Is it an LOLR? No, It’s a Trap. And you should be mad.

Pic from AIER

Banking regulators set a trap for bankers, depositors and taxpayers back in 2008 into which they're all falling, explains Michael Munger in this guest post. And now the trap is sprung, we're up to our pocket-books in moral hazard and "too big to fail." What those regulators failed to fully understand is the proper role for the Lender of Last Resort (LOLR) ...

Is it an LOLR? No, It’s a Trap

by Michael Munger

In the 1983 film Return of the Jedi, Admiral Ackbar turns to the officers on the bridge and says what everyone already knew: “It’s a trap!” It had seemed a little too easy to be able to destroy the main threat, permanently and with no risk. Of course that turned out badly for the Alliance; they shouldn’t have been fooled.

Dodd-Frank and other post-2008 banking regulations were supposed to have fixed the banking system, permanently and without risk. But once again that was too good to be true. Turns out that all that new regulation did was to set another trap, Not intentionally (although the benefits to large firms are at least partly intentional). The solution to effective banking regulation however is to understand the role of the “Lender of Last Resort,” and to commit to doing nothing more, no matter what. As Richard Salsman and I argued more than a decade ago, the alternative, “Too Big to Fail,” has proven disastrous.

The Way to Regulate Banks: The Lender of Last Resort

Banks, and many other financial institutions, are brokers, mediating transactions between people who have money — depositors — and people who want to secure loans to do things with the money — borrowers. Brokers generally don’t hold on to the money that is deposited with them; the value of brokerage is connecting that money with an investment. In fact, the banking business was long described as a sleepy-but-safe activity, one that followed the “3-6-3 rule”:

• 3 percent — the interest you pay on deposits
• 6 percent — the rate you charge on loans
• 3 pm — your daily tee time on the golf course, because this business runs itself

Banks package and sell a product called “liquidity.” Liquidity is a measure of how quickly and cheaply an asset can be used to buy something else. Importantly, liquidity is not money, but a measure of the demand to hold cash balances, rather than holding wealth in some other form. Still, cash is liquid. It is easy to agree on a price, and transferring ownership is cheap. Loans are (usually) illiquid. Loans (such as mortgages) are contracts that bind one party to another, requiring payments that are secured by an asset. In the case of a mortgage, for example, the loan is secured by the value of a home, meaning that it is possible to negotiate a much-lower interest rate than on an unsecured personal loan, because the risk to the lender is smaller.

It is possible to buy and sell loans, or stocks, or other equities, but it is much more expensive than paying cash. (This illiquidity was part of the reason that mortgage-backed securities seemed like such a good idea back pre-2008, because in theory at least those were liquid; in fact, it appears that mortgage-backed securities were pretty liquid, and held their value better than is sometimes described). Another form of loan is called a “bond,” which is a promise to make periodic payments for a term of time, and then repay the full amount of the loan, the principal, at the end of that term. Ten-year US Treasury bonds, for example, have a face value and an implied interest rate paid to the buyer of the bond.

As I said earlier, banks are brokers. They take in deposits, and then use those deposits to “buy” loans. The bank might be the originator of a loan, as in the case of many mortgages. Or the bank might literally buy bonds or other securities, financial instruments that generate a higher rate of return than just holding money.

The problem is obvious. There can be a mismatch in liquidity between the bank’s liabilities (depositors put in cash, and they want to be able to take cash out) and assets (loans, bonds, other securities of various kinds). It is easy to imagine situations where a bank will be technically solvent — i.e., the total value of all its assets exceeds the value of all its liabilities — but the bank can’t convert enough of those valuable assets into cash fast enough to let everyone pull out their money right now. And when everyone does want their cash, right now, that’s called a bank run.

A bank run is dramatic, and has been used in movies from It’s a Wonderful Life to Mary Poppins. (It can be fun to use these movies in class, as illustrations!) The reason folks hurry to get their money is that there isn’t enough, and if you snooze you lose. The policy problem is that there is enough value, there just isn’t enough cash, today. That’s why the Lender of Last Resort (LOLR) function is so crucial. All that is required is a short-term loan so that there is enough cash today.

The cool thing about the Lender-of-Last-Resort solution (and note that the Lender of Last Resort could be either a private central clearinghouse, or a store of cash that maintains value in liquid form for immediate disbursal) is that if people believe the Lender of Last Resort will act immediately and effectively, then the Lender of Last Resort entity never has to act at all. If I know that I can get my money out, today, or for that matter tomorrow or the next day because the bank won’t run out of money — it cannot run out of money — then I don’t try to get my money out in the first place.

Walter Bagehot (Lombard Street, 1873) made the very sensible argument that many financial crises are not problems of insolvency, but only of illiquidity. And illiquidity is only a problem if literally everyone wants to take their money out of the bank at the same time. That problem is that “everyone wants to pull their money out at the same time” is literally the definition of a bank run, where depositors rush to get their cash while there is still some cash left.

Bagehot (pronounced “BADGE-uht”) claimed that the Lender of Last Resort must be fully committed to do three things, and never to do more than these three things:

1. Lend as much money as necessary directly to troubled (temporarily illiquid) banks; 
2. At a penalty rate (far above the market interest rate) 
3. But only against good collateral, as offered by a technically solvent bank.

Since there is immediate, unlimited cash available, there will be no bank runs. 

Since the interest rate is high, loans that are made will be very short-term. 

And since the bank has sufficient assets to cover its liabilities, there is no problem securing longer-term loans if that is necessary. Loaning to provide liquidity is cheap and effective, but it is not a bailout, because the bank has equity, it just lacks liquidity.

The Way NOT to Regulate Banks: Become the Insurer of Last Resort

The drawback with relying solely on Bagehot’s Lender-of-Last-Resort solution is that it does nothing to address “financial contagion,” when problem banks suffer not just from a liquidity shortage but from full-on insolvency. I learned about “contagion” as part of my professor Hyman P. Minsky’s theory of “fragility” in a financial system, so I tend toward his definition of contagion as a cascade of failures, animated by one or more financial institutions failing to make good on its commitments. When these assets become worthless, other banks immediately become technically insolvent also, though they were solvent an hour ago. The failures propagate like falling dominoes, quickly causing massive financial failures.

The reader will likely notice that the US has abandoned the Bagehot rules in favour of trying to limit contagion. Our present-day Lender of Last Resort, a composite of the Federal Reserve and the Treasury Department, routinely and wilfully misuses the discretion afforded central bankers. In their defence, though, the Bagehot criteria are not politically viable, because failing banks that lack good collateral are just as contagious, and maybe more contagious, than banks that have good collateral.

