Re: Disruptions and Technology-NY Times

From: Technotranscendence (
Date: Sat Dec 22 2001 - 20:34:49 MST

On Saturday, December 22, 2001 5:16 PM wrote:
>>The Alan Greenspan/Paul Krugman explanation seems to be
>> very Keynesian: human irrationality took over. This doesn't
>> explain anything. Why did irrationality take over then and not
>> sooner or later? Instead, the answer lies in the inflationary
>> and regulatory policies pursued during that period.
> Many economists would indicate that the entire marketplace is
> wracked by irrationality; irrational exuberence, irrational
> pessimism, irrational greed, ad naseum.

You got that right. This kind of pushes off the explanation for
economic phenomena to pop psychology. This is nice hand waving that the
public eats write up, but it doesn't explain anything. It's too bad
Keynes made it fashionable to do this and that the fashion has stuck
since the 1930s.

> What I seem to recall from the last 18 months, is the beliefs that
> the economic goodtimes were over (in part) because of the
> OPEC creeps, jacking up prices. Whether this is true, is open
> to question.

It might be too early to tell which was the trigger, but the inflation
and the regulatory regime definitely impacted the economy to make a) the
triggering reaction possible and b) the outcome: a bust. Absent these
factors, an increase in oil prices -- which I personally doubt was _the_
trigger -- or a variety of other triggers would have just been one more
variable for people to account for rather than the unveiling of a
investment structure that was rickety and ready to collapse.

See also , which doesn't show the kind of
correlation you're talking about. During much of the 1980s, crude oil
prices were well above current prices, yet, by most lights, these were
boom times. I also think the oil shortage of the 1970s did have an
economic economic, but the inflation of the same period was much more
significant and not driven by oil prices, but instead by the US going
off the gold standard and the using inflation to monetize government
debt. (I'm not a gold bug here. I don't the gold standard is a cure
all for banking ills. If a central bank remains in place, a lot of the
same problems will play out, gold or no. See Kevin Dowd's
_Laissez-Faire Banking_ and many of his other works on banking.)

Also, inflation is a strictly monetary phenomena. Yes, it has real
effects -- the business cycle being one of them -- but it is because
prices, especially relative prices -- the prices between goods as
opposed to the overall price level -- distorts economic activity.
Malinvestments occur and when the game is up, they are usually hard to
liquidate, leading to real losses. In other words, entrepreneurs are
fooled into believing there are real opportunities when there are
none -- or much less than they anticipated across the board. (This
matters more in the area of capital, since a lot of capital is highly
specific and is hard to shift around, especially to shift around
costlessly to new uses. See Roger Garrison's _Time and Money_ and
Stephen Horwitz's _Microfoundations and Macroeconomics_.)

> I would claim the mere perception of such an occurence, was
> enough to pop the bubble.

I would not. I think the bubble popped because real factors caught up
with monetary ones. Inflation, on the macroeconomic levels leads to
unsustainable growth. Why? Well, one way of putting is that investment
and consumption both grow, though investment predominates. This means
that as consumers, people plan to spend more, but as investors, they
also plan to invest more. In the real world, you can't have your cake
and eat it too, but inflation's impact makes it seem like you can. In
fact, because a money economy only loosely links -- due to time lags --
the money supply with the demand for money, stuff like this can happen.
(Under a free banking regime, this process would be swifting
self-correcting, since individual inflating banks would lose reserves
and even go bankrupt. Banks that didn't inflate would increase market
share. In other words, inflating would directly hurt the inflating firm
in a very short time -- very much shorter than your average boom and
likely in a matter of weeks or less.)

> Remember, that Greenspan was using the post WW2 German
> model that inflation causes recession/depression and that low
> inflation was the target-goal.

That might have been his rhetoric, but actual Fed and international
monetary policy (often led by the Fed) was inflationary and risk
externalizing -- allowing risk takers to pass risk along. Examples of
the former include the lowering of interests from 1996 until 2000.
Examples of the latter include the repeated instance of government
funded or arranged bailouts -- in Mexico, Asia, Russia, and of Long Term
Capital Management. Such bailouts pass the buck on risk taking.

Also, the deficit reduction policy -- hide the deficit under Social
Security and pretend it doesn't exist -- now in place adds more wood to
the fire. We could have a much more efficient market with sustainable
growth if all these policies were reduced or, even better, gotten rid
of. The latter would, to my mind, be the more Extropian policy since it
would allow higher levels of wealth production and social
coordination -- i.e., of socio-economic extropy.:)

Also, it's not the German model but the Austrian model of von Mises and
Hayek. Granted, the German central bank has tried to sell itself as
anti-inflationary, but it doesn't completely live up to its rhetoric
either. The actual track record shows that bank fluctuating between a
low inflationary policy and a higher one -- though not as high as many
of its neighbors at the same time. See, e.g., "The Rise and Fall of the
German Miracle" by Wolgang Kerber and Sandra Hartig (_Critical Review_
13(3-4): 337-358).

Of course, inflation is not the only problem with the German economy --
now in recession, by the way. It has a bloated public sector, a lot of
economic regulation, and reunification hasn't helped matters.

> The method was to use minetary
> policy to prevent the typical 'business cycle' to close, and thus,
> perpetuate the prosperity that we experienced during most of
> the 1990's.

