0% inflation, like 0% unemployment, is one of those ideas that looks good on paper, but is horrible for an economy. Pretty much the only people that support both have no understanding of economics.

I guess the entire Austrian school is wrong then, huh? I'm glad you're able to single-handedly refute an entire school of thought with an unsupported assertion.

[Mo]

You betray your ignorance right there. TIPS are not calculated using cor CPI. They're calculated with regular CPI. And what country are you in where long term inflation is 10%?

There are many historical examples of deflation being linked to higher unemployment and a pull back on GDP. The years following the Panics of 1893 and 1907, Japan in the 90s, etc.

How is backing by an arbitrary commodity and less of a fiat monetary system than our current system. If there's a collapse in the US government backing of the dollar, then it doesn't matter if fairy dust or gold backs the dollar, other staples and useful commodities would have greater value.

[Captain Awesome]

"other staples and useful commodities would have greater value."

Too bad it's so impractical to base a unit of currency on a KwH. An ideal currency would probably be based on a bundle of diversified staples (oil, food, land).

[squarooticus]

You betray your ignorance right there. TIPS are not calculated using cor CPI. They're calculated with regular CPI.

I presume this is inflation as it is calculated today rather than as it was calculated in 1990? CPI today is cooked to look lower than the rate at which consumer prices are actually rising. Your daily experience should tell you that. It surely has for many people: even one of the Fed's own presidents said the same thing.

And what country are you in where long term inflation is 10%?

Note this M3 chart, calculated the same way the government stopped calculating it in 2006. Since inflation is defined as growth in the money supply, we are looking at greater than 15% inflation over the past year.

How is backing by an arbitrary commodity and less of a fiat monetary system than our current system. If there's a collapse in the US government backing of the dollar, then it doesn't matter if fairy dust or gold backs the dollar, other staples and useful commodities would have greater value.

Not sure what you are getting at here. If you mean "If the government defaults on its obligation to convert dollars into gold..." then the dollar really isn't gold-backed, is it? OTOH, if the dollar is 100% gold-backed, I fail to see why the government policy beyond convertibility would have anything to do with its value: each dollar would be pegged to a certain quantity of gold, which provides a lower bound on its value due to gold's 5,000 year long history as money in the Western world. Paper has no lower bound on its value.

[squarooticus]

Too bad it's so impractical to base a unit of currency on a KwH.

Except that money is supposed to be a unit of exchange and a store of value, not something that is supposed to be indexed to some commodity that has intrinsic value, like a KWH, the cost of which goes up and down depending on the prices of commodities used to generate it.

This is one of the reasons why gold is so good at being money: gold has very little intrinsic value as a commodity, and so functions well as a medium of exchange without interference from markets wanting to use it as a raw material; it isn't consumed or destroyed, so the need to create or dig up more of it all the time isn't there, unlike oil; and it cannot be arbitrarily created, unlike paper currency, so its value cannot drop off a cliff as a result of any realistic (economically-viable) action, much less as a result of capricious decisions by a small group of people.

FWIW, I'm not 100% in bed with gold: I recognize that a gold-backed currency has problems. The winning argument for gold, however, is that all the alternatives so far have been far worse. I actually agree with the notion that a properly managed fiat currency can theoretically be better (at medium of exchange + store of value) than gold-backed currency; however, politics and greed mean that realistically the handcuffs placed on banks by the scarcity of gold will always be superior to the management of money by men.

[Captain Awesome]

So the value of gold as a currency is in it's arbitrariness?

"So the need to create or dig up more of it all the time isn't there, unlike oil"

Hasn't a majority of all gold unearthed in human history been unearthed within the last 50 years?

[squarooticus]

So the value of gold as a currency is in it's arbitrariness?

Glib, but true in part. Who knows what originally propelled people to like gold? Probably beauty combined with scarcity. After a while, though, it became irrelevant: for all but the last 100 years gold was money because everyone accepted it as money? just like dollars today, which have absolutely zero intrinsic value, lacking even the beauty and scarcity part.

The main thing that separates dollars from gold is that dollars can be printed at someone's whim, while gold costs a lot of money to dig up. It costs nothing-nothing!-for the government to create an additional $900 or $9,000,000,000,000. OTOH, it costs a lot of money to dig up another ounce, much less 10,000,000,000 ounces.? And digging up gold is at least egalitarian: the government has a monopoly on counterfeiting, which would be immaterial if it didn't so regularly exercise it.

Hasn't a majority of all gold unearthed in human history been unearthed within the last 50 years?