If the job of the Lender of Last Resort is to prevent contagion — and that is how the regulatory authorities describe their job — then it is logically impossible to hold to Bagehot’s third rule, lending only to banks that are solvent but need liquidity. But that changes everything. Without the constraint of requiring good collateral, the Lender of Last Resort becomes instead an insurer of last resort — a backstop for depositors who have no reason to consider risk when deciding where to place their funds. This problem has been massively exacerbated by the “deposit insurance” guarantees, which have now been extended far beyond the statutory $250,000 limit for despite protection, to have become essentially unlimited.

And that’s what happened for the depositors of Silicon Valley Bank, and Signature Bank (and, by the time this appears, possibly more banks). All of the deposits were guaranteed by taxpayers, even though the banks were insolvent, not illiquid. The usual story has been that the deposits were guaranteed by “the government,” but that’s nonsense. Money is being taken from taxpayers and used to support depositors who made a bad bet about where to put their money.

Since our regulatory practice has gone beyond making loans to illiquid-but-solvent banks, to paying back all the deposits of insolvent banks, the result is that there is no reason for depositors to care about whether their bank is taking excessive risks. This is called “moral hazard,” because it encourages the very risk-taking that regulators are later asking taxpayers to pay for.

The problem of moral hazard sounds arcane, but it’s a trap. In the case of Silicon Valley Bank, the risks in the bank weren’t even intentional, but revealed an astonishing lack of knowledge of basic financial principles regarding the capital value of bonds in times of inflation. To be fair, the stockholders of the bank itself have been punished by market forces (maybe, unless the Treasury loses its nerve, and succumbs to political pressure from union and state pension funds. Stay tuned!), because their equity is worthless. But the depositors should have been more careful. And they would have been more careful, except that deposits are insured by taxpayers who have no say in rewarding foolish risks. Worse, the fact that deposits of greater than the $250,000 statutory limit are now being covered by taxpayers means that the signal to all other depositors is that they need not look at their own banks, because taxpayers will cover those deposits, too.

The reason this is infuriating is that we are being told that taxpayers should be willing to double down, to reimburse even-more-careless depositors for their negligent inattention to risk. And I suppose you can see why, given that this dangerous assumption is now baked into expectations about how regulators will behave.

As Obi-Wan said to Luke, also in Return of the Jedi: “What I told you was true, from a certain point of view.” But Luke was mad that he had been lied to, and you should be mad, too.

 

Michael Munger is a Professor of Political Science, Economics, and Public Policy at Duke University and Senior Fellow of the American Institute for Economic Research.
His degrees are from Davidson College, Washingon University in St. Louis, and Washington University.
His research interests include regulation, political institutions, and political economy. he is the author of the 2021 book Is Capitalism Sustainable?
His post first appeared at the blog for the American Institute for Economic Research.

“Deposit insurance is a cancer at the heart of the capitalist system..." [updated]

“Deposit insurance is a cancer at the heart of the capitalist system, destroying its ethical foundations. Rich depositors should not be able to secure returns, in the good times, for investing in fundamentally riskbearing activities (which fractional reserve deposits are, by their nature) but then be bailed out by the government when times are tougher. And banks are the largest allocators of capital in the economy – so this fundamental injustice gets spread across the entire economic system.”
– Andrew Lilico, from his post 'The post-2008 banking reforms are now being tested – and they are failing'

Hat tip Johnathan Pearce and readers at Samizdata, who point out both the moral hard here -- and that a further large problem here is that  investors and depositors being bailed out, such as those who were via Silicon Valley Bank, or Credit Suisse, etc, is that they tend to be politically connected. Essentially creating three tiers of banks: 

• those "too big to fail"; 
• those too politically connected to fail; and 
• those about whom no-one in power cares if they fail.

UPDATE 1:

"[US Treasury Secretary Janet] Yellen, in the meantime, continues today to reassure everyone that the US banking system is sound — because she has to. Her reassurance claims the present situation is nothing like the banking bust in ’08 on the basis that 2008 was all about solvency in banks due to their taking on low-quality mortgage-backed securities, whereas the present crisis is merely due to “contagious bank runs” ... the [same] kind of thing that plunged the world into the Great Depression...
    "We ALL already know that the runs at these banks were created by a completely systemic bond-value-reduction that was caused by the Fed for all banks. We all know this bond devaluation by Fed policy effectively rendered those 'safe-haven' instruments  [i..e. long-term Treasury bonds] just as un-tradable for banks as junk mortgage-backed securities were in ’08. While they are a different kind of supposedly safer instrument, they have been substantially devalued all the same. Because that imperils the reserves of all banks, the Fed had to create a new loan programme available to all banks. Now, we appear to have, additionally, another systemic bank-run issue percolating beneath the surface being caused by the rescue programme because it gave sweeping depositor insurance to ONLY the top-tier banks."

~ David Maggith, from his post 'Janet Yellen: Creature of Chaos'

UPDATE 2:

Describing Yellen's haphazard defence of the bailout political preference programme to Congress, blogger El Gato Malo describes it as "Too Big to Flail," aka "Yellen Into the Void."

 

The triumvirate of fools at the US Federal Reserve Bank, US Treasury and Federal Deposit Insurance Corporation (FDIC) have abandoned any idea of a limited bailout for depositors in the two recently failed  banks, explains Thos Bishop in this Guest Post. Apparently there is now a new standard just made up by the banking bureaucrats: Too Mid-Size to Fail.
Welcome to the new economic paradigm where laws are broken, the rules are made up and the dollars don’t matter....

A Bank Crisis Was Predictable. Was the Fed Lying or Blind?

by Thos Bishop

Welcome to Whose Economy Is It, Anyway?, where the rules are made up and the dollars don’t matter. Or at least that seems to be the view of the Yellen/Powell regime.

As Doug French noted last week, Silicon Valley Bank (SVB) was the canary in the coal mine. Over the weekend, Signature Bank became the third-largest bank failure in modern history, just weeks after both firms were given a stamp of approval by KPMG, one of the Big Four auditing firms.

While some in the crypto community are suggesting that the closure of Signature Bank has more to do with a larger war on crypto, the regulatory action was enough to push coordinated action from the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and the Treasury to do what they do best, ignore clearly established rules to flood a financial crisis with liquidity.

Out: FDIC insurance limits on bank deposits lower than $250,000, haircuts for the largest bank depositors, and Walter Bagehot’s golden rule to lenders of last resort, “Lend freely, at a high rate of interest, against good collateral.” In: emergency financing to secure all deposits, accepting collateral at face value (rather than its current diminished market value) with no fee.

Don’t worry, the government promises this is only a year-long programme. It definitely won’t become a standing policy. They promise.

