gpadave

Defining a Depression

Inflation is a way of loan forgivness. The loan is paid off with cheap currency the loan holder gets less. An interesting way to SPREAD the wealth.


On Nov 12 01:21 PM mathgeek2 wrote:

> Interesting analysis, but I have to take issue with some of the specifics.
>
>
> Your first quote references new industries as the source of bubbles.
> I don't think this is an essential component. I do strongly agree
> that bubbles are often a credit phenomenon, but I think you miss
> some key aspects of the self-reinforcing mechanisms.
>
> At least in theory, any asset could be subject to a bubble, so long
> as there is some plausible way to belive in a very high future value
> of the asset. New industries have historically fit the bill, but
> so have assets which are belived to be functionally finite. What
> this allows is plausible speculation of very high future values.
> "The amount of land in California is fixed, demand will continue
> to grow, so prices will always go up."
>
> I agree that a loose monetary environment often is a crucial trigger
> for the bubble. It is easy to obtain credit to invest in the bubble
> asset.
>
> But this is where the truly pernicious aspects of an asset bubble
> kick in.
>
> - The price appreciates rapidly. So much so that a wider and wider
> pool of potential investors begins to belive that any inherent economic
> value is irrelevant, and they buy on the simple anticipation of the
> asset rising in value. In other words, people start to buy the asset
> for no reason other than the expectation it will continue to go up
> in value. This drives the price up, which reinforces their viewpoint.
>
>
> - Crucially, the asset also absorbs liquidity. An actively investable
> asset that is rising rapidly can readily absorb liquidity. What this
> literally means is that, as money supply expands, that excess money
> is sunk into purchases of the bubble asset. From the point of view
> of the central bank, all is well, because the economy is humming
> along, but yet there is not execessive inflation in the economy at
> large... all of the "inflation" is taking place in the bubble asset.
>
>
> - Finally, the growth of the asset bubble reduces apparent risk.
> Loans made using the bubble asset for collateral are rarely or never
> incurr losses. Institutions or persons under financial stress can
> readily paper over their challenges either by selling any of the
> bubble asset they hold or by borrowing against it. This reduction
> in apparent risk leads to further increases in leverage.
>
> This is an asset bubble, and we have yet to develop a method for
> dealing with them effectively in our economy. Nonetheless, this is
> an old problem.
>
> Eventually of course, often triggered by an exogenous shock or a
> decrease in available credit / money supply / liquidity, there are
> no more buyers to sustain the ponzi scheme of ever-increasing prices,
> and the asset value goes into free-fall. This leads to removal of
> credit, demand for (non-bubble!) collatoral, and eventually forced
> liquidation, driving prices down further.
>
> Depending on the amount of leverage involved, the net effect can
> be a severe contraction of the money supply, deflation, and a credit
> freeze. The intensity of the housing bubble collapse compared to
> the internet bubble is a direct correlate to the size of the asset
> and the degree of leverage employed.
>
> Depending on what specific actions David Merkel is referring to,
> it can be argued that Herber Hoover certainly and FDR probably made
> the Depression much worse.
>
> Specifically, allowing runs on banks is disasterous. Cutting government
> spending and raising taxes (as Hoover did, and FDR did in 34-35)
> is a huge mistake. And of course onerous trade restrictions made
> things much worse.
>
> If, on the other hand Merkel is suggesting, as Herbert Hoover's economic
> advisors did, that the answer is "liquidate, liquidate, liquidate"
> then I must beg to differ. While that is part of the answer, government
> actions to counteract the contraction of credit and the money supply,
> and in extreme cases, directly support aggregate demand, are the
> appropriate responses to the threat of a major deflation-led depression
> in the wake of a major bubble.
>
>
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