The Federal Reserve: Love it or Hate it

[DcifrThs]

fair: here's my response xposted. last one of cross postings,

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Well if there is a definite trend towards more frequent and "aggressive" interventions from central banks, that must be symptomatic of something. (BTW I am not sure this is the Austrian arguement, it just seems like the correct line of inquiry in response to your graphs).

If that trend is definate is it not unreasonable to hypothesis that there is an upper limit to the "aggressiveness" of the FED, and that if its interventions are trending upwards on the "aggression index?" then we must be approaching the upper limit where intervention becomes impotent and boooom or should I say bust.

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right, but if there were ever a time for that massive catastrophe, 1979 was the time. inflation expectations were about as bad as could ever possibly be. the fed abandoned its methodology of fighting inflation by targeting the fed funds rate (like it does now) and instead decided to absolutely do whatever necessary via monetarist intervention in order to quell inflation.

this massive reduction in the money supply led to huge spikes in short term interest rates. i'm sure some austrians then must have been having this same argument.

further, jumping to more recently, the fed hasn't had to do anything since the fed funds rate reached 5.25% until this immeidate injection of liquidity by global banks.

i'd content that if i could cosntruct a good indicator of "aggressiveness of fed intervention" that it would follow some sort of cycle that is in some way related to teh business cycle. this follows from the austrian concept that the fed causes busines cycles, so their interventions
must either lag or preceed the cycle's indicator itself.

this is a good line of inquiry imo. good job!

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Dont see how we can prove this before the fact, but can only lend credence to the hypothesise that fed interventions project and magnify problems forward in time requiring more and more frequent and aggressive interventions in the future.

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the only issue here is that the aggressiveness reached a massive peak not likely to be mimicked (sp?) for a looong time.

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That there must be a sustainable limit to this process would seem a fair conjecture.

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right, but it seems we've tested this system pretty severely.

let's keep going down this road though since maybe it'll help solidify in my head a good way to construct the indicator and try to test this out.

thanks,
Barron

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[DcifrThs]

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business cycles come from an inability to manage perfectly. when demand has been higher than previous periods, we order more (typically far more) on the assumption that the next period will have more of the same. it takes a realization of the decreased demand to reduce orders for the next period (again by too much). humans over-react and no matter what you do (as has been studied in oprations research), that extrapolation is unavoidable and thus business cycles will always be around regardless of whether we have a fed or not.


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I dont really see how this is irrational, mabey more just bad management. And of course there will be small cycles in particular industries, but how can you have an entire economy collapse from individual industries?

Your example works much the same way as my stock market example. If you dont take into account future demand and I do, I make a profit and you go out of business. Considering the level of competition in most industries I find it very unlikely that there will be much mismanagement from year to year among competant capitalists.

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this point i made earlier is wrong. i'd like to redefine it.

humanity making decisions under uncertainty is what causes business cycles. not my "irrationality" comment earlier. that was a mistaken catagorization imo.

Barron

[Copernicus]

There seems to be a basic misunderstanding in this thread of what "risk" is in investment terms. Risk is volatility, not the more general notion of "safety of principal". The risk free rate of return is what an investor would demand IF there was no volatility in those returns. Loss of prinicpal can be the result of volatility if you need to liquidate when the value of the investment is down, but most actual loss of principal comes from mispricing the asset in the first place.

There is no totally non-volatile asset, but 3 month Treasuries are so short term that for all practical purposes an investor can hold them to maturity which does eliminate volatility. Treasuries arent "risk free" (in investment terms) simply because the US government isnt going to default on them, and they dont bear "risk" simply because of some small but finite possibility that the government might default.

If you look at most financial models that are driven by risk free returns, rather than inflation, short term Treasuries are assumed to have standard deviation...ie they are not assumed to be "risk free"

[DcifrThs]

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There seems to be a basic misunderstanding in this thread of what "risk" is in investment terms. Risk is volatility, not the more general notion of "safety of principal". The risk free rate of return is what an investor would demand IF there was no volatility in those returns. Loss of prinicpal can be the result of volatility if you need to liquidate when the value of the investment is down, but most actual loss of principal comes from mispricing the asset in the first place.

There is no totally non-volatile asset, but 3 month Treasuries are so short term that for all practical purposes an investor can hold them to maturity which does eliminate volatility. Treasuries arent "risk free" (in investment terms) simply because the US government isnt going to default on them, and they dont bear "risk" simply because of some small but finite possibility that the government might default.