It is poetic that Barney Frank was serving as the director of Signature Bank at the time of its capture. This emergency action from the feds signals the failure of Frank’s key legislative accomplishment, the 2010 Dodd-Frank Act. The bill designated large financial institutions as “systemically important financial institutions,” with an additional layer of regulatory scrutiny as a means to end “too big to fail.”

Instead, the bill consolidated community banks into larger regional banks and empowered financial regulators that have now proven to be blind to the underlying risks of the banks. After all, it was state bank regulators, not the feds, that raised the flag on both SVB and Signature. Meanwhile, the hyper-fragile environment of the post-2008 financial crisis has created an environment where most financial institutions are treated as too big to fail, with no one too small to bear the costs.

Federal bank regulators and KPMG auditors aren’t the only ones blind to the underlying problems facing these large regional banking institutions. Just last week, Jerome Powell said that he saw no systemic risk in the banking sector from the Fed’s aggressive rise in interest rates and signaled confidence that they would continue in the near future. Less than a week later, few buy Powell’s projection.

While Powell deserves a level of credit for his willingness to take inflation risks more seriously than many of his peers, the instability we’re witnessing was predictable. As is repeated regularly on the Mises Wire, the decade-plus reign of low interest rates didn’t only incentivize financial risk but necessitated it. The benefactors were tech firms, the real estate market, and a variety of other financial markets. The consequence has been corporate consolidation and the creation of numerous overly leveraged, unprofitable zombie companies that depend upon refinancing at low interest rates to function. The Fed’s rising interest rates have always been a threat to these parts of the economy.

In defense of Powell, lying about the state of the economy is a necessary part of the modern financial system. Regardless of one’s opinion about the virtues of free banking, state intervention has created a fractional reserve banking system saturated with risk and moral hazard. Since no bank is equipped to deal with a significant increase in demand for deposits, even relatively conservative banks can be brought down by a confidence crisis fueled by the instantaneous communication of social media.

The Feds have signalled a bailout for all because everyone is at risk.

It doesn’t have to be this way. Caitlin Long has been fighting the financial regime for years in her quest to create Custodia Bank, a full-reserve bitcoin bank in Wyoming. There has been a coordinated attempt to stop her efforts, ironically including voicing concerns that Custodia could fuel “systemic risk.” Honk honk. [And despite all the interest-rate chicanery and money-printing Keith Weiner continues his efforts at Monetary Metals to remind everyone that the ultimate money is still a precious metal.]

The short-term question is whether the efforts of the Fed and the Treasury are enough to prop up confidence and prevent escalating pressure on financial institutions. However, these are not solutions to the underlying systemic problems that these bodies have created.

Unfortunately, the consequence of the complete politicisation of the economy is that financial policies are necessarily focused on the short term at the expense of the long term.

There is no serious solution until there is the political will to deal with our monetary hedonism.

Author: Tho Bishop
Tho is an assistant editor for the Mises Wire, and can assist with questions from the press. Prior to working for the Mises Institute, he served as Deputy Communications Director for the House Financial Services Committee. His articles have been featured in 'The Federalist,' the 'Daily Caller,' and 'Business Insider.'

His post first appeared at the Mises Wire.

Is a bank run always a bad thing?

I know what you're all thinking this morning, after hearing news of the collapse of the Silicon Valley Bank, a key "tech" lender. It'll be things like "When America sneezes, NZ catches a cold"; and "the whole financial system is interconnected so when one goes down, they all go down!"; and "all bank runs are bad, we have to have a bailout!"

Free banking expert Lawrence White disagrees with you. On that last, at least. "A run on an insolvent bank," he explains, "has the salutary effect of pulling the plug on a wealth-destroying machine." He continues, explaining the necessity that an insolvent bank dies:

An insolvent bank has taken $100 in depositor funds and turned it into <$100 in assets. Hence it has [already] destroyed wealth. If not closed promptly, owners will gamble for recovery by taking risky bets, which will (more likely than not) destroy more wealth.

As a reminder, he points to the Savings and Loan fiasco, which destroyed billions. 

A bank run is not necessarily a bad thing. Not when it stops the further destruction of wealth it isn't.

Money v 'currency'

"Money is routinely defined by what it does, rather than what it is. That is unfortunate because its modern definition overlooks money’s important – but now forgotten – fourth function.
    "Aristotle observed that money is a medium of exchange, unit of account, and store of value. This definition omits the fourth function needed to explain money and currency in our modern economy....
    "[T]he word ‘currency’ only came into existence in the late 1600s when a nascent banking industry began taking root in London and paper banknotes started circulating. Anyone who accepted a banknote knew that it was not money, namely, silver or gold coin, but rather, a money-substitute that was only a promise to pay money on demand. Thus, banknotes were recognised simply as currency from the Latin ‘currens’, meaning running or moving like the current of a river. Silver and gold money have existed since the dawn of civilisation, so compared to their track record, currency is a relatively modern term....
    "As governments removed precious metal coin from circulation in the twentieth century, the distinct concepts of money and currency became conflated. It is an understandable result because money and currencies both convey purchasing power, thereby performing Aristotle’s three functions. Money-substitutes, however, come with risks not found in money, highlighting the importance of its overlooked fourth function – the payment needed to conclude a transaction....
    "Final payment is achieved when the obligation of the payer to the payee is extinguished ... When any of today’s currencies are used to purchase a good or service, payment is not concluded at the time of purchase... Regardless of whether the currency used in a payment is paper banknotes or bank deposits circulated by cheque, plastic cards, wire transfers, or online, all national currencies in circulation today are a liability of some bank. The bank owes you the purchasing power that you placed with it. When you purchase a good or service, your purchasing power is then conveyed to the merchant by the currency you use in the transaction....
    "Payment by money is an immediate and final transfer of purchasing power from the payer to the payee. In contrast, national currency is conveyed in a three party transaction requiring clearing and settlement processed through the banking system, which introduces the counterparty risk that a bank may default....
    "Since the emergence of banks in seventeenth century London that included the founding of the Bank of England in 1694, humanity has built a monetary system with ever-growing complexity that has become so vulnerable to collapse it is no longer fit for purpose. The disadvantages of using bank liabilities as currency are writ large by recurring bank crises and the costs of bailing-out ‘too big to fail’ banks. Fortunately, there is a solution.
    "Lending and payments need to be separated. They are distinct businesses that should not be combined in one entity. In this way, bad banks that collapse into insolvency will not threaten the payment system. Payments should instead be made by companies focused solely on providing with modern technology a safe and efficient currency, or even better and more importantly, re-establishing the circulation of money to fulfil its four functions."

