Tuesday, November 18, 2008


The popularity of this blog has grown tremendously recently. I can still remember when I was excited about this blog getting 100 visits per day. In recent weeks, this number has grown to more than 1,000 per day. This is very good of course, although I still think that number is too low, considering the 50,000 to 100,000 numbers that Calculated Risk, Barry Ritholtz and Mike Shedlock have. I will therefore try to boost my visitor numbers further, something which readers can help with by spreading the word whenever you see any post you find particularly interesting or tip about this blog in general.

One side-effect of this growing popularity is that I am getting an increased number of e-mails asking me economics questions. I answer most of them, but they're becoming so many that I have difficulty finding time to answer all of them while having time for the blog and other projects that I'm involved with.

For this reason, I will introduce a new feature on this blog called Q&A, inspired by a similar feature on the blog of Swedish objectivist philosopher Carl Svanberg. In the comment field of the Q&A post you can post whatever questions you have about issues related to economics. Related to economics doesn't just mean questions about economic theory or how the economy works, but also related issues like economic policy, the epistemology and methodology of economics, economic history, financial market developments and so on. Questions that I consider completely irrelevant or otherwise inappropriate will however not be posted or answered.

The advantage of this feature is that not only does it give readers a place that they can turn too when they're uncertain about something, but they can also see in the comment thread whether I have already answered it or not, which in time will make it a reference point and almost an encyclopedia. In some cases I will simply answer by referring to an older post or article where the answer can be found. In some cases I will answer directly in the comment thread, in other cases when I consider it to be of particular general interest I will answer in a new post on the blog while in the comment thread linking to that new post.

I will therefore stop answering general economic questions via e-mail and instead refer those who continue to contact me to this post. Some of the questions I get via e-mail come from Swedes who -knowing that I am a Swede too- ask them in Swedish. I would prefer if even my Swedish readers ask questions in English (as most readers can’t understand Swedish), although I will at least sometimes approve (and translate for non-Swedish readers) questions in Swedish if you find it too difficult to formulate them in English. Since I don't understand other languages I will however not approve any questions in other languages than Swedish or English. This post will soon disappear from front page of the post section of the blog as new posts appear, but it will be a permanent feature of the side bar, that you can access whenever you have a new question. As an introduction I will answer two questions that have come via e-mail and in a comment thread on another blog and answer them in the comment section. To access that if you're on the main page click on either comments or the permanent link of this post.

The first question comes from blogger Wille Faler who wants to know more about Austrian economics and wonders which books I recommend. This is a question which I have received a lot of times from many other people, so it is clearly a good place to start.

The other question is not just one question, but several. The mail was written in Swedish by a student at the Stockholm school of Economics, but I'll present a translated version of them here:

1) Have I understood it correctly that the quantity theory in its modern version is incorrect? Is not velocity irrelevant for long-term general price increases?

2)I know that an (artificially) lowered central bank funds rate creates an increased money supply through a credit expansion, but I've also heard that an increased money supply lowers interest rates, which interest rates? What comes first, low interest rates or higher money supply? Why was inflation so high in Sweden in the 1980s when the central bank funds rate was also very high?

3)I know that an central bank is supposed to "control" inflation using the funds rate but that this is extremely difficult? In what other way do they directly control money supply? Does the central bank buy government bonds for money that don't exist and why do they do it and what happens when the bond is "paid back"? Who really controls money supply, the government or the central bank or both? I have read a bit Hazlitt and he makes it appear a little like the government creates money at will.

4) What does it mean when the central bank pumps in liquidity? Do they buy government bonds for money that doesn’t exist or do they give new loans to the banks?

5) Do all Swedish banks have the same reserve requirements? Where can you find information about that?


Blogger stefankarlsson said...

Beginning with the literature list, the perhaps best introductory book is Henry Hazlitt's Economics in One Lesson. It can be read online for free here.

If you want a paper version it can be found on both the Mises Institute book store and in for example amazon.com.

The best book on the most important Austrian theory, the Austrian business cycle theory, is Murray Rothbard's America's Great Depression. It can be read online here. A Paper version can be ordered at various places, including here.

Another important book from Rothbard is What Has Government Done To Our Money?. It can be read online here and ordered at various places including here.

Also of interest in these days are Peter Schiff's book Crash Proof, which discusses the background of the crisis from an Austrian perspective and also discusses investment implications. It can be ordered in various places including here.

When it comes to deeper understanding, there are 3 long treaties or magnum opus to choose from. Ludwig von Mises' Human Action, Murray Rothbard's Man, Economy and State and George Reisman's Capitalism. Human Action can be read online here and ordered from various places including here. Man, Economy and State can be read online here and ordered from various places including here. Capitalism can be read online here and ordered from various places including here.

The ideal would be to read all 3 of them, but since each are more than 1,000 pages long, most people won't have the time to read them all, especially since some of it is advanced. So which should be chosen? Each book has its advantages and shortcomings compared to the others, so Austrians disagree on this issue. Human Action is of course the original Austrian magnum opus so many would prefer it, and many objectivists prefer Capitalism since Reisman is an objectivist too. I personally prefer Man, Economy and State (particularly the original version that didn't include the Power and Market section) since I think it is the most lucid and pedagogic of the three. It starts with the basics of human action and then gradualy through the book expands its applications, thus enabling the reader a good grasp of the subject.


Turning now to the questions about how the monetary system works:

"1) Have I understood it correctly that the quantity theory in its modern version is incorrect?"

If you by quantity theory refer to the simplistic view that nominal GDP should increase at the same pace as money supply, and no significant changes in "velocity" should occurr, then it is incorrect. Regardless of which money supply measure you use, you often see significant shifts in velocity happen during many years.

"Is not velocity irrelevant for long-term general price increases?"

Not necessarily as there can be shifts in velocity due to shifts in demand for money for other purposes than transactions of goods. Even so, in the really long run, money supply should increase at roughly the same pace as nominal GDP (PY). However, the point is that in the short- to medium term there can be quite significant shifts in velocity due to various reasons, for example asset price bubbles.

"I know that an (artificially) lowered central bank funds rate creates an increased money supply through a credit expansion, but I've also heard that an increased money supply lowers interest rates, which interest rates? What comes first, low interest rates or higher money supply?"

Both can come first. That depends on whether the central bank targets money supply or interest rates. Today virtually all central banks target either exchange rates or interest rates. This means that interest rates -or exchange rates- come first and that the exact money supply increase is a result of the level of interest rates.

"Why was inflation so high in Sweden in the 1980s when the central bank funds rate was also very high?"

The main reason was the eliminations of restrictions on bank lending in 1985, which caused a massive credit- and money supply expansion. Also, if you take into account the high inflation expectations and the tax systems which allowed people to take up most of their interest expenses as a tax deduction, interest rates weren't high. The real after-tax interest rate was in fact negative in Sweden in the 1980s.

"3)I know that an central bank is supposed to "control" inflation using the funds rate but that this is extremely difficult? In what other way do they directly control money supply? Does the central bank buy government bonds for money that don't exist and why do they do it and what happens when the bond is "paid back"? Who really controls money supply, the government or the central bank or both? I have read a bit Hazlitt and he makes it appear a little like the government creates money at will."