If you look at most financial models that are driven by risk free returns, rather than inflation, short term Treasuries are assumed to have standard deviation...ie they are not assumed to be "risk free"

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how do you calculate excess returns?

see one of my points? you can't construct a portfolio without assuming a risk free rate of return in the form of the "guaranteed" return you'd get on 3mo tbills (or 1 mo repo rate). you need the excess return streams to assess the volatility of other positions....the volatility of other positions relative to that of some risk free return you could earn in each period.

even US 10yrs are subject to this (i.e. when looking at the excess return, you subtract out the "risk free" rate of return).

To take your post one step further, all securities (including 10yrs) give Total Return.

total return can be broken down into all of its constituent parts. TR(US10yr)=price change + coupon

so there's price and coupon returns. since price of the 10yr responds to changes in long term inflation expectations and yield curve shifts (and moves), the price risk is significant. duration of 10yrs is about 7.5yrs so a 1bp change in yield leads to about .075% change in price.

default risk would be factored into the coupon payment. if you believe in fairly efficient markets, it already (or mostly already) is.

Barron

[DcifrThs]

Just to correct something i said:

Total return=Price change + Coupon + risk free rate

Excess return= Total return-risk free rate.

so the Excess return=price change + coupon. to get the excess return, you need the risk free rate.

More generally, Total Return= XR + cash

where XR is the excess return of whatever you are looking at and cash is colloquial for the risk free rate.

Barron

[DcifrThs]

Pvn,

Well my friend, better late than never [img]/images/graemlins/smile.gif[/img]

Here are my responses to your post. They go basically point by point and ignore everything not germane (i.e. the bickering of which I’m at fault too). I’m not quoting it because it is hard enough as it is to read and don’t want to make it worse.

Issues:

- Morality of the greater good: I’m not going there. period. I’m just going to stick to why it might be better to have a centrally managed economy. I am not qualified nor do I care to discuss morality and so I’m steering clear of it. My contention that consent of the governed is implicit has obvious caused quite a stir so lets forget that for now. The question of “why should a centrally managed economy be imposed?” from a moral standpoint I’ll let lie. I will, however, discuss the pros and cons.

- Politically connected!= politicians. You are correct here that I completely misread that. Also wealth doesn’t equal money as I stated earlier. This isn’t something I glossed over. I usedt he wrong word there.

- “regular” people’s savings are devalued, but then again, so are the savings of the wealthy (except for things like houses or other hard things that can be sold at a similar real value). The devaluation through inflationary monetary policies gives flexibility to the system and overall does help those who need it via the economic mechanisms I discussed

- Those mechanisms are similar to “trickeldownaments” but more robust and actually do work. The difference in trickle down vs. real economic production is that the former was part of regan (& laffer’s) tax policy where reducing taxes would generate more income from wealthy people to spend. Well first off, they misjudged the amt of saving vs. consumption is undertaken by those people and second off, they misjudged the types of things that would be purchased with that extra money. Those who benefited from tax cuts were proportionally more likely not to spend it on things that generate real economic growth (i.e. buying one large ticket item like a painting doesn’t really help increase employment). When many people are buying many more things again the overall effect is increased employment, increased productivity (which brings down the initial inflation in real terms), and increased growth.

- The feedback look you mention is what I discussed above with the business cycles, it may be a feedback loop but the loop is getting smaller, not bigger. Further, you have to prove that without it (economic management) people would be better off. Where is the data to prove that? How can you say that a business cycle is entirely exogenous (caused by shocks to supply/demand) and not because of how humans make decisions under uncertainty? If left unchecked, the pain in unemployment, reduced production, and reduced productivity would hurt far more than the above issues imo.

- You then speak about how a government can’t be trusted to restrain themselves to stay on a 1:1 ratio. You then say inflating is too tempting and use a horrible sentence to conclude “So you're basically in agreement with me. Governments can't actually restrain themselves and stay on a 1:1 ratio - inflating is too tempting. So now that you've recognized that governments can't be trusted to not inflate, you decide that inflating is somehow a GOOD thing? Pain is bad, so we need to implement policies that cause more pain in the long run!”…. but pvn, you haven’t dealt with the problem of WHY governments inflate. i.e. if they DO NOT inflate, the trough of the cycle is so freaking severe that there would be riots and an overthrow of the govt. this is the problem. It is proven and documented and studied. It isn’t my opinion! It is a fact. Unflexible specie systems lead to that problem of massive fluctuations that hurt so bad that govt.s are FORCED to intervene or be overthrown or voted out or whatever.

- You are correct that standardized can emerge without centralization. My point was to show how it comes about. I did a very poor job of that. Int’l trade though occurs through fiat floating currencies (for the most part) due to standardized mediums of exchange.