~ James Turk, from his post 'The Forgotten Fourth Function of Money and G-SIBs'

RELATED: 

• Real Money is Not Debt - NOT PC
• Rising Housing Prices: It's frightening, and there are two leading causes - NOT PC
• 'The Organisation of Debt into Currency...' - Robert Blume, MISES.ORG

Money Pumping Won’t Fix What’s Wrong with the Economic System

Central banks everywhere, including our own, are in the process of "expanding their balance sheets" to "counter the side-effects of lockdowns, to buy exploding government debt, to "stimulate" the economy, to avoid the possibility of a severe recession ... but as Frank Shostak argues in this guest post, both history and sound economics tell us that expanding the money stock to reverse an economic slump undermines the process of wealth generation, and it prolongs the slump. In other words ...

Money Pumping Won’t Fix What’s Wrong with the Economic System

by Frank Shostak

To counter the likely severe side effects of the "lockdowns" on the economy—introduced to prevent the spread of the coronavirus—the U.S Federal Reserve has embarked on massive expansion of its balance sheet. The size of the Fed’s assets jumped to $6.2 trillion in April this year from $3.9 trillion in April last year—an increase of 58.9 percent. [In NZ, the size of the Reserve Bank's assets jumped to $42.3 billion in March this year from $26.0 last year, an increase of 62.7%!]

In response to this pumping, the momentum of the money supply has jumped sharply, with the yearly growth rate climbing to 23.7 percent in the week ending April 13, from 13.1 percent in March and 2.4 percent in April 2019. [In NZ

, the increase to March was 8.3%. The April number is not yet in.]

It seems that the Fed is eager to avoid the possibility of a severe recession, hence the reason for its aggressive stance. By this way of thinking, an increase in the growth rate of the money supply will strengthen the demand for goods, which will in turn strengthen the production of these goods.

Most economists are of the view that during periods of economic difficulties it is the duty of the central bank to pursue aggressive monetary pumping to prevent the economy falling into a severe recessionary black hole. An important influence behind this way of thinking is the work of Milton Friedman.

In his writings, Friedman blamed central bank policies for causing the Great Depression in the 1930s. According to him, the Federal Reserve failed to pump enough reserves into the banking system to prevent a collapse in the money stock. As a result of this failure, Friedman argued, the money stock M1, which stood at $28.264 billion in October 1929, had fallen to $19.039 billion by April 1933—a decline of almost 33 percent. [1]

Friedman held that because of the fall in the money stock, economic activity followed suit. By July 1932, year-on-year industrial production had fallen by over 31 percent. Also, year-on-year the consumer price index (CPI) had plunged: by October 1932, the CPI had fallen by 10.7 percent.

In fact, contrary to Milton Friedman’s view, the fall in the money stock took place regardless of the Fed’s alleged failure to aggressively pump money. The sharp fall in the money stock was in response to the shrinking pool of wealth brought about by the previous loose monetary policies of the central bank.

The Essence of the Pool of Wealth

Essentially, the pool of wealth is the quantity of consumer goods available in an economy to support future production. In the simplest of terms, an individual on an island is able to pick twenty-five apples an hour. With the aid of a picking tool, he is able to raise his output to fifty apples an hour. Making the tool, however, takes time.

During the time he is busy making the tool, the individual will not be able to pick any apples. In order to have the tool the individual must first have enough apples to sustain himself while he is busy making it. His pool of wealth or his means of sustenance for this period is the quantity of apples he has saved for this purpose.

The size of this pool determines whether a more sophisticated tool—a more sophisticated means of production—can be introduced. If this tool requires one year of work to build but the individual has only enough apples saved to sustain him for one month, then the tool will not be built—and the individual will not be able to increase his productivity.

More sophistication is added to the island scenario by the introduction of multiple individuals who trade with each other and use money. The essence, however, remains the same—the size of the pool of wealth (i.e., the stock of consumer goods) puts a brake on the development of more efficient methods of production.

Trouble erupts whenever the banking system makes it appear as if the pool of wealth is larger than it is in reality. When the supply of money expands, this does not enlarge the pool of wealth. This expansion instead sets in motion an exchange of newly-created money for existing goods. It gives rise to the consumption of goods that has not been preceded by the production of these goods. It leads to a decline in the means of sustenance. It is true that the expansion of money supply lifts the demand for goods, but this demand cannot support an expansion in the production of goods without an accompanying expansion in the pool of wealth.

If and for as long as the pool of wealth continues to expand, loose monetary policies give the impression that the expansion of the money supply is the key factor in economic growth.

That this is not the case however becomes apparent as soon as the pool of wealth begins to stagnate or shrink. Once this happens, the economy begins its downward cycle. The most aggressive monetary pumping will not reverse the plunge (for money cannot replace apples).

How Fractional Reserve Banking Leads to the Disappearance of Money

The existence of the central bank and fractional reserve banking permits commercial banks to generate credit that is not backed by the prior creation of real wealth. Once this unbacked credit is generated, it produces the same effect that the expansion of money does: it sets in motion the consumption of goods without the preceding production of these goods.

Whenever the extensive generation of credit out of "thin air" lifts the pace of wealth consumption above the pace of wealth production (as we have described above in relation to central bank monetary pumping) this starts to undermine the pool of wealth. Consequently, the performance of various activities starts to deteriorate and banks’ bad loans start to increase. In response to this, banks curtail the expansion of lending out of “thin air,” setting in motion a decline in the money stock. An example clarifies how this decline emerges:

Let us assume that an individual, Tom, places $1,000 in saving deposit for three months with Bank A. The bank lends the $1,000 to Mark for three months. On the maturity date, Mark repays the bank $1,000 plus interest. After deducting its fees, Bank A returns the original money plus interest to Tom.

In this scenario, Tom has lent his $1,000 for three months, i.e., he has transferred the $1,000 to Mark through the mediation of Bank A. The lending is fully backed, since existent money from Tom to Mark and then back via the mediation of Bank A.

Things are different when Bank A lends money out of “thin air.” For instance, let's say Tom exercises his demand for money by placing $1,000 in demand deposit with Bank A. By placing the money in demand deposit, he retains total claim to the $1,000. This means that the $1,000 is Tom’s exclusive property and no one is allowed to violate this right.

Now, Bank A may decide to take $100 from Tom’s demand deposit without Tom’s agreement and lend it to Mark. As a result, Bank A generates a demand deposit for Mark to the tune of $100. The money stock has now increased by $100. Because of this lending, we now have $1,100 that is only backed by $1,000 proper. In this case the $100 loaned also does not have an original lender, as it was generated out of “thin air” by Bank A.

When Mark repays the borrowed $100 to Bank A on the maturity date, it disappears. The money supply is now back at $1,000. If the bank continues to renew its lending out of thin air, then the stock of money will not decline. Indeed, the more lending out of “thin air” supplied by the bank, the greater the expansion of money supply will be.

