John Lee Responds to Nobel Laureate Stiglitz's Subprime Thesis

Mr. Joseph E Stiglitz, a Nobel Prize winner in 2001 for his work on the economics of information, recently attended the World Economic Forum in Davos and wrote an article published on February 5th, 2008 titled Sub-prime crisis has led to the humbling of America.

The article highlights were:

1. Those who think that globalization, technology, and the market economy will solve the world's problems seemed subdued.

2. If we know the price of cream and the price of skim milk, we can figure out the price of milk with 1 per cent cream, 2 per cent cream, or 4 per cent cream. There might be some money in repackaging, but not the billions that banks made by slicing and dicing sub-prime mortgages into packages whose value was much greater than their contents.

3. Mr. Stiglitz also argued that central bankers also got it wrong by misjudging the threat of a downturn and failed to provide sufficient regulation. They waited too long to take action. Because it normally takes a year or more for the full effects of monetary policy to be felt, central banks need to act pre-emptively, not reactively.

4. This is the third US crisis in the past twenty years, after the Savings & Loan crisis of 1989 and the Enron/World.Com crisis in 2002. Deregulation has not worked. Unfettered markets may produce big bonuses for CEO's, but they do not lead, as if by an invisible hand, to societal well-being. Until we achieve a better balance between markets and government, the world will continue to pay a high price.

For any economic problem, it’s interesting how Keynesian economists always find the greedy bankers guilty, the public innocent, and the government responsible for prevention AND a cure through regulation.

Mr. Stiglitz correctly explained how the subprime problem started. However he failed to point out the root cause. The cause is not globalization, deregulation, technology, or free market. The bankers were greedy to lend to earn interests, and the public were greedy to borrow money and spend on things they couldn’t afford.

But how can we fault Johnny who loans his money to Jane that can't pay back? We can't blame the government for not regulating the lending industry. The banks didn't jam the money down our throat or force us to sign the dotted line did they?

Government actions often times have good intentions but with unintended consequences. Should the government be more proactive in lowering interest rates and early bailouts as Mr. Stiglitz suggests, this would amount to loosening monetary policies, or to put it more bluntly, money printing, which is a stealth wealth transfer by diluting savings of others.

Those who study the history of money understand the cause of the debt bubble is composed of two factors: The centralized interest rate model and the fractional reserve system.

• The Fed unilaterally sets the national interest rates, which indiscriminately applies to Bob, Jane, and everyone else. The economy endured several years of unprecedented, historic low interest rates below 3% since 2001. Low interest rates encourage excessive borrowing, and ultra low interest rates like 1% exacerbate the problem even more.
• Through the fractional reserve banking system installed in 1913, banks can print money out of thin air and lend to earn an interest. This magic of making something from nothing leads to lax lending standards. The Fractional reserve banking system is also directly responsible for gas prices going from .15 cents a gallon in 1910 to today’s $4 a gallon.

The solution is less regulation, not more as Mr. Stiglitz or Mr. Obama have proposed. Set the market truly free. Let every individual lender, not the Fed, decide what interest rate to apply to each of his borrowers. Eliminate fractional reserve banking and phase out the Fed, this will restore confidence of the dollar, restrict excessive spending by all levels of government and consumers, fix the money supply, and stop frivolous lending. Remove all government sponsored enterprises, other government guarantee and bailout programs. Those programs and agencies only distort markets, offer a false sense of security, and contribute further to inequality.

We can't regulate the patient who wants to overdose on painkillers. We shouldn’t over burden all banks with piles of rules designed to prevent a few outlaw borrowers either. Remove the government as the safety net and return the responsibility back to the people. Let the careless and the weak fall, isn’t that what capitalism, evolution, and free markets are all about?

Until then, dollar will continue to lose value and gold and oil will continue to rise in dollar terms.

For those who are interested in the gold and resource market, a good introduction will be to visit for free, the world’s most attended resource investment conference. Hosted by Cambridge House, the next event will be held this February 9th through 10th in sunny Phoenix, Arizona. An interview between me and the conference’s president is available here.

Comments

[flow5]

Some of the craziest shit I've ever read.

"Remove the government as the safety net and return the responsibility back to the people." We already went through that experiment many many times. That's why the Federal Reserve System was established.

"Until then, dollar will continue to lose value and gold and oil will continue to rise in dollar terms." (1) While the prudential reserve E-D market exerts downward pressure on the dollar, it is the current account deficit that that is the principal villian. (2) It is the current account deficit that feeds the E-D market. (3) The U.S. must drastically reduce our dependence on foreign oil, (4) eliminate our foreign multilateral claims on the dollar (our far flung military bases, e.,g., Korea, Germany, etc, and the wars in Afghanistan & Iraq) and (5) sell higher quaility and lower cost goods & services. And I bet these remedies will never be considered let alone take place.

But an even greater impediment to our "free wheeling speculation" is acquiring a technical staff that knows:

A. the difference between the supply of money and the supply of loan funds.

B. the difference between means-of-payment money and liquid assets.

C. the difference between financial intermediaries and money creating institutions.

D. recognize aggregate monetary demand is measured by the monetary flows (MVt) not nominal GDP.

E. recognize that interest rates are the price of loan-funds, not the price of money

F. recognize that the price of money is represented by the price (CPI) level.

G. & realize that inflation is the most important factor determining interest rates, operating as it does through both the demand for and the supply of loan-funds.

The U.S. will of course never understand, nor realize these objectives.

[flow5]

"Americans worry about their dependency on imported energy, but the $145,368,000,000 paid to OPEC in 2006 is a small part of the total import bill. Americans imported $602,539,000,000 in industrial supplies and materials; $418,271,000,000 in capital goods; $256,660,000,000 in automotive vehicles, parts and engines; $423,973,000,000 in manufactured consumer goods; and $74,937,000,000 in foods, feeds and beverages." Paul Craig Roberts

[eric hart]

Mr. Lee,
Your libertarian free market philosophy, if taken to its logical conclusion, leads to some interesting conclusions:

1) Most of our governments intervention in markets would be eliminated, including the SEC
2) Federal reserve would be eliminated
3) FDIC insurance eliminated
4) and really, why not have each state defend its own borders (by private contractors) instead of the socialized national defense we have now?

Let each person fend for themselves and see what happens.

Apart from the fact that the vast majority of the public doesn't support these objectives, the contradictions inherent in the ideology would ultimately do it in.

A major reason that so many investors flock to the US with their dollars is that we have well (mostly) regulated markets. Take away that regulation and you seriously curtail the flow of capital across borders. See Zimbabwean stock market...

"Let the careless and the weak fall, isn’t that what capitalism, evolution, and free markets are all about?" Well actually no. Read Adam Smith before the "Wealth of Nations". He states quite clearly the need for some governmental controls.

Do we truly want our markets to be unrestrained evolutionary experiments? Then you would have to accept Exxon/Chevron/Conoco-P... and Mircosoft/oracle/yahoo... as mega monopolies.

It is true that governments often over regulate...but the current mess is not an example of this over regulation.

"Set the market truly free" ? Be careful what you wish for...
Mr. Hart

[Hugh]

The "libertarian free market philosophy," is based on a moral principle rather than an economic one. The concept is that one man has the right to trade with another without government interdiction. If one man is in China and the other in America the principle still applies.

[E Nuff Sed]

This is nothing new - the victorian ideal of captialim free of every restraint - we have been through this before - the robber barons, explotation of the weak and the great depression.

The truth like always is in the middle - a capitalist society with regulatory controls.