- I’m not dealing with this next issue of consent

- How would a money management system emerge from a free market? Explain this please. Show that it is the case. Cite 1 example, 1 study, 1 anything to back it. More is better but just start with one.

- Are you measuring “people losing faith in the US dollar” by the value of the dollar? If so, then you should know that there are many explanations that are logical and more likely correct than that one unless you mean faith to include “balance of payment issues and relative interest rate and growth data”

- Again, gold has proven a bad base (as has all specie systems) because it isn’t flexible. Govt.s don’t randomly choose to move off gold standards for the sake of it, they are forced to due to the downsides of that system.

Sorry for the delay but other things are more enjoyable than this argument.

Barron

[Copernicus]

"see one of my points? you can't construct a portfolio without assuming a risk free rate of return in the form of the "guaranteed" return you'd get on 3mo tbills (or 1 mo repo rate). you need the excess return streams to assess the volatility of other positions....the volatility of other positions relative to that of some risk free return you could earn in each period."

It sounds like you read my post as disagreeing with you..I don't. Modeling based on a "risky risk free assets" (where they are risky in the sense of having standard deviation from period to period), with excess returns generated based based on mean differentials and cross-correlations is no more difficult than assuming they are totally risk free (and therefore unchanged from period to period). In fact excess returns are modeled more accurately, at least to the extent of the sophistication of Markowitz models, with a risky risk free asset, since the end users are most interested in total returns rather than excess returns, and assuming that 3 month Treasuries don't have standard deviation from period to period is ignoring reality.

My post was just trying to point out that most people in this thread (and even in most of the investment term glossaries you find online) don't understand what "risk free" means, or use it so casually that it can be confusing.

Edit: in fact their sloppy understanding or use of the word "risk" is what is primarily blocking people from understanding your points on speculation vs excess earnings from the risk premium.

[pvn]

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Morality of the greater good: I’m not going there. period. I’m just going to stick to why it might be better to have a centrally managed economy.

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Better according to whose subjective personal preferences? If you're saying "everyone" or heading for some sort of utilitarian argument, you need to explain two things:

1) how you're measuring (accurately!) people's individual subjective personal preferences.

2) why anyone needs to be forced to participate in whatever "THIS IS IT" plan you come up with. If YOU think it's "better" to have some smart guys cotrolling the supply of whatever you decide makes a good medium of exchange, why do I need to be drug along?

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I am not qualified nor do I care to discuss morality and so I’m steering clear of it. My contention that consent of the governed is implicit has obvious caused quite a stir so lets forget that for now. The question of “why should a centrally managed economy be imposed?” from a moral standpoint I’ll let lie. I will, however, discuss the pros and cons.

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And by pros and cons, it seems that you mean basically something that reduces to EV. And people say *ACists* only think about money. In fact, it's quite the opposite.

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“regular” people’s savings are devalued, but then again, so are the savings of the wealthy (except for things like houses or other hard things that can be sold at a similar real value). The devaluation through inflationary monetary policies gives flexibility to the system and overall does help those who need it via the economic mechanisms I discussed

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Of course, the wealthy hold a vanishingly tiny percentage of their overall wealth in cash savings, compared to the poor. Bill Gates doesn't have a scrooge mcduck vault full of $100 bills. He doesn't have $50,000,000,000 in his passbook savings account.

You keep talking about "flexibility" with a bunch of warm fuzzy "intentions" stuff. "Oh we want to help people." I don't really care what your intent is. This is effectively no different than the other thread, where the guy says he doesn't consider taxation theft because intent matters. BS. I can't accurately *know* what your *real* intent is - I can't read your mind. You can say whatever you want. I have no reason to trust what you say your intentions are - I must analyze what you propose based on the merits, with logic, and your overt intentions don't change the analysis.


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The feedback look you mention is what I discussed above with the business cycles, it may be a feedback loop but the loop is getting smaller, not bigger. Further, you have to prove that without it (economic management) people would be better off. Where is the data to prove that? How can you say that a business cycle is entirely exogenous (caused by shocks to supply/demand) and not because of how humans make decisions under uncertainty? If left unchecked, the pain in unemployment, reduced production, and reduced productivity would hurt far more than the above issues imo.

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When you talk about people being "better off" or the "pain" the experience, you're making subjective judgements. And you don't have any way to accurately do this. If you DID, then there's no reason you should stop your attempts to impose management on the money supply - you should go ALL THE WAY. Everything should be centrally planned if you can accurately measure "better off" and "pain". But you can't. So this is nothing more than the same old fuzzy intentions and feelings emotional stuff. Handwaving, it's often called.