The existence of fractional reserve banking (banks creating several claims on a given dollar) coupled with the subsequent unwillingness to renew and expand this lending out of “thin air” is the key factor in money disappearance. There must be a reason, however, why banks do not renew their “thin air” lending, causing this disappearance of money.

What Causes Banks to Curtail Lending?

A key reason is the weakening of the process of wealth generation, which makes it much harder to find quality borrowers. [The result of a declining marginal productivity of debt.] Remember that what weakens this process is the previous expansion in money supply due to the easy monetary policies of the central bank.

Loose monetary policies set in motion an exchange of nothing for something—i.e., consumption that is not supported by the prior production of wealth. This results in the transfer of real wealth from wealth generators to non–wealth generators.

This means that a decline in the money supply (i.e., monetary deflation) emerges because of the prior monetary inflation that diluted the pool of wealth. It follows that a fall in the money supply is really just a symptom. The fall in the money stock comes in response to the damage that the previous monetary inflation caused to the process of wealth formation.

Note that between December 1920 and August 1924, the U.S. Federal Reserve was pursuing a very easy interest rate policy and as a result the yield on the three-month government Treasury bill fell from 5.9 percent in December 1920 to 1.9 percent by August 1924. 

By December 1925 the yield had climbed back to 3.5 percent before declining to 3.1 percent by April 1926. 

Thereafter the yield followed a rising trend, closing at 5.1 by May 1929. (Observe that the average of the yield on the three-month Treasury Bill from September 1924 to October 1929 stood at 3.5 percent—below the average of 3.9 percent from December 1920 to August 1924.)

Coupled with the increase in money supply from January 1927 to October 1929 (the yearly growth rate of M1 money supply shot up from –2.2 percent in January 1927 to almost 8 percent by October 1929), setting in motion an economic boom, and inflicting severe damage on the process of wealth generation, i.e., severely undermined the pool of wealth. 

Note that the yearly growth rate of industrial production by April 1929 stood at 22 percent! Also, note that the previous massive booms had likely damaged the pool of wealth when the yearly growth rate of industrial production had stood at 42 percent in December 1922, and 28 percent in June 1926.

Because of the fall in the money stock from October 1929 to April 1933, various activities that had sprang up on the back of the previous monetary expansion found it hard going.

It is those non–wealth generating activities that ended up having the most difficulties in servicing their debt, since those activities never really generated any real wealth and were, so to speak, riding on the coattails of genuine wealth generators. [As Warren Buffett says, it's only once the tide goes out that you see who has been swimming naked.] After closing at 8.7 percent in November 1929, the yearly growth rate of bank loans had plunged to –20.8 percent by September 1932 (see chart). As a result the money supply (M1) collapsed (see chart).

With the fall in the money out of “thin air,” the support provided to non–wealth generators was arrested. This set in motion the demise of various non–wealth generating activities, which manifested in the economic nightmare that we now label the Great Depression.

Summary and Conclusions

Contrary to the popular view, it was not the Fed’s failure to pump aggressively during the 1930s  that was behind the Great Depression of the 1930s, instead it was the loose monetary policy of the Fed during the 1920s.

Even if the central bank had been successful in preventing the fall in the money stock, if the pool of wealth had been declining this would not have been able to prevent the economic slump.

Contrary to popular thinking, the lifting of the money stock to reverse an economic slump undermines the process of wealth generation and prolongs the slump. Being the medium of exchange, money can only facilitate the flow of goods and services in an economy—it cannot expand the of production of goods and services as such. The key to this expansion is an increase in the pool of real wealth.

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1.Milton Friedman and Rose Friedman, Free To Choose: A Personal Statement (Melbourne: Macmillan Company of Australia, 1980), pp. 70–90.
Frank Shostak's consulting firm, Applied Austrian School Economics, provides in-depth assessments of financial markets and global economies. His post previously appeared at the Mises Wire.
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"Our so-called economic recovery is actually a 'bubblecovery' based on the growth of dangerous new bubbles and another debt binge." #QotD

"I have been warning that we are experiencing another massive bubble for eight years now (starting in June 2011) and I am proud of it...  My belief is that our so-called economic recovery (both U.S. and global) is actually a 'bubblecovery' based on the growth of dangerous new bubbles and another debt binge. These bubbles are ballooning across the globe in numerous assets, industries, and countries such as U.S. equities and bonds, U.S. higher education, U.S. corporate debt, tech startups, shale energy, China and emerging markets, New Zealand, Australian and Canadian property, and more. The actual driver of these bubbles is the extremely aggressive central bank policies since the global financial crisis (i.e., record-low interest rates and quantitative easing).
    "While most of my trolls and critics assume that I’ve been calling to short the market for nearly a decade because of my bubble warnings (and have, therefore, been wrong all along), they couldn’t be further from the truth..."

~ Jesse Colombo, from his post 'Why Warning About A Bubble For A Decade Is Completely Rational'

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"The turn of the credit cycle and the rise of American protectionism was the same combination that led to the Wall Street crash in 1929-32 & the depression that followed. History is rhyming, though few connect the dots." #QotD

"The turn of the credit cycle and the rise of American protectionism was the same combination that led to the Wall Street crash in 1929-32 and the depression that both accompanied and followed it. Those who follow statistics are now seeing the depressing evidence that history is rhyming, though they have yet to connect the dots."
          ~ Alasdair McLeod, from his post 'For those who don’t understand inflation'
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The housing crisis: the causes in four tweets

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Hayek asks: Has monetary policy has ever done any good?

As the ruling parties work to change the country's monetary policy, Hayek's answer to the question above couldn't be more topical.

Hayek's answer starts with the origins of money, as explained by Carl Menger:

You see, the great trouble is that money wasn’t allowed to develop further. After two or three hundred years of coins all governments put up their hands and stopped any further developments. We’re not allowed to experiment on it — and money hasn’t been improved, rather it has become worse in the course of time.
Because … with law and language and money [you have] the three paradigms of spontaneously [developed] institutions [as explained by Carl Menger and Hume and Mandeville]. Now fortunately, law and language have been allowed to develop; money has originated in original form, but as soon as it was there in its original form [however] it was frozen — government said it must nor develop any further. And what we have had since in development were matters of government invention — mostly wrong, mostly abuses of money — and I have come to the position of asking if monetary policy has ever done any good. I don’t think it has. I think it has done only harm, and that is why I am pleading now for the de-nationalisation of money …

In his view, with which I concur, the problem is not what monetary policy the government adopts, but that it has any monetary policy at all.