Sometimes Hazlitt and other Austrians express themselves in a simplistic manner which is largely true but partially misleading. The government apart from the central bank does not directly control the money supply. They do however influence through the interest rate is set and are because of that and the protection they give fractional reserve bankers they should be considered responsible for the money supply increases that follow. As I put it in my recent post discussing the denial of the Fed's responsibility for the housing bubble by Cato economists David Henderson and Jeffrey Hummel:

"They then argues that the fact that many parts of broader money supply measures M2 and MZM lack reserve requirements somehow mean that the Fed can't control them . That is true in the sense that the Fed doesn’t decide on the exact money supply increases in their meetings. As I've explained before, money supply is a residual factor of the interest rate that the Fed sets and the various other factors that affect interest rates. Or more correctly, the other factors that would have affected interest rates if the Fed hadn't fixed it. Now that the Fed has fixed it, these other factors instead affect money supply. But, by fixing interest rates at a certain level the Fed is ultimately responsible for the increases in the money supply and it could have controlled it if it had targeted it instead of interest rates."

As for what happens when government bonds reach maturity, the central banks usually simply gets "paid back" with newly issued bonds.

"4) What does it mean when the central bank pumps in liquidity? Do they buy government bonds for money that doesn’t exist or do they give new loans to the banks?"

Usually it is done through so-called open market operations where they buy bonds and pay simply by expanding the value of commercial bank deposits at the central bank (which is part of bank reserves). They can however also borrow directly to banks, through what is called the discount window.

During the recent financial crisis, primarily the Fed but to a lesser extent also other central banks have launched countless new schemes aimed at boosting liquidity, something which has caused an unprecedented increase in the monetary base.

"5) Do all Swedish banks have the same reserve requirements? Where can you find information about that?"

These days, Swedish banks don't have reserve requirements in the old sense. Instead, regulators focus on capital adequacy according to the Basel accord approach, which is to say focusing on banks having sufficient capital in relation to the risk adjusted asset level. Read more on this in brief form in the wikipedia entries on Basel I and Basel II and for even more in the reference list provided in these entries.

11:03 PM  
Anonymous Per-Olof Samuelsson said...

Good idea! And congratulations on the growth of interest in your blog!

11:34 PM  
Anonymous Michael Boldin said...


Great news...I've read your blog for a while now, and in the past few weeks have decided to start submitting it to a number of social media sites...reddit, digg, propeller and stumbleupon.

I'm glad to hear that this has helped get at least a little extra recognition of your writing. Keep up the great work!

In liberty...

Michael Boldin

2:21 AM  
Anonymous vpatel said...


Thanks for your blog. My questions:

1) I am going to read Man, Economy, and State per your recommendation. You say you like the edition without the Power and Market section. Can you elaborate (is there something wrong with the Power and Market section)?

2) In your profile you say you largely agree with the Austrian school of economic thought. What are the main points, if any, that you disagree with the Austrian school on?

3) I've always wondered why LIBOR does not almost exactly track the Federal Funds rate. Both rates are market driven with influence from open market operations of the Fed. If the Fed buys Treasuries on the open market to drive and the Federal Funds rate does down, why wouldn't LIBOR also come down in parity? I understand that the Fed Funds Rate is the rate US banks charge each other for loans and the overnight LIBOR is the rate banks outside the US charge each other for US dollar loans. The banking system for dollars is fluid between US and non-US banks (right?) so how come there is this difference in rates?


9:02 AM  
Anonymous Pehr said...

Question: Do you know any Swedish books etc about Austrian economics? I have had trouble finding info about ASE in Swedish.


1:43 PM  
Blogger stefankarlsson said...

Per-Olof Samuelsson: thanks!

Michael Boldin: Thanks a lot for the help!

vpatel: With regard to P&M I have no major problem with it. I disagree with his consumption tax analysis in that section for reasons I explained here. But perhaps more importantly, it is a to a too large extent a repetition of the content in the last chapter of the original MES. Given how many extra pages P & M adds and so causes, the original good content that does exist hardly seems worth it to me. If you had unlimited time, then it would be worth it, but most students don't have that. But again, that is not really a great problem as people can always choose to postpone reading that part if they want to.

I don't have any significant disagreements with the Austrian school. I do however as stated above disagree with for example Rothbard on the consumption tax issue, and I further don't believe in the Austrian theory of fluctuating fiat exchange rates, which basically argues for an extreme Purchasing Power Parity-view, which says that exchange rates are always equal to their PPP. Given the often dramatic and erratic fluctuations I see on currency markets, I find that theory unrealistic.

As for the Fed funds rate and LIBOR, you're right that they should be the same as they're both forms of interbank loans. However, they refer to somewhat different forms of transactions. Fed funds rate is the rate at which reserve balances at the Fed are exchanged while LIBOR is the rate at which euro dollars are exchanged.

As Fed funds transactions thus involve banks exchanging reserve balances at the Fed and as the Fed is considered 100% safe, these transactions are also considered risk free. Interbank loans of euro dollar balances are by contrast not considered safe as there is a perceived risk of default. And so banks charge a risk premium in the interbank market of euro dollars.

Pehr: the only Swedish book about Austrian economics I know of is Johan Hakelius' Den Österrikiska skolan. It is fairly good, except that it is more focused on the Hayekian version of Austrian economics, instead of the Misesian version that I prefer.

4:43 PM  
Anonymous Per-Olof Samuelsson said...

Pehr: There is a book by Alexander H. Shand, called "The capitalist alternative : an introduction to neo-Austrian economics", that has been translated into Swedish. But I have not read it, and I think this, too, might be "hayekian" rather than "misesian".

10:01 PM  
Anonymous Per-Olof Samuelsson said...

And, btw, Hazlitt's "Economics in One Lesson" has been translated into Swedish under the title "Sunt förnuft i nationalekonomi". But this was in the 50s, and I think the book is almost impossible to get hold of today.

Also, two of Mises' books have been translated a long time ago. One is "The Anti-Capitalist Mentality" and the other one, I believe, is "Liberalism". But those, too, are hard to get hold of today.

10:35 PM  
Anonymous Pehr said...

Thanks Stefan and Per-Olof.

So, what is the main differenceses between the "Hayekian" viewpoint and the "Misesian"?


12:12 AM  
Anonymous Jason Aren said...


You have often stated that the U.S. is going to experience significant inflation in the near future.

Would you explain why you believe they won't face a Japanese-style 1990's deflation?


7:34 AM  
Anonymous Anonymous said...

Thank you for this forum.
Question: I've heard that the HK government is trying to defend the HK$ by buying the US$. In fact, the HK government has been buying UD$ every day for a month to do this. But it wasn't clear as to whether the action was to prevent the HK$ from strengthening or from weakening. Do you know what's going on? Do you foresee the HK$ de-pegging? And if so, what would happen? Should I continue to keep my cash in HK$ or US$?

9:43 AM  
Blogger stefankarlsson said...

Pehr, I've answered your question in a separate post.