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You then speak about how a government can’t be trusted to restrain themselves to stay on a 1:1 ratio. You then say inflating is too tempting and use a horrible sentence to conclude “So you're basically in agreement with me. Governments can't actually restrain themselves and stay on a 1:1 ratio - inflating is too tempting. So now that you've recognized that governments can't be trusted to not inflate, you decide that inflating is somehow a GOOD thing? Pain is bad, so we need to implement policies that cause more pain in the long run!”…. but pvn, you haven’t dealt with the problem of WHY governments inflate. i.e. if they DO NOT inflate, the trough of the cycle is so freaking severe that there would be riots and an overthrow of the govt. this is the problem. It is proven and documented and studied. It isn’t my opinion! It is a fact. Unflexible specie systems lead to that problem of massive fluctuations that hurt so bad that govt.s are FORCED to intervene or be overthrown or voted out or whatever.

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You say this as if the removal of an immoral institution would be a bad thing. And you're STILL ignoring the question of what causes the "trough of the cycle" in the first place.

And you're still making a lot of bad assumptions about my position - analyzing a "unflexible" specie system with an interventionist, monkeying government and concluding "bad" doesn't make a compelling argument against my position, mostly because I'm not proposing any particular specie system, and because I'm outright opposed to any interventionist (is there any other kind?) government.

When there is no government, there is no government to overthrow or vote out. When there's no expansion of credit due to distorted incentives caused by inflation, there's no correction of that misallocation. Those crows are coming home to roost *right now*, and just as you predict, the central bankers are trying to shoo them off the only way they know how - by throwing more money at the problem. All they can do is delay the inevitable. Misallocations are NOT sustainable, and piling up more and more of them just makes the correction that much more severe when it does come.

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How would a money management system emerge from a free market? Explain this please. Show that it is the case. Cite 1 example, 1 study, 1 anything to back it. More is better but just start with one.

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Are you serious? How do you think gold came to be used for money, thousands of years before anyone thought of central banking?

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Again, gold has proven a bad base (as has all specie systems) because it isn’t flexible. Govt.s don’t randomly choose to move off gold standards for the sake of it, they are forced to due to the downsides of that system.

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But the incentives that "government" has (note that government is not an actor, only individuals are) are a lot different than the ones I have. I don't really care if government is "forced" to do anything. I'm sure you could make an arguement that government's don't randomly choose to, e.g. invade other countries, but are "forced" to by the downsides of not doing so. Not my problem - or rather, there's no justification for *making* it my problem, but I end up being forced to pay for it. Just like I'm forced to pay for the US government's "need" to use a fiat currency. But I like this line. "Your honor, I didn't randomly chose to rob that bank. I was forced to. You know, cause I needed some money. Cause I spent too much. But don't worry, it's for a good cause, I'm going to help some people who are in pain. Namely, me. kthnxbai!"

[Borodog]

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How would a money management system emerge from a free market? Explain this please. Show that it is the case. Cite 1 example, 1 study, 1 anything to back it. More is better but just start with one.

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A money is a market commodity who some smart fellow realizes is more easily exchanged than what he has produced. If he can exchange his goods for this more readily exchanged good, the value of his own goods and his ability to get what he wants have both gone up. There is a snowball effect in the market, and a few commodities will rapidly become moneys, and will become valuable as a medium of exchange (in addition to whatever uses they already served in the market). Market moneys compete against each other, and ultimately there are usually only one or two. Historically there have been many moneys, including salt, sugar, seashells, tin, etc. but ultimately gold won out (with a few places still using silver) in the 19th century. The reasons that gold makes a good money is that it is durable, easily divisible, hard to counterfeit, and has a high value to weight ratio.

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From my On Capitalism post.

[Zygote]

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correct. but ther can never be perfect safety that your monitor won't jump off your desk right now. just because you can live a billion lifetimes and still not see such a thing and it is STILL not perfect, doesn't mean you can or should live your life around that fact.

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I never said anything about living your life around anything. Again, you seem to be saying you can live a billion life times and never have a government default on their debt or pay back with a devalued currency.

Further being aware of quantum mechanics is worth knowing in itself. Insuring against negative events would cost virtually nothing but other than that there is NOTHING you can do about this. On the other hand, you CAN CHOOSE whether or not to buy government debt.

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this is where i digress in agreement. capital, i.e. investment capital, can and DOES bear interest. that interest is the risk premium i spoke of earlier.


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To be clear there exist only two such things.

1) Originary interest. This bears interest but not profit. Interest has taken on many meanings through the ages but let me try be as clear as possible.