Watch the full interview (F. A. Hayek on Monetary Policy, the Gold Standard, Deficits, Inflation, and John Maynard Keynes):

NZ housing nearing a trillion in total ‘value.’ Does anyone have a pin?

 

So, I just thought you’d like to know that “the runaway property boom has driven the combined value of all homes to over $900 billion for the first time, according to Reserve Bank figures.”  That’s edging up ever closer to one-trillion dollars in paper value, more than four times the country’s measured GDP.

This figure is up from “the end of December, [when] Reserve banks figures indicated New Zealand homes were worth a combined $873 billion.” That’s a six-percent year-on-year price inflation.

And that’s on the back of an eight-percent increase year-on-year in mortgage lending – new money borrowed into existence under the authority of the Reserve Bank at an ever-increasing rate into an ever-more restricted housing market.

But yes, we have no inflation …

The rise has incensed affordable housing campaigner Hugh Pavletich, who called it "obscene and dangerous" that houses and apartments were worth about four times the country's gross domestic product (GDP).
    "It's just ridiculous," Pavletich said. "Obscene and dangerous is the only way to describe it."
    In 2014 Pavletich compared the ratios in different countries of housing stock value to GDP. He found New Zealand's was 3.2 times GDP, behind only Australia, but ahead of the United Kingdom, Canada and the United States.
    "The housing stock should not be worth more than 1.2 times GDP to 1.5 times, tops, but nowhere near this 3.6 getting close to four times GDP," Pavletich said.

There is something wrong with the system of organising debt into currency that has helped to blow up this bubble. Something very wrong, and far too little attention paid to it…

[This] entire fractional reserve system is …inherently unstable, ‘a mad system of kiting between the banks and their customers — and an enormous superstructure of debt is built thereon, keeping almost every [merchant] in danger of bankruptcy.’

Which explains so much of tomorrow’s headlines, don’t you think?

RELATED POSTS:

• “I’ve been interested at all this talk of rising house prices—houses, in our little economy, being one of the main reasons for which New Zealanders borrow money. Or to put it another way, one of the main reasons for which debt is created.
      “In our system—and in most of the western world—the way new money comes into the system is by means of this new debt; debt organised into currency. An elastic currency.
      “And in New Zealand in recent years, new debt has been coming into the system at an increasing rate in recent years—almost at the pace it was coming in during the 2003-2007 boom. Which is to say, the year-on-year growth in our elastic currency is taking off again…”
  More money, higher house prices… – NOT PC
• [2014] “New Zealand’s current economic activity is being “juiced up” due to a China Bubble Boom and the excessive costs of the Christchurch earthquake recovery. Bureaucratic incompetence has meant this painfully long recovery will be a $NZ40 billion exercise, when it should have been in the order of $NZ15 billion.
      “Sadly it would appear, The Broken Window Fallacy is not understood by economic commentators, in that the Christchurch earthquake recovery (with some flooding problems due to Council incompetence with poorly maintained drainage infrastructure … in the main) is not building new wealth but simply the replacement (eventually, if ever) of the damaged and destroyed capital stock.
      “The latest figures from the Reserve Bank of New Zealand indicate the New Zealand housing stock has a “value” of some $NZ716 billion … roughly 3.4 times its GDP. It should not exceed 1.5 times ($NZ315 billion … ideally 1.2 times ($NZ252 billion). This suggests there is something in the order of $NZ401 and $NZ461 billions of bubble value in New Zealand housing. It takes about 25% of mortgages incorporated within this bubble value to fuel it … some$NZ100 billion through $NZ115 billion of at risk bubble mortgage value.
      “The problem is the New Zealand Banks only have a capital base of about $NZ29 billion…”
  New Zealand’s Bubble Economy Is Vulnerable – NOT PC, 2014
• “Forbes magazine columnist Jesse Colombo invites international investors enamoured with NZ’s ‘rockstar economy’ to think again – offering 12 Reasons Why New Zealand's Economic Bubble Will End In Disaster, pointing out among other things the conjunction of historically ultra-low (unsustainably low) interest rates and a mortgage bubble grown by 165% in a little over a decade, with the fact that nearly half of all NZers mortgages have floating interest rates, with mortgages themselves accounting for nearly 60% of banks’ loan portfolios.
      “So sit tight waiting for the pop when interest rates head back towards reality.”
  “12 Reasons Why New Zealand's Economic Bubble Will End In Disaster” – NOT PC, 2014
• “There aren’t just problems with the way the morons measure “growth”  (by which they generally just mean consumption). There were problems, as we’ve now discovered, with NZ’s three supposed pillars of permanent prosperity.
      “But not to worry says the Herald business editor… the continuing inflation of this asset bubble could be ‘good news.’
      “In a pig’s arse, it is.”
  Herald business editor praises latest asset bubble – NOT PC

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“Why younger people can’t afford a house”

Dominic Frisby tells Guardian readers why younger people can’t afford a house. Three reasons:

• money became too cheap
• planning rules became too numerous, and
• it’s in the interests of the political elite to keep them that way.

This is not just true for the UK, but every place following their flawed prescription of town planning plus fractional-reserve banking. Which is to say, every developed country on the planet.

House prices [in the UK] have risen by 10% in the last year …What that means is that the intergenerational wealth divide just rose by another 10% – and anyone born after 1985 is going to find it 10% harder to ever buy a home.
    There is perhaps no greater manifestation of the wealth gap in this country than who owns a house and who doesn’t, and yet it’s so unnecessary.

Measure so-called “inequality” by reference to home ownership, and you’ll blow away every other single measure.

Ignoring land prices for the moment, houses do not cost a lot of money to build – a quick search online shows you can buy the materials for a three-bed timber-framed house for less than £30,000; in China a 3D printer can build a basic home for less than £3,000 – and the building cost of the houses we already have has long since been paid.

The building cost of houses has already been paid, but in many places (NZ being one) building regulation has also pushed up home building costs at an even faster rate than house prices have accelerated. Still..

How can it be that, in the liberal, peaceful, educated society that is 21st-century Britain, a generation is priced out? These are not times of war, nor are they, for the most part, periods of national emergency, so why should one couple be able to settle down and start a family and another not, by virtue of the fact that one was born 15 years earlier than the other?
    There has been a failure in both the media and government to properly diagnose the cause of high house prices. Until the causes – our systems of money and planning – are properly understood, we cannot hope to fix the problem.

Understanding the effect of these two, and how their negative effects exacerbate each other, this is the key.

The standard solution is: “we need to build more”, but this is not a simple supply-and-demand issue. Between 1997 and 2007 the housing stock grew by 10%, but the population only grew by 5%. If house prices were a function of supply and demand, they should have fallen slightly over this period. They didn’t. They rose by more than 300%.