I honestly have no idea. But let's say 75% of the world's gold has appeared in the last 50 years. Guess what? 75% of the world's dollars have been printed in the last 15 years and the rate is accelerating, whereas the rate of increase of the above-ground gold supply is flat despite gold's rapid rise in value over the last 6 years. There's only so much gold available to humans at this point in history: there is no such restriction on dollars.

?For reference, the total amount of above-ground gold is about 5,000,000,000 ounces, so I'm guessing digging up another 200% is a pipe dream, anyway.

[Captain Awesome]

I'm actually not disagreeing with you Squarooticus. I have sympathy for goldbugs but don't see it as much of a panacea. Wouldn't gold give us a pro-cyclical money supply, and wouldn't that be very harsh on a large dynamic national economy?

"And digging up gold is at least egalitarian: the government has a monopoly on counterfeiting."

Speaking of egalitarian monetary systems, what would the opinion here be of a system like Ripple?
http://ripple.sourceforge.net/

[squarooticus]

Wouldn't gold give us a pro-cyclical money supply, and wouldn't that be very harsh on a large dynamic national economy?

I'm not sure I buy this. The purchasing power of gold has varied by less than 50% its historical average over nearly its entire history. That makes it an ideal money, versus the dollar, whose value versus other currencies peaks and troughs every decade and whose purchasing power has dropped by 95% since 1913, never to rise to 1913 levels again.

The reason this is the case is that the supply of gold doesn't increase very rapidly, which actually removes one volatile variable from the increasingly complex financial system. Stated otherwise: taking away the power of the Fed to create money out of thin air would eliminate the bubbles in which cheap money follows overly-risky ventures, followed inevitably by the bubble popping and the money supply deflating.

But the icing on the paper money cake is that this deflation is not allowed to proceed to a natural equilibrium-politicians won't allow it-so imminent deflation nearly always results in the Fed re-inflating, which just moves the bubble elsewhere in the economy. This is what happened after the tech bubble burst in 2000, and is what the Fed is trying to do now that the housing bubble has burst.

Speaking of egalitarian monetary systems, what would the opinion here be of a system like Ripple?
http://ripple.sourceforge.net/

I took a quick look at this, and couldn't find a connection between this and the money supply. It seems like this is just a paypal replacement with some added privacy and confidentiality. It sounds like it still needs one or more currencies in which to quantify the magnitude of transactions.

[sadielou]

Squarerooticus:
This is the first clear and reasoned defense of the gold standard I've read; thanks for the education.

I'm still skeptical about a few things, though. First of all, couldn't new gold discoveries alter the money supply unexpectedly? It happened (around) 1903, and three decades of deflation reversed.

Second, I'm concerned that "natural deflation" in recessions could be a lot more painful than you make it sound, at least if you think full employment is a legitimate policy goal. There is a near-perfect correlation between the countries that stayed on the gold standard longest, and the countries where the Great Depression was longest and severest. (The UK was one one side of the spectrum, while Spain and Germany were on the other.) You don't think there's a place for (predictable) counter-cyclical monetary policy?

[squarooticus]

I'm still skeptical about a few things, though. First of all, couldn't new gold discoveries alter the money supply unexpectedly? It happened (around) 1903, and three decades of deflation reversed.

I actually don't see a huge drop in the purchasing power of gold at that time, but it has at times taken quite a beating; most of that is in the last hundred years, however, which is a historically volatile time due to competition with fiat currencies.

It's hard to tell from the few historical charts I have access to how well they equate to large increases in supply or to fiat experiments that had been occurring in fits and starts over the last few centuries. Remember Gresham's Law: bad money drives good money out of circulation. In periods of legal tender, people tend to use the legislated currency and hoard the hard money, which makes calculating gold's true purchasing power more difficult.

You don't think there's a place for (predictable) counter-cyclical monetary policy?

I never claimed that all intervention in the money supply is counterproductive: I'm simply in the camp of people who believe (with substantial evidence) that giving one group complete control of the money supply invariably leads to mischief and mismanagement for the benefit of a select few. Unfortunately, there's no such thing as being a little pregnant, and no such thing as a "sorta" hard currency: either you give government the ability to control the money supply and accept the consequences of that, or you keep a commodity money and accept the consequences of that.

I'd rather have the latter, which subjects me only to the vagaries of the market digging more of the stuff up, rather than the former, which pits me against a cabal of international bankers intent on robbing me as much as they can without destroying the currency, and frequently getting too greedy and pushing the currency over the edge into hyperinflation.