Jason: Actually, I changed my short-term outlook on inflation a few months ago because I saw that money supply growth had ceased. But while I believe in deflation in the short-term, inflation will probably be revived in the medium term. The reason for that is that the Fed is determined to use all possible means to reignite inflation. And while deleveraging will probably prevent them from succeeding in the short-term, ultimately they will succeed as the quantity of base money just get bigger and bigger and as there will be less and less leverage to deleverage.

Anonymous: If the HK central bank buys U.S. dollars, this means they are supporting the U.S. dollar and trying to prevent the H.K. dollar from appreciating.

I don't think the H.K. dollar peg will disappear in the coming year or so, but in the long run it will be replaced by a peg to the yuan and later the H.K. dollar will be abolished and replaced with the yuan. When that shift happens a few years from now, the H.K. dollar will probably be stronger, so to the extent there will be any difference, the H.K. dollar is a better place to invest in. But again, it will likely be at least a year and probably several years until the current peg is dropped so in the short- to mediumterm it won't matter.

5:05 PM  
Blogger Flavian said...

Do remember that the HK dollar is not too much of a problem since there is no capital gains tax in Hong Kong. That means that you can invest in other currencies including gold and later return into the HK dollar and keep the so called profit.

Therefore I think that the people of Hong Kong will shift from HK and US dollars for long term investments.

Perhaps we will se the emergence of a gold-based private currency system in Hong Kong.

9:20 PM  
Anonymous Jason Aren said...

Stefan, thanks for your answer re: Japanese deflation. I assume this position also holds true for the deflation experienced during the Great Depression?

A second question: there has been much discussion regarding the infamous savings glut. My understanding of the counter-argument is this: China sterilizes dollar inflows (both investment and export purchases by Americans) by printing RMB. However, there wouldn't have been such a large dollar inflow had the Fed not kept interest rates unnatural low. So while the Chinese are helping to push U.S. rates down, the cycle was in fact started by the U.S. Fed.

Do you believe this is an accurate summary of the counterargument to the savings glut theory?

Thanks again.

11:06 PM  
Anonymous Akbar said...


What is your take on the argument that central banks are more likely to tame inflation in the current environment because of asset deflation and de-leveraging compared to the 70s when asset prices were not inflated and the debt ratio was low?


1:28 AM  
Blogger Martin Rojko said...

Hi, Stefan, I´m happy to see your blog to grow. Thanks for QA, here´s another:

I´m interested in your opinion as regards the impact of joining eurozone in Slovakia. Could euro protect economy from problems? Woudn´t be better to face current (and future) situation with own currency? Especially when depression will arise fully in eurozone? What about Czech republic, which don´t want euro too much and soon...

11:47 PM  
Blogger stefankarlsson said...

Akbar: that view is certainly correct in the short-term. We see now how deleveraging is having deflationary effects that are canceling out the inflationary effects of monetary policy. But as I explained above, eventually central banks will win.

Martin: I've written in more general terms about the issue of monetary unions here. In brief, monetary unions are generally preferable to smaller currency areas as they boost trade and protect you from the kind of erratic exchange rate fluctuations we've seen in recent months, but if an independent monetary policy would be sufficiently sounder than the one in the monetary union, then it might be preferable after all to have an independent monetary policy.

The latter could be an issue later for Slovakia who with its high growth rate could be more willing to pursue sounder policies than the ECB with its many weak economies. With the current turmoil, the risk of a bubble being created in Slovakia similar to the one in Ireland looks small, but it could later be a problem.

I am not sure about why there is much more skepticism in the Czech Republic than in Slovakia, but it could perhaps be the fear that ECB policy could be too loose for them and so create a bubble like in the case of Ireland. In other cases I suspect it is simply a matter of nationalism.

4:09 AM  
Anonymous Pehr said...

Thank you for the answer on the Mises/Hayek-question!

What currency/currencies would you recommend to invest in for the medium and long term now and why?


7:36 PM  
Blogger Acton. said...

I have a question,

What, in your opinion, caused the Great Depression? Do you subscribe more to Friedman's Great Contraction Theory or Rothbard's?

9:24 PM  
Blogger stefankarlsson said...

Pehr: In the really long run, I think the Japanese yen and Swiss franc will perform better than others because they have structually lower inflation.

I am less certain about the medium term. The Japanese yen have risen so much so fast that it could siffer in the coming years, although its safe haven status could push it even higher for the next few months as the financial crisi continue. Once this crisis is over, which will hopefully (although that is not certain) be in 2010 a lot of currencies that have suffered greatly will probably recover significantly. That incluses for example the Swedish krona, the Aussie and New Zealand dollars and the South Korean won. The Polish zloty also looks interesting, assuming the financial crisis ends before Poland starts joining the euro.

Acton: Given that I recommended Rothbard's book "America's Great Depression" in the reading list it should be apparent that I am closer to Rothbard's interpretation of it.

10:28 PM  
Anonymous Jason Aren said...

Re: Rothbard's versus Friedman's analysis of the Great Depression, what would you say are the biggest differences? I have read Rothbard's book, but have not yet had a chance to read Friedman's opus.

6:48 AM  
Blogger stefankarlsson said...

The difference is basically that while Rothbard thought that the main cause of the Depression was the inflationary excesses of the 1920s, Friedman claimed that no inflationary excesses existed during the 1920s and that the main cause was the monetary deflation during the 1930s caused by bank failures. In short, Rothbard blamed monetary inflation while Friedman blamed monetary deflation.

In addition, both agree that various other policies by Hoover, such as increased government spending and taxation, higher tariffs and wage controls aggravated the downturn.

7:56 AM  
Anonymous Pehr said...

Hello again, Stefan!

Today at our finance lecture one student asked the teacher the following question:

"Is there any negative effects for the economy by a banning short selling?"

And the teacher answered by saying that he didn't know or couldn't think of any negative effects by doing this.

My instinct though says that a banning of short-selling is NOT good for the economy but I cannot explain why. I don't have any arguments except that it interfers with the free market.

Do you have a better answer on this question?


6:07 PM  
Blogger stefankarlsson said...

Pehr, I have answered your question in a separate post.

11:30 PM  
Blogger Acton. said...

What's your opinion on the Card+Kreuger piece on the minimum wage?

12:47 AM  
Anonymous Mattias Karlsson said...

Perhaps not a question but a wish for your opinion.
What is your view on linking external effects to the economy like climate change, loss of biodiversity, loss of ecosystem services and polluting air, water and land for exampel ?

9:55 AM  
Blogger stefankarlsson said...

Acton, The Card-Krueger study had a pretty sloppy methodology of calling employers and asking them what they planned to do. A better approach would have been to look at actual employment.

Their conclusion that minimum wages do not destroy jobs is even more misleading, although given how low the minimum wage is in America, I don't think an increase of 20% or so would cause any significant damage, but it would on the other hand not mean much wage increases either.

Mattias Karlsson, I don't think "climate change" should be considered a problem. With regard to external effects in general, if it can be shown that property rights are violated, then that is a problem and that should preferrably be handled in civil trials.

8:49 PM  
Anonymous Mattias Karlsson said...