Once you realise however that demand is actually a function of desire coupled with the abillity to pay, then you understand it actually is a function of suppy and demand. Because the cause of house price rises is the unrestrained supply of new money. That is to say (in our modern fiat-money world) of debt.

[So while housing stock increased by 10% and house prices rose by more than 300%], mortgage lending over the same period went up by 370%, thinktank Positive Money’s research shows. It was newly created debt that pushed up prices in a decade of extraordinarily loose lending, which gave birth to a national obsession. Houses were no longer places to live, but financial assets. Property owners became immensely wealthy without actually doing anything. And this great, unearned wealth saw the rise of a new rentier class: the buy-to-let landlord.
    When you have runaway price inflation such as this, the Bank of England has a responsibility to quash it, usually by putting up interest rates. But – and here is the great sleight of hand – the Bank has seen fit not to include house prices in its measures of price inflation. So, throughout the 90s and 00s, they could then “prove” price inflation was low or moderate and interest rates meandered lower. Meanwhile, more and more mortgages were issued, and so more and more money was created, and it pushed up prices. The government didn’t mind.
    Homeowners vote and homeowners were happy – they were getting rich.

Just one reason the political elites of every party offer no serious solution to the problem. And still the fraud continues…

The Bank of England says inflation is 0.3%. Really?
   With house prices up by 10% last year?
    When you make money this cheap, you create bubbles. Combining a money system that requires ever-expanding debt to function with a national policy of ignoring where that money goes is asking for trouble. And trouble is what we have.
    2008 gave us the crisis we needed to address the problems inherent in our money system – how is money created? Who gains and who suffers by this system? – but our leaders chose not to. Instead interest rates were slashed, so mortgages and other debts became incredibly cheap to service (great if you already had a mortgage). We got the great obfuscation that is quantitative easing; £375bn of newly printed money flowed into the financial sector and on into the London property in which it mostly lives. Asset-owners were bailed out and the next generation was made to pay the price.
    Then we got help-to-buy, which is just another way to get new money into the market. And where lending has tightened in the UK, it hasn’t abroad, and so we have vast sums of money created overseas now entering our housing market and further driving up prices. Today in London everywhere you look there is a crane. There is no shortage of newbuild, yet we still have a crisis, because prices are so high.
    People associate debt with the poor. But large, cheap debt is, in fact, a luxury of large corporations, of the rich and of governments. It has created this unholy alliance between the three and with it an international culture of keeping debt costs low and asset prices high, whatever the consequences.

Risk-free profits, that’s what this culture has come to expect, backed up with bailouts should the shit hit the fan yet again.

Planning laws are the second part of the problem. All this money is pouring into a market that is restricted in how it can expand.
    Just 1.1% of rural and urban land in England and Wales has domestic property on it, according to the 2011 National Ecosystem Assessment. 1.1%! Another 1% has commercial property and 2% is roads. The rest is not built on. You could almost double the housing stock of England and Wales, using little more than 1% of available land. But planning laws prevent that.

The same sort of figures apply here in New Zealand, except even less so. According to the Landcover Database of Terralink, urban areas and urban open space in New Zealand account for less than 1 percent of total area, one quarter of that in the Auckland region. If all of NZ's 1,471,476 existing households were to be rebuilt on an acre of land (which was the sort of thing proposed by Frank Lloyd Wright in his Broadacre project), we'd all fit in an area less than one-quarter the size of the Waikato -- and think how easy it'd be to thumb a lift out to Raglan!

The sad fact is this makes housing unaffordable for everyone not already owning a house; it means they suck capital from those who don’t. The even sadder part, for small builders, is that it tends to make house building the preserve of a few large companies; and for those seeking housing that’s in any way attractive, it leads (partly because of this near-monopoly) to the bland and characterless buildings that so blight every new suburb and every coastal development.

Our most beautiful domestic architecture was predominantly built in the 18th and 19th century, before planning laws [just as NZ’s most desired suburbs are those ‘planned’ before planning laws were themselves invented]. The more planning there is, the uglier our buildings [and suburbs] seem to get. [Have you ever visited Albany? Or Manuka City?]
   It’s inevitable when the final say on creative decisions is in the hands of regulators. Imagine Van Gogh needing regulatory approval on a painting. Let us simplify planning, let self-build flourish and let the creative – not the corporations – do the building. I’ve always dreamed of building my own home. I’m sure you have too. It needn’t cost a lot of money – except that it does. An acre of rural land worth £10,000 becomes an acre of land worth as much as £1m once it has planning permission. [Just as an acre of land just outside Auckland’s Metropolitian Urban Limit is priced at around ten times more than a similar acre just inside.]  That is an expensive and needless cost of government.
    [Britain’s] 1947 planning act was founded on the … aim “that all the land of the country is used in the best interests of the whole people”. The opposite has happened. [Which is generally the case with all such aims.] The act reinforced the monopoly of the landowner and we now have a situation where more than 70% of UK land is owned by just 6,000 or so landowners (the Crown, large institutions and a few rich families). The act has led to huge concentrations of capital and people in areas that are already built up – especially London – bringing vast unearned wealth to those who own at the expense of those who don’t. It has actually caused the wealth gap to grow.

This is the most important, perhaps the only important wealth gap about which to worry: the gap propped up by governments making savers and those who don’t own homes prop up the wealth of those who do. However …

    The solution to the housing crisis is lower prices. What politician will stand for that? They daren’t let this market fail because too many people’s wealth is dependent on the value of their home – and homeowners vote more than renters. It’s not just the vested interest issue, with so many MPs being buy-to-let landlords (including 39% of Conservatives) [and almost every MP in the NZ parliament].
    The collapse of property prices between 1989 and 1994 made the Tories unelectable for half a generation. No party wants such a fate. Indeed if interest rates reflected 10% house price inflation, homes would become affordable pretty quickly, but then the whole financial house of cards would come crashing down too. Those responsible for that would become even more unelectable than the Tories were.
    However this ends – falling house prices or a generation even more excluded – it is going to be painful. But the sooner we recognise the causes of high house prices – our systems of money and planning – the sooner the problem can be properly dealt with.

Hear, hear.

[Hat tip Ziv Du]

Dairy, oil, iron, rubber, steel, malinvestment

 

Oil prices are historically low, and oil producers are struggling to cope.

Dairy prices are historically low, and dairy farmers are struggling to cope.

These two stories are both in the news this morning.

These two stories are not unrelated.

The price of all commodities are at historical lows, not just these, and the reason for all is the same: the creation in the last seven years of counterfeit capital at record rates. This is what “stimulus season” finally wrought: an avalanche of malinvestment creating a mountain of over-supply.