When you give up money now for money in the future you get the same value in return. With originary interest, you only benefit in the same sense that you benefit from trading $10 for a hamburger. You and all of us prefer more choices to less which why everyone prefers something now to the same thing later. However, even if dont mind money later for money now the sacrifice of not being able to reconsider equalizes the "price" paid on your money. I wouldnt even call this a "price" though because the apparent extra money is just value added to be equalized by sacrificing control of capital over time. The money now is equal to the larger sum of money later due to the time difference. People cannot display pure indifference though which is why there can be preferential differences in such an exchange.


2) In reality there are no precise trades like originary interest because when you give up money you suffer a real default risk, not just the cost of being without your capital.

When you assume default risk you are speculating. This is not passive investing. You are being entrepreneurial and must analyze the risks of your debtor.

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it is far larger than the default rates, inflation, "risk free rates" etc. both historic and expected. i can cite data here to prove this.

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So? You are saying people have successfully speculated over time and there is a real and successful market for lenders. What is your point against me though?

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where is mises's cites? what is he basing this on? the burden of proof here is on mises, i've already presented my case with facts. he has not yet, though it may be that borodog will do a better job of this in his coming post.


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He has presented a case with facts. What is disputable about what he said?

You want him to cite evidence that risks exist and the world's markets are not evenly rotating? Go buy a history book. Human Action is long enough already to include such obvious information, especially since he goes over some of the logical risks inherent to lending to different institutions with snibbets of synthetic cases to aid the reader already.

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agreed. and it has been able to "not disappear entirely", "yield interest," AND yield premium above interest.

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If you agree with this you must conceding the implication that lending is entrepreneurial.

Also what you do mean by it? Are you saying every lender has done well over time?

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here he loses me a bit. what does he mean "net interest is a magnitude which only analytical thinking can extract from the gross proceeds of the creditor"?


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He's talking about originary interest. Analytical thinking is similar to tautological thinking. He's saying this needs no empirical base to be interpreted and just refers to what ive said about originary interest if you want to understand that part.

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borodog, can you chime in here and explicitly state what he means here and how it relates to the discussion at hand?

thanks,


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You really think im retarded dont you?

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again, i have faith in the legal and institutional setting. i don't need to have a PERFECT proof of that to invest.

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So you in invest on faith. I invest on reason. Lets at least keep this clear.

Ive seen legal systems break down. Ive seen legal system be abused. Ive seen legalized theft by taxation and inflation. You can go about your investment profession loaning money to government, purchasing their debt, and making no analysis of their credit because you have faith.

On the other hand, i analyze geopolitical and geoeconomic situations. I assess all conceivable risks and come about with some credit rating that helps me more accurately value my asset. I see differences and think about which governments debt is worth more than others based on a dynamic range of credit and compare to any available alternatives.

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this is really the whole crux of his argument. i believe there is a risk free asset above which there is a return that can be earned as to be NOT speculation.


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If this is true then you still aren't right. This is not speculation because there is no value appreciation and no risk. Whenever you invest in a risk free asset there is only time preference involved.

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yup again. in this case, the government is the borrower and i have faith enough to call it a risk free asset as it has proven historically the ability to earn that moniker.

mises has yet to prove to me his case.

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You're saying every government around the world has the identical default/devaluation risk of 0? Your defense of this is faith? I hope you tell the people you invest for that you think this way.

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do i think the US govt will lose its ability to tax?

no i do not.

do i htink the US economy will collapse to the point of making the "risk free asset" "risky?"

no i do not.

where is mises's data to counter these beliefs?


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Mises called the great depression in his time. The government confiscated the nations gold after this event too, im sure your faith saw you through that though too.

If he was around today he would tell you there are problems in the making. Ive been talking about them quite a bit on here. Why dont you counter and show these risks to be entirely unworthy of consideration to the point that they are non risks?

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That there is, besides, something basically vicious in all kinds of long-term government debts, has been pointed out already.[1]



where?


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What could i honestly say that would overcome your faith?

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i was with him till that last part...i guess i don't know what "expropriation of creditors" means.

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The masses want easy access to cash. The credit rating of the society is destroyed if this is centralized at the expense of the minority who is attempting to create an environment of creditability. All of those involved in "passive" savings are abused throughout the process as well as the artificially debt-biased society progresses.

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i.e. when the US govt defaults on its debt.


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Defaults or in many other cases abuses the monetary base or contract order of the debt.

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thanks for making me go through all that.


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you're very welcome. I hope you learned something.

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now prove to me mises theoretical case.


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Is this your faith talking again?