Hi again

I don´t think you really answered my question.
For exampel in Sweden we have 16 environmental tragets, should we fullfill them or take the tragets away ?
Property laws is impossible to use on the big isssues, biodiversity loss, climate change and ecosystem services.
So how do you think we should link them to the economy ?

9:23 AM  
Anonymous Anonymous said...


Assume a country where the head of Fed, Mr Austin Ryan, is a staunch Austrian. The goal of Fed set by the politicians is longterm, stable growth. Mr Ryan may use the instruments of the Fed as he sees fit (dismantling the Fed is not one of those instruments). What would Mr Ryan do?

5:27 PM  
Blogger stefankarlsson said...

Mattias, targets that does not involve the protection of property right, including biodiversity and climate change should be eliminated.

Anonymous: I'd say Ryan should try to mimick the situation without a central bank as far as it is possible (I don't think it is possible to do that perfectly though), and that means primarily limiting money supply growth to the kind of level we would have under a gold standard, i.e. 0-2%

5:58 PM  
Blogger Acton. said...

Theres something wrong with this:


I can't quite put my finger on it.

can you help?

11:12 PM  
Anonymous Akbar said...

what are your thoughts on performance of gold in a deflationary environment? In theory, it shouldn't be good. since it's a physical asset and cash should buy more assets tomorrow than today.

3:05 AM  
Blogger Matthew said...

Could you comment on this analysis of the dollar's recent strength:

The enormous debt overhang (dollar denominated debt obligations that are far in excess of the number of dollars that exist to pay them off) creates tremendous upward pressure on the dollar during deleveraging. This is because unwinding debts requires dollars to pay them off, and the demand for dollars to do so far outstrips their supply. This explains simply and elegantly the recent strength of the dollar. The question for the strength of the dollar in the short term is, will Bernanke be able to stay ahead of the curve in expanding the monetary base? Obviously he was behind the curve for a while (hence the strength of the dollar), but there is recent evidence that he may have at least caught up with it, if not gotten ahead, as the dollar has been relatively flat for a month.

My very brief thoughts added on: Since the debts are pyramided via derivatives (hundreds of trillions of dollars worth), and the obligations get larger as you go up, there is the possibility for explosive unwinding and a hysterical runup in the dollar before a stupendous crash. Jim Rogers has hinted at this as well, although he did not explain his comments. A lot hinges on whether or not Bernanke can monetize these debts as fast as they unwind. My guess is that he will probably be lulled into thinking that his "liquidity injections" are working, get cautious, get behind again, start pumping with renewed vigor, shampoo, rinse, repeat. How many times this occurs, I don't know, but the whole thing is about as unstable as you can possibly imagine.

6:15 PM  
Anonymous Anonymous said...

Two questions:

First -
Several comments above, Jason Aren gives his analysis of what is behind the "savings glut." Do you believe his description is accurate?

Second -
The Federal Reserve now pays interest on reserve holding. This seems counterproductive as banks have less reason to lend to each other. Is the point behind doing this to make banks loan more to businesses and consumers? Or is it because the Fed wants to inject liquidity only to specific companies or financial institutions without impacting inflation (as much)? Or something altogether different?

1:33 AM  
Blogger stefankarlsson said...

Acton, yes you're right that there was something wrong with it, but as you have probably already noticed I commented on and refuted it here.

Akbar, on the one hand deflation in itself should lower gold for two reasons. In addition to generally decreasing the value of everything (including gold) relative to paper money, it will also lower demand for gold as an inflation hedge.

On the other hand, if deflation cause nominal interest rates to fall then the opportunity cost of holding gold falls to, which increase the demand for gold.

Matthew: yes, deleveraging was probably one of the factors behind the dollar rally. Another factor was as I described before central bank purchases. Then there is yet another reason that I will soon elaborate upon in a separate post.

I think however that you greatly exaggerate the value of those bets, as these tens of trillions of dollar numbers involve multiple double countings. For example, if you have a debt of $1 billion and it is insured away with a CDS and the issuer of the CDS then sells it to someone else wholly or partially then the total notional values of these CDS' will be tens of billions of dollars even though the actually aggregate potential loss is just $1 billion.

Anonymous: Thanks for pointing out that I forgot to answer Jason Aren's argument about the savings glut. And yes, I do think it is largely correct.

As for the reason for the Fed to pay interest, it is reportedly that they want greater control over interbank interest rates. By paying interest rates on reserves, they set a floor on it.

Another unofficial reason is that they likely want to subsidize the banking system.

9:41 PM  
Anonymous Anonymous said...

In recent FT article Martin Wolf stated that the world has a $350 surplus with itself (i.e., total size of surpluses exceeds that of deficits). Could you comment on that? Aren't surpluses and deficits supposed to cancel each other on an aggregate basis?

3:47 AM  
Anonymous newson said...

first, my link to the fed "H8" table on commercial bank lending seems to end at nov 28. i'm using http://www.federalreserve.gov/releases/h8/Current/
is this the same page you access?

second, i'm still trying to pin you down on naked as opposed to covered short-selling. it seems to me an important distinction and you didn't address it in the recent post.


3:53 AM  
Blogger Celal Birader said...

Hello Stefan,

Q for you, my friend :

We read that China has actually devalued the RMB.

While at the same time the YEN is appreciating.

First, can or will these two trends continue ?

And if they do, what will be the implication for the Asian region and also for the world economy ?

Thank you in advance for your response,

2:38 PM  
Blogger earth that was said...


This is not an "Austrian Economics" question just a plain old economics question.

In the recent bust I have heard some resurrection of the idea that prices and wages need to kept up in order to maintain demand.

The idea is that wage cuts in particular lead to lower spending, less demand, hence lesser employment etc.

I am familiar with the micro-economic argument against minimum wage laws etc. What counter arguments exist for this particular point? And have there been any empirical tests or historic examples we can point to either in support or opposition?

11:32 PM  
Blogger stefankarlsson said...

Anonymous: I don't know if Wolff's exact numbers are correct, but it is no doubt often the case that the world according to official statistics has an aggregate current account surplus or deficit. This is of course impossible (unless we start trading with space aliens) in reality, so it instead reflects a so-called statistical discrepancy, problems related to data collection problems.

Newson: of course the data end on November 28, because that was the date of the last weekly release (though by the time you and most others read this, a new weekly release will have been posted).

As for naked shorting, I do find the practice dubious as it means that the short sellers sell something before he has it or will ever have it. But while not good for that reason, I don't think it does much damage.

Celal: The yuan devaluation was extremely modest (just 0.5% against the USD) and the yuan has in fact risen in recent months against nearly all currencies except the USD and the yen.

The yen will probably continue to rise as long as the financial turmoil continues, while the yuan will likely stay roughly unchanged against the USD.

The stronger yen and other trends will cause Japanese price deflation to become relatively significant, while at the same time making Japanese companies increasingly uncompetitive.

11:44 PM  
Anonymous Anonymous said...

I was wondering why the Swedish household saving rate is so much higher than that in it's neighbouring Nordic countries.(http://micpohling.wordpress.com/2008/11/26/household-saving-rates-1990-2008-nordic-countries-denmark-finland-norway-and-sweden/).Is it a matter of interest rates, a consumer/housing boom, taxes or the state actively promotes saving? What really determines the saving rate?

2:53 AM  
Anonymous Anonymous said...

Going Off the Gold Standard

I have seen several blog posts and articles by economists that state that during the Great Depression, the countries that were the first to go off the gold standard also recovered first (examples being several nordic countries and the UK.) Some writers attributed this to an increase in exports due to currency devaluations relative to gold and thus the currencies of countries still on the gold standard.

What would be the counter-argument to this theory?


8:44 AM  
Blogger stefankarlsson said...

Earth that was: I answered that question in that I told you about in my recent post on Krugman and wage cuts.

As I put it in that post:

"Finally, I should mention one objection that I know many Keynesians will be thinking about, even though Krugman didn't mention it, namely won't lower real wages lower the purchasing power of workers and so reduce demand? That lower real wages will lower worker's purchasing power is true more or less by definition, and it is certainly likely that workers whose only income is their wage/salary will reduce their demand. But since companies and their owners will experience reduced losses/higher profits, their demand will increase. Moreover, in a situation where pay cuts can boost employment, this is not simply a zero sum game, it is something which will boost total production and demand as new workers will get jobs and so will also receive an income."

And no, I am not familiar with any statistical studies on this subject. But it was the case in all slumps before the 1930s that wages were relatively flexible. That did imply that while unemployment did temporarily spike because of monetary contraction after bank failures, it quickly fell as wages soon adjusted.

"Anonymous 2:53"

I'm not sure that chart is correct as official Swedish statistics says the savings rate was a lot lower, particularly for 2005 and 2006.

"Anonymous 8:44"

Well, that theory is probably actually correct in the sense that monetary inflation after a period of monetary deflation did produce a short-term upswing. But that doesn't mean that the long-term effects of new inflation were good as it helped sow the seeds of a new crisis. The only permanent positive effects it could create would be by lowering too high real wages in a hidden way after government intervention had prevented sufficient reductions in real wages in the more open form of nominal wage cuts.

11:13 PM  
Blogger Celal Birader said...

Hello Stefan,

I have been trying in vain to find a table showing the daily movements in the USD Index (DXY)for as far back as i can go.

Failing that, i tried to generate the numbers myself. So i managed to find the formula (HERE).

Then i tried to input the various components into the formula i generated my own table (HERE).

As you can see for yourself, the numbers i generated in my table vary quite significantly from the actual DXY.

When you have some time, could you please have a look and tell me where i am going wrong ?

Or to save us all a lot of trouble, could you direct me to any site on the internet where these historical numbers can be found please ?

Many Thanks !

9:40 AM  
Blogger stefankarlsson said...

Celal, I am not sure which index you refer to, but the Fed has on its web site daily data over several different dollar indexes on its web site.

5:41 PM  
Blogger Celal Birader said...

Brilliant !

THIS is precisely the one i was looking for.

Many Thanks Stefan.

12:31 AM  
Anonymous Daniel said...


I wonder if someone here has read "An Introduction to the Theory of Value on the Lines of Menger, Wieser, and Böhm-Bawerk" (William Smart, 1895) and if it is worth buying the book?

7:50 AM  
Anonymous Anonymous said...

Why is the actually Fed funds rate below the amount the Fed is paying on reserves?


11:51 PM  
Blogger stefankarlsson said...

Daniel: Sorry I haven't read that book, so I can't answer that question. But if any other reader has read it, they're welcome to comment.

Anonymous: Well, as I understand it, the interest rate on reserves is linked to the official target rate, while the effective rate has been systematically below the target rate for nearly 3 months.

Why the Fed keeps the official target rate much higher than the one they appear to target in practice is a good question. I am not entirely sure about that, but I suspect that it could in fact be linked to the reserve interest rate question. The Fed wants to flood the banking system with money, and that requires pushing down the effective rate to today's level of 0.10% to 0.15%. At the same time they want to subsidize the banking system by paying them interest, but that requires that the target rate stays well above 0.15%.

8:01 AM  
Anonymous Anonymous said...

Re: effective Fed funds rate -

Sorry if I don't fully understand your answer (or perhaps my original question was unclear) but why would a bank loan out reserves at an interest rate that is less than what they could earn by keeping the reserves at the Fed?

Thanks again.

8:49 AM  
Anonymous Akbar said...

Re: effective Fed funds rate

I note that only depository institutions earn interest on excess reserves, non-depository institutions (e.g., Freddie Mac o Fannie Mae) do not earn interest on theirs. If the effective rate is lower that target rate, banks can buy the funds from say Freddie or Fannie at below target rates and earn a profit on excess reserves. Interest on excess reserves encourages buildup of reserves, and the spread earned by banks (target over effective)helps bank recapitalization.

1:18 AM  
Anonymous Anonymous said...

Dear Mr. Stefan Karlsson,

I found you on Mises.org and then followed you to your blog. I wonder if you have time to provide you opinion on something?

I'm currently jobless and tired of swimming upstream (i.e., trying to find employment in sectors where jobs are disappearing). I've done my own property tax appeals in the past and am now thinking about starting my own one-person property tax appeals/reduction business, to help property owners who are paying taxes based on property values from the last few years (higher than today's values). I think this could be a good business model for at least a few years but my concern is that I don't really understand how the eventual inflation will affect property values.

Will property values/prices continue to decline (in both real values and nominal dollars) or will they decline in real value but increase in nominal dollars, thereby causing property tax appeals to be non-applicable in the long term?

Will inflation affect values of income-producing properties differently than values of housing and land, going forward? It seems to me that it’s possible that values of non-income producing properties could stay low but values of income-producing properties could rise because rents will increase with inflation but fixed mortgages will remain low, increasing cash flow and therefore value. But, I’m not confident that I understand it well enough to bank on those assumptions.

Thanks in advance for any insight you can provide.

10:21 PM  
Anonymous newson said...

dec 12, bob murphy posted an article on mises.org with an attempt to link greenspan empirically with the housing bubble.

in his musings, he's used a 10% figure for bank reserves. that seems way to low, given sweeps. lucas engelhardt has done some numbers to arrive at a much higher figure.
any thoughts?

7:30 AM  
Blogger stefankarlsson said...

Regarding the housing market, house prices will have to fall some more before things will turn around. That means primarily real house prices. Because I believe that general price inflation will be reignited, the decline in nominal terms will be smaller.

I'm not sure of what you mean by income producing property, but assuming you're talking about commercial property like malls and factories, then they have a longer way to go before they bottom than residential real estate. The reason for that was that while residential real estate peaked in 2006, commercial real estate continued to boom into 2008. They have thus barely begun their adjustment.

Whether or not monetary inflation has a greater effect on residential or commercial real estate depends on the specific circumstances of each period of time.

Newson, sweeps actually means that the reserve figure is lower. The whole point about sweeps is to enable a larger quantity of deposits for a given level of reserves, thus lowering the reserve ratio.

8:31 AM  
Anonymous Akbar said...


There is a view in the market that the unfurling worldwide recession is going to hit the trade surplus countries harder than the trade deficit countries inasmuch as the unustainable global imbalance of payments is bound to be adjusted. To the extent such a scenario is possible and even likely, would you agree that generally it would not bode well for currencies of surplus countries, such as yen or swiss francs among others?

3:30 AM  
Blogger stefankarlsson said...

Akbar-I don't think surplus countries will be hit harder. Remember, most of the countries with bubbles have been deficit countries, like the U.S., the U.K. and Spain and as they are "ground zero" in this crisis they will be hit hardest.

The surpluses of the surplus countries could in fact be used to finance higher domestic spending in those countries, thus compensating for any reduction in net exports.

In practice, that will be difficult though, which is why surplus countries will be (and already have been) hit too. But deficit countries will usually be hit hardest.

8:50 AM  
Blogger Celal Birader said...

Hello Stefan,

I have a two part question.

As far as i am aware Japan did not experience large amounts of inflation during its time of "quantitative easing", is that right ? How come ? It seems counter-intuitive.

Also, as Bernanke is about to embark on this, how will the experiment likely differ from that of Japan since unlike Japan, the USA has huge trade and budget deficits ?

Many Thanks.

2:34 PM  
Anonymous Arthur Burns said...

Care to comment on how sound the reasoning at How Deflation Creates Hyperinflation is from an Austrian perspetive? Thanks.

12:17 PM  
Blogger stefankarlsson said...

Celal, the reason why the Japanese "quantitative easing " failed to produce significant inflation is simply that it was too limited in its quantities. Had they adopted proposals to for example finance the budget deficit of more than 10% of GDP directly from the printing presses, inflation would have eventually resulted.

And that offers a clue to the answer of your second question, namely that the reason to believe that Bernanke will be more successful is that he will inflate a lot more than the Japanese ever did.

Arthur, the reasoning appears to be mostly sound, though I would rather say that the increase in velocity is a result of previous monetary inflation. The higher price inflation will lower money demand, which in turn causes price inflation to rise further in an inflationary spiral.

5:11 PM  
Anonymous Arthur Burns said...

Many thanks for your answer to the previous question. Here's another one for your consideration (apologies for the length):

I am getting a tad dispirited by the vacuousness of the common reaction to attempting to explain and discuss the economic crisis from an Austrian (or even free-market) point of view. The knee-jerk response I inevitably encounter is incredulity at the thought that the entire mainstream economic establishment (and the talking heads on TV) could somehow be this blatantly wrong, as well as accusations of arrogance in thinking that I could possibly know better than the highly-educated and highly-respected mathematical wizards (Bernanke et al) running the show.

(In other words, the usual argument from established authority, aka "I have no historical perspective and have abdicated my brain to the powers that be".)

Well-reasoned articles from websites such as Mises.org or your blog are dismissed with hardly a glance as being the rantings of "outliers". The Wikipedia entry for the Austrian School is mindlessly (and over and over again) referenced as "proving" that the discipline is "unscientific" (oh, the irony).

I've tried reminding people that scientific truth isn't established by consensus, that no amount of scientists subscribing to the Flat Earth hypothesis will make it true. I've tried pointing out that I don't need to have memorized all the "begats" in a particular religion's Holy Book in order to dismiss its axioms, built on mere wisps of fancy; nor do I need to prove any competing theory (such as Austrian economics) in order to be able to tear down a defunct one.

I've tried explaining some of the most obvious epistemological flaws underlying mainstream economics: the futility of trying to emulate the physical sciences in a social science, the absurdity of believing that human action can be reduced to or predicted by mathematical formulae, the stupidity of believing that (say) emergent order in fluid dynamics in any way qualifies similar statistical models for use on human societies, the abysmal track record of quantitative methods (including the Long-Term Capital Management story), and the intellectual bankruptcy of logical positivism as an explanatory framework for inferring and differentiating causes from effects.

Now, it may be that I'm simply barking up the wrong tree; I suppose questioning and rejecting orthodoxy might take a certain, ah, aptitude of the mind that perhaps atrophies if not exercised early on in life. (Objectivists would no doubt smack me on the head for trying to talk any sense into what they might regard as "second-handers".)

But if you think this subject isn't wholly hopeless, I'd love to see more blog posts (in common-sense language) on the *justification* of rejecting the self-serving, ivory-tower group think that passes for mainstream economics today. It would also be most fascinating to hear about any actual real-life experiences you may have had in helping people go from blindly trusting the so-called "experts" (so callously playing with not just our wallets but our very lives) to relying on their own head and common sense (for starters).

In addition, it would be great to try and throw some light on what the belief system of a mainstream economist must be like, as yet another objection encountered is that they'd have to be either "evil" (implying some form of "conspiracies", I suppose) or "stupid", both which seem implausible, to be following the theories and policies that they do. Now, knowing enough about the history of science and about academic tenure I personally have no problem with just plain "misguided" and/or "deluded", but your perspective and insight on this would be very interesting.

(Additionally, somebody really ought to write an up-to-date and well-researched online pamphlet titled "The Numerous and Endless Failures of the New Economics", but I'll try and limit my wishlist to something borderline reasonable... this was a tall order as-is ;-))

Tackar och bockar... and happy New Year!

5:47 AM  
Anonymous Anonymous said...

Hello Stefan,
I was wondering why real wage growth has been so low(or even negative) in Germany and Japan. These two countries have large surpluses and their companies have huge savings. Is there any connection with their demographic situation(high median age, falling population) or this phenomenon was caused by the absence of a housing bubble and a credit fuelled consumer boom?

2:40 PM  
Blogger stefankarlsson said...

The main reason for weak wage growth in Germany and Japan is weak productivity growth especially in Japan as well as weaker bargaining position for workers. In Germany unions have become weaker and more restrained while various reforms have boosted labor supply, causing their bargaining position to weaken. This has limited real wage growth, but boosted profits and employment. Similarly, in Japan worker's bargaining position has been weakened by the increased share of lower paid non-regular workers. Japan has also suffered from deteriorating terms of trade as it faces fierce competition from other Asian countries in for example consumer electronics, something which has limited real income growth in Japan.

The absence of a bubble has however not played any role. In fact, bubbles would have further increased the relative share of profits during the boom, while damaging long term productivity growth.

6:38 PM  
Anonymous Thomas Nyberg said...

Is it correct to understand the current falling prices as mostly just an effect of the deleveraging ("forced liquidation") associated with the bust in this business cycle, and not deflation in any monetary sense?

If so, that presumably means that prices aren't actually falling in aggregate, even if it seems to the common man that they are dropping overall?

You did write about a brief contraction of MZM in October, but I suppose its effects would be minor compared to the deleveraging?

What I'm most confused by is the price of oil; was there a bubble in oil (and commodities in general), or is there another explanation for the fall of oil prices?

10:49 AM  
Anonymous newson said...

hi stefan.
the fed's h8 table shows commercial banks' credit, but what about non-bank credit (syndicated loans etc.)? is this not to be considered in evaluating the "credit crunch"?

4:55 AM  
Anonymous Anonymous said...

Hi Stefan,
I read your article with great interest. I have a very specific question for you:
I live in Canada, 1 hour from the USA. Given your knowledge of the fall of past empires in the world, and your predictions for the fall of the US empire, how do you think Canada will be affected? I have
considered some scenarios which might seem positive for Canada, and some negative. Perhaps some of both? Could you give me any specific and general predictions on what this inevitable collapse of America will mean for Canada? Also, since you're in Europe, do you think it would be wise for me to move my family to Europe if the opportunity comes up?

Keep up your great work.


10:54 AM  
Blogger stefankarlsson said...

Newson: of course it sgould be included as well. The trouble is that statistics over total non-bank credit appears a lot less frequently than statistics over bank credit.

Terry: I'm not sure I have really claimed that the U.S. would necessarily collapse, just that it would fall into a deep cyclical slump, though the risk of a more permanent decline has certainly increased after the election of Obama as president.

Anyway, as for the impact on Canada, it is more dependent on the U.S. than all other rich nations (unless you count Mexico), so Canada will certainly be dragged down by any U.S. decline. Canada could however in a longer term to some extent decouple if China again starts bidding up the prices of Canadian commodities and/or if it pursues sound policies.

As for moving to Europe, it should be noted that many European countries also face difficulties. If you're going to move somewhere, Slovakia looks promising. If you want an English speaking country you have only the U.K. and Ireland to choose from. Of those two, Ireland looks best.

11:15 AM  
Anonymous newson said...

does the us government (fed?) release these non-bank credit figures, or is this an industry function?


3:34 AM  
Blogger stefankarlsson said...

Newson: The only statistical source on all non-bank credit in the U.S. is the Fed's quarterly "Flow of Funds" report. They are published the third month after the end of the quarter which it describes (December for Q3, March for Q4 and so on).

However, there are industry statistics for some specific forms of non-bank credit which are published sooner, but which again only describe limited parts of the credit market.

9:22 AM  
Blogger Celal Birader said...

Newson: The only statistical source on all non-bank credit in the U.S. is the Fed's quarterly "Flow of Funds" report. They are published the third month after the end of the quarter which it describes (December for Q3, March for Q4 and so on).

Hello Stefan, Can you please post a link to this report ? Many Thanks

Also just a couple of comments on Newson original query regarding syndicated loans :

First, i would suggest that the BIS in Switzerland might have statistics re syndicated loans (and if you find that link can you kindly post it here).

Second, since these loans are often structured by and include banks from a wide range of countries (and currencies?) is it correct to surmise that it might muddy the waters if one were seeking to determine the total amount of credit in any one currency --- or would it ?

12:27 PM  
Blogger stefankarlsson said...

Celal, here is the link to the Flow of Funds report.

5:11 PM  
Blogger goo8734 said...

Hi Stefan:

I would love to hear your thoughts on this article by John Cochrane:


Also, on a side note Cochrane made some Austrian-like comments that caused Krugman to restate his anti-hangover theory again recently.

Thanks again,

10:47 PM  
Blogger stefankarlsson said...

Jeremy, the point of the article appears to be that somehow the crisis is caused by too high risk aversion, and that this must solved by issuing government debt. And he prefers if the proceeds of that is used to buy more risky debt, instead of normal spending and tax cuts as it reduces the risk of inflation and permanently high debt burden.

I don't agree that the key problem is too high risk aversion, but he is right that this approach is probably easier to unwind than regular deficits.

4:30 PM  
Anonymous Dan said...

Stefan, I'd like your thoughts on this:
Is it possible that we are entering a new regime where bank reserves will be "permanently" (i.e. even after economic recovery) less leveraged than before the crisis began? Could that "lock-up" the current high level of reserves so that high inflation might not occur when more normal economic conditions resume?

5:20 AM  
Blogger stefankarlsson said...

Dan, yes I think reserves will be permanently higher simply because the Fed now pays interest on reserves, making it more attractive to hold reserves.

As for the effects on inflation, this will not necessarily limit inflation as long as the Fed accomodates this higher demand for reserves by expanding its balance sheet. Or in other words, while it means that money supply will decrease given a certain level of reserves, money supply could still increase if only reserves increase enough.

6:57 AM  
Blogger goo8734 said...

Stefan: what's your view on this krugman piece (and the "dark matter" pieces he links to)? I believe you have discussed this issue before: how to explain the persistence of the US trade deficits. I also remember you discussing the returns of US investments abroad versus investments by non-US citizens in the US. Also does this all imply a sudden collapse in the US dollar once world interest rates start to rise again?

Link to Krugman Piece

Thanks again!

5:11 AM  
Blogger stefankarlsson said...

Jeremy, there was no such thing as "dark matter". What this reflected was that Americans as a group to a larger extent held high yielding assets such as equities than non-Americans, something which produced gains for Americans, an effect re-inforced by the weak dollar. However, in 2008 with the large equity sell-off and dollar rally, Americans lost more than others because of this. And that is what I believe Krugman and the economist he linked to argued too, so I basically agree with him on this issue.

As for the dollar falling in value when interest rates rise again, that depends on whether America will start raising them faster or slower than other countries.

7:38 AM  
Blogger Celal Birader said...

Hello Stefan,

Can you please post the link to the official U.S. government site listing the monthly increases in unemployment ?

Thank you

9:51 PM  
Blogger stefankarlsson said...

Sure, here it is.

10:21 PM  
Anonymous Chris G. said...

What do you think of Obama trying the "Swedish" approach to dealing with the US banks?

Could you explain how this worked out for Sweden and if it is worse than how the Japanese handled their banks during their crisis.


12:26 AM  
Blogger marc.van.den.bosch said...

What's happening with the SEK this last week? Anything out of the ordinary going on in Sweden?

11:25 PM  
Blogger stefankarlsson said...

Chris, I commented on the Swedish banking approach here. While not perfect, it is better than the approach Obama seems to be opting for now.

Marc, the SEK fell for 3 reasons: 1) Continued after effects from the unexpectedly large Riksbank interest rate cut 2) Global stock market sell-off led investors to flee small currencies in general 3) Increased worries about Swedish bank exposure to Eastern Europe in general and the Baltic countries in particular.

11:52 PM  
Blogger Pehr said...

I have a question regarding the so called bond-bubble. Some economists like Peter Schiff often talk about the bond market as bubble-market. The argument is that many people sell of their stocks etc and puts the money in government bonds, and this would lead to a bubble.

I have very little knowledge about the bond market so could you explain in detail what he means with that? How does the bond market work, what makes it a bubble and how/why will the market in that case collapse?

I also would like to have an explanation of how the following funds:

These funds are investing in mostly government bonds, right?
How is it possible that they have given a return of between 7 and 11 percent since the beginning of 2009?

I've also read a lot about commodities and I've been listening to Jim Rogers who's very bullish on commodities.
What's your view on commodities and if I want to invest in commodities, how do I do? The Swedish banks doesn't have much to offer when it comes to commodities. Right?

And finally, where do you invest your own money today?

Thank you in advance

2:50 AM  
Blogger stefankarlsson said...

Pehr, the explanation for the high return is very simple: They invest in foreign government bonds, and because most currencies have risen against the SEK, return in terms of SEK will be high.

As for commodities, I am bullish on them in the medium to long-term, and while I think there is a good chanse of them rising in the short term too, that is less certain.

As for how you invest in them, I think you should ask your bank or broker for more on this, but one option would be Jim Rogers fund.

As for your last question, I have a strict principle of not answering personal questions, but if we reformulate the question into what I recommend, gold is something that I like. And as I indicated in my reply to your question about commodities, I recommend commodities in general in a medium to long term perspective, though it is very risky in a short term perspective (so if you know you would find short-term losses intolerable, stay out them for now).

If you have debts, then paying off them might be a good idea in the short-term, since interest rates on that tends to be high.

9:57 AM  
Blogger Björn said...


When it comes to predicting and guidance..
To get the best general view of the state of the markets and the economies..Which are the most important overall indicators you recommend that investors should keep their eyes at??


12:56 AM  
Blogger stefankarlsson said...

Björn, there are several dozens of relevant indicators, but the most important are money supply, GDP/national income, CPI, current account balance and employment among statistical indicators, and commodity prices, stock prices and exchange rates among market indicators.

8:07 AM  
Blogger Celal Birader said...

Hello Stefan,

I have a question about mark-to-market.

I believe you already have posted something on this topic which made eminent sense and which i have not seen mentioned anywhere else in he blogosphere.

I hope i am not misrepresenting your view which i believe is that you suggested in one of your posts that discounted cash flow would be the best alternative for assets for which there was not a liquid market place. Is that correct ?

So why are the banks not being told to values these Level 3 illiquid assets in this way ?

Does it have something to do with allowing banks to maintain lending capital ratios ? If so, then perhaps the intention is to enable bad banks to lend more money. Am i on the right track here ?

But, if that is the case, then i sense this will not necessarily be successful since lending also involves another party : the borrower.

We know the household sector is de-leveraging. So that leaves the corporate sector.

Is there any reason to believe the corporate sector will increase their borrowing ? Are there any particular scenarios in which they would do so ?

2:31 PM  
Blogger Celal Birader said...

Hello Stefan,

What is you experience of the accuracy of forecasts put out by the OECD ?

For instance, HERE the OECD has GDP growth and unemployment forecasts to the end of 2010.

What do you think about their forecasting methodology ?

Is it possible, that they could be very wrong with their unemployment forecast and that it could be higher than the 10% they are forecasting?

Is it probable that unemployment could even go to 25% as it did during the Great Depression ?

Thank you in advance for your kind response.

10:13 AM  
Blogger stefankarlsson said...

Celal, I am not sure about how it is done in American banks, but the standard practice in Swedish accounting is in fact to use discounted cashflow where market values are unavailable. That would have been an appropriate valuation technique if that future cash flow had been known, but the problem is that we really don't know. Meaning it creates the possibility of overvaluing asset values through over optimistic assumptions about the future.

The main reason for overvauing assets is indeed to ensure that equity levels reach what regulators require them too. Although it can also be used to improve the ability to raise new capital from both shareholders and creditors.

As for the possibility of increased borrowing, I don't see much reason to increase borrowing for most companies except to cover losses.

I am not sure about but what exact forecasting technique the OECD use, but it appears that they use the standard forecasting technique of neoclassical economists: which is to say they simply expect the past to repeat itself. Which is why they didn't forecast the current slump before it was already a fact, and which is why they now think growth will relatively soon

They are far too optimistic about the unemployment rate, believing the U.S. unemployment rate won't rise above 10% until next year and will peak at 10.5%. It will peak at a much higher level than that. It probably won't go as high as 25% though.

1:01 PM  
Blogger Celal Birader said...

Thank you, Stefan.
Happy Easter, my friend.

6:55 PM  
Blogger Celal Birader said...

What is the difference between what is called 'the monetary base' and 'the money supply' ? If they are different things in what do they differ ? Thank you.

1:14 AM  
Blogger stefankarlsson said...

Celal, the monetary base is equal to currency in circulation + bank reserves. Money supply is equal to currency in circulation + bank deposits.

Or to put it another way: the monetary base is (in a fiat money system) all the money created directly by the central bank, while money supply in addition also includes money created through the banking system.

4:20 PM  
Blogger Celal Birader said...

Crystal clear. Thank you Stefan.

12:35 AM  
Blogger Metin said...

Would you pls comment on this? Thx

2:27 AM  
Blogger hajjen said...


What do you think about Mark Skousen’s and Jesus Heurta de Soto’s view that gross output (or gross national output in Skousen’s terms) is a better measure of economic activity than GDP?


11:25 AM  
Blogger stefankarlsson said...

Meti: The author of that article is right that a higher monetary base need not result in higher money supply if there is deleveraging, and that higher money supply need not result in higher prices if money demand also increases, and that this has so far limited price inflation.

Yet what is overlooked is that deleveraging and higher money demand will likely not continue forever and that unless the Fed starts to deflate (something which is unlikely as it would cause a short-term slump) price inflation will follow, and we have already seen the first signs of this in the form of higher commodity prices.

Hajjen: I don't like their approach since it involves too much double counting and therefore really doesn't make sense. What matters is the additional value created through transaction, not the nominal sum exchanged. Assume for example that a meat processing plant decided to split its slaughtering division and the division that turns the meat into meat products (like bacon, hot dogs or ham). That way monetary transactions between these two divisions would appear, yet surely no additional value has been created through this.

For GDP and national income this would be accurately recorded as no change in the value of production, yet the Skousen approach would record a dramatic increase in the value of production, even though nothing real has changed.

5:53 PM  
Blogger investmentgardener said...

I was wondering how you would rate the Latvian government's response to the current crisis against the austrian economics framework.

The latvians have run a current account deficit for a long time and are now faced with a crisis that would force most governments to opt for devaluation of the currency or printing more money. (e.g. UK). Instead they have opted to keep a currency peg to the euro, which given the tiny size of the latvian economy is as good as a gold peg. I have read accounts that people have been forced to accept huge pay cuts as a result (instead of facing much higher loan repayments). These range from 10% to over 50%.

Is the Latvian government doing the right thing at the moment? Would this be the reaction of a government that follows austrian economics and if not where do the differences lie?

11:22 PM  
Blogger stefankarlsson said...

Investmentgardener: I've now discussed this issue in a separate post.

11:37 PM  
Blogger vzeebjtf said...

I have read the argument that in a free market, with free banking, a limit on the ability of a bank to inflate its currency is the call for redemption of checks by other, full-reserve, banks. But if the value of checks drawn on inflating banks and deposited in non-inflating banks is more-or-less equal to the value of checks going in the opposite direction, then settlement involves only a small transfer of reserves, which wouldn’t seem to pose a danger to the inflating bank. I must be missing something, but I can’t see what it is.

Thank you very much for helping me to understand this.

6:41 AM  
Blogger Celal Birader said...

Hi Stefan,

Do you see the likelihood of the US Index breaking above 78 and going higher ?


2:05 PM  
Blogger stefankarlsson said...

vzeebtjf: I am not sure I understand your question, but usually bank inflation involves customers retaining the ability to use their deposits for payments while the funds are lent out. Usually that ability isn't exercised enough or counteracted by new deposits, but the crisis arises when a large number of depositors wants to