See, here’s the thing. While many were worrying when stimulunacy was all the rage that record low interest rates being lent out at record levels would simply result in hyper-inflation. (And, if you look at Auckland house prices, they’re partly right.)

But not all of that record lending went into buying holidays for cashed-up Auckland vendors. As much or as more of that record lending went into production—to production in a very bad context. That context being this: this seven-year period of Greater Recession began because the structure of prodution was out of whack. (That’s what generally causes a recession: the structure of production being out of whack often because of a period of profligate lending at low interest rates.)

So, much of that new lending going into production around the world simply helped prop up these existing bad positions. It kept the zombies going. But as much again went into genuinely new production: of impossibly productive shale oil fields; of newly-rich dairy farms; of iron ore and steel and rubber and on and on and on.

All that lending going into what Hayek explained as the “early stages” of production produced a short-term yet (this time) very flaccid boom. The bust is what happens when it is realised not all the world wants all that product, and at those prices as they are now few are in a position to stay afloat.

That was the Fourth Act of this depressing story played out on Morning Report today with fourth-generation Northland farmer Ben Smith one of those taking the fall. [Listen to his interview here.]

So too are rubber producers.

And iron-ore producers.

And oil producers.

And on, and on, and on.

It’s true that in the last two decades in which central banks have been organising debt into currency at record rates much economic progress has been made, and much real wealth has been produced. But in times like this it’s desperately hard to tell the malinvestment from the real thing.

Stated differently, the worldwide economic and industrial boom since the early 1990s was not indicative of sublime human progress or the break-out of a newly energetic market capitalism on a global basis. Instead, the approximate $50 trillion gain in the reported global GDP over the past two decades was an unhealthy and unsustainable economic deformation financed by a vast outpouring of fiat credit and false prices in the capital markets.
    For that reason, the radical swings in commodity prices during the last two decades mark not merely the unique local supply and demand factors which pertain to crude oil, copper, iron ore, or the rest, but the path of a central bank generated macro-economic bubble.

Folk like Ben Smith are now paying that price.

RELATED POSTS:

• “Dairy farm debt has reached $38 billion, and the Reserve Bank's financial stability report said the risk of non-performing loans had increased over the past two years. It listed a ‘severe’ future scenario as a milk price of $4. The "worst case scenario" would feature a slow recovery in payout and sharp decline in land values resulting in non-performing loans - in other words, defaults on payments - increasing to about 44 percent.”
  Dairy downturn expected to hit land values: 'They are going to see land values drop' – RADIO NZ
• “From the debt problems of an underwater government --now over $100 billion in debt and counting -- to the debt problems of underwater dairy farmers who, like dairy farmers around the globe, had credit extended to bring new dairy into production, only to find that debt-driven overproduction has lowered dairy prices below what many need even just to repay their debt.
  ”Can anyone yet spell malinvestment?”
  Dairy’s debt delusion – NOT PC, 2015
• “Are you surprised?  Mainstream economists might be, but this is precisely what Austrian economists expect to see as the “rapid growth” of a credit-created boom turns into debt-based bust.   You see, Austrian economists understand two relevant things here that mainstreamers don’t … “
  Dairy bubble starts to pop – and guess who’s holding the pin? – NOT PC, 2009
• “Investors’ desperate search for yield has all the Fed’s counterfeit capital been pumped into supplying more commodities, like oil, than the market actually demands? If so, does that make the recent savage surge in oil supply a classic Austrian mountain of malinvestment? And if so, then what happens next?”
  Q: So what happens when oil hits $45 a barrel? – NOT PC, 2015

Dairy’s debt delusion

From the debt problems of an underwater government --now over $100 billion in debt and counting -- to the debt problems of underwater dairy farmers who, like dairy farmers around the globe, had credit extended to bring new dairy into production, only to find that debt-driven overproduction has lowered dairy prices below what many need even just to repay their debt.

An anyone yet spell malinvestment?

Over the weekend a blog reader was asking why I haven’t written on the dairy debt crisis. I said I had: it was a few years ago before the malinvestment became obvious. You can read those again if you like, since only the details have changed (they’re below) or you should read Michael Reddell’s recent analysis here and here which (like this very post you’re reading) are tinged with the sadness of “I-told-you-so”:

The rate at which new dairy debt has been taken on (and made available by lenders) has slowed markedly since around 2009.  Dairy debt grew at an average annual rate of 17 per cent from 2003 to 2009, and by around 4 per cent per annum in the six years since then. … That [now means] that dairy farmers on average have $6 of debt for every $1 of GDP they generate –  and among the indebted farmers that ratio will be much much higher. …

• October 2009: Dairy bubble starts to pop – and guess who’s holding the pin?The Crafars are the tip of a multi-billion-dollar pyramid of debt – a pyramid propped up by the very assets that have been inflated by all that debt. … The Crafars’ collapse indicates the first major signal that defeat on all three fronts is now upon us … Are you surprised?  Mainstream economists might be, but this is precisely what Austrian economists expect to see as the “rapid growth” of a credit-created boom turns into debt-based bust. …
      If you want to get angry at someone, don’t get angry at the Crafars – get angry at those responsible for creating all the credit-backed profligacy: at the denizens of the Reserve Bank. It was them who inflated the bubble.  It’s reality that’s now holding the pin.
• July 2009: The Biggest Bill: And here ‘s another piece, on the debt problems of the dairy industry, who (in a story that’s now all too familiar) have partially substituted the “economically perverse” illusion of debt-fuelled capital gain (i.e., the illusory “wealth” of a bubble) for real productivity growth. Read Analyst warns of dairy debt tsunami
• June 2009: The credit/debt delusion: The faster you go, the bigger the mess: Many farmers have apparently been riding the bubble -- "farming for asset gains" the Agriculture Production Economics report calls it – leaving them exposed on three fronts … No debt bubble has ended well … Garrett talks about the “delusion of credit,” a mass delusion as widespread now as it was in the 1920s. And as destructive…
      Prosperity is so very far from being a product of credit that it is almost one-hundred and eighty degrees wrong to suppose that it is – in that the delusion that prosperity is a product of credit wipes out the pool of real savings that has been created by the increase and exchange of wealth, and on which further wealth creation actually depends.  Frank Shostak explained the destruction back in 2005 [as being robbed by means of loose monetary policy].
      “Robbed by means of loose monetary policy.”  That’s as true for creditors as is for debtors, and everyone in between.

RELATED POSTS:

• We’re rock stars – NOT PC, 2014
• NZ’s commodities crash rivals Australia’s – Leith Van Onselen, MACRO BUSINESS, July 23, 2015
• Corporate welfare is not dead – NOT PC, 2010