Admittedly, the Fed does try to out-think the market, but there are two
problems with this. First, the Fed modeling of the economy can hardly
predict the effects of inflation. If it could do this well, ex ante,
then you'd have a strong argument for socialism. In fact, it would have
solved the socialist calculation problem! (Again, I counsel ditching
the Fed and going to a free market banking system. Kevin Dowd offers
some suggestions on just how to do this with minimal pain in the closing
pages of his 1996 book _Competition and Finance: A Reinterpretation of
Financial and Monetary Economics_.)

Second, this is a different time. The Fed is closely watched and market
actors (banks, brokers, hedge funds, etc.) closely follow Fed
activities -- open market operations, fiddlings with the prime rate and
reserve ratios, and other tools and reports. This doesn't mean these
actors make perfect calls, but they arbitrage out some intended affects,
often to dampen or hide the impact, making prediction and tracking even
harder. (Add to this, risk externalization and other changes in the
overall economy make this time a little different than previous

Third, incentives are really not there for the Fed not to inflate.
After all, despite the rhetoric, inflation is politically sexy. In the
short run, it usually pushes up the stock market, lowers unemployment,
and increases consumer spending. Its bad effects only come later when
the discoordinations work themselves through the economy. (If this
weren't so, central banks would have little reason to inflate and the
whole history of the 20th century would not be marred by inflationary

Fourth, the Fed is not Greenspan. He's only one man on the Board -- not
the whole shebang.:)

> Further comment: German style anti-inflationary policy, in order
> to ensure a prosperity, does not work when the cause of inflation
> in outside of banking control. What is outside of banking control?
> The OPEC bastards, or more formally, the Wahabbis. My sense
> is that the bomb, combined with the foolishness of
> government policy in California, helped jack up the price of
> domestic natural gas costs. Remember that?

Actually, these things are not inflationary per se. Granted, they can
make for shocks to the economy and that's no laughing matter, but
inflation is specifically a monetary phenomena -- i.e., when money
supply exceeds the effective demands for money. (In the US, this can
happen only through the Fed lowering interest rates, buying government
securities, or lowering reserve requirements for banks. Well, that and
any other new way to create fiat money.) A shock like a sudden jump in
the price of some good is a _real_ not a _monetary_ happening.

A good way to separate the two is think of a barter economy. In a
barter economy, there is, by definition, no money, hence no inflation.
Yet, under such a system, something could, e.g., decrease the supply of
some good like, say, cattle. Disease might hit the heard. That would
make for less cows and those who had cows or cow products might be able
to trade them for more of other stuff. But the effects would not
systematically distort perceptions. Most people who trade for cows and
cow products would know right away that there are less cows and cow
products. (They might not know why, but there would be no way to spread
the mailaise beyond the cow shortage. Not that I'm advocating a return
to barter.:)

> The economy was deflating during 2000,

At best, the the Fed rates were higher. Whether this was inflation
(could still be so, since inflation could either increase at a slower
differential rate -- e.g., if the rise was expected to be 2% and only
rose 1.5% -- or if the Fed's other operations actually nullified rate
cuts), disinflation (i.e., lowering the rate of inflation -- e.g., if
the absolute level was expect to be 5% and was actually 3%) or deflation
is debatable. I definitely do not think deflation -- i.e., when the
effective demand for money exceeds its supply -- occurred.

At best, I think there was mild deflation, though many on the market
expected continued increases in money supply and overall credit
loosening. Four years of such policies -- such as the Fed giving a lot
of the debtors what they wanted -- habituated people for this. (Look at
the prime rate during that time frame. Also, consider that Fed policy
is not the whole interest rate picture, though it is a commanding part
of it. If the Fed lowers rates, but the government is actually
borrowing more, this can drive up market rates because the supply of
loanable funds will be much lower than without government borrowing.)
When it did not come, that spelled the end, but the end would have
sooner or later as eventually the contradiction between investments and
profits and between risk premia and actual results came to fruition.

> and all the interest-rate
> cuts have done squat (although iy supposedly takes at least 12
> mos for the interest rate cuts to generate a response).

Part of this is that it takes a long time to reallign capital. Workers
can much more easily, though no costlessly move about. Capital usually
can't. Relatively to workers capital is much harder in most cases to
change to other uses and often involves huge losses. (Capital is
actually quite heterogeneous too, something that Fed and monetary models
hardly take into account. It's not a lump of stuff that's infinitely
malleable. That's why we see many businesses that are suddenly
worthless. They put together capital combinations that just weren't
profitable and were often extremely sensitive to interest rate changes.)

> 9-11
> transformed the economy from a weak one, into a recessionary
> one. Which points up the need to develop an alternative to petroleum.

I think the September 11th attacks only gave the government to come out
and use the R word. Even they admit, the economy was in recession by
their definition months before the attacks. The attacks just made it
politically feasible to say so. (Again, this plays into the pop
psychology view of markets. The President and the former President both
saw business confidence as some sort of fickle primary. Instead, it's
actually based on market results and expectations. Business people feel
more confident when their succeeding and they expect to keep succeeding.
The Keynesian "animal spirits" tripe has got to be disposed of if we're
ever to hope to understand the economy.)

Happy Holidays!

Daniel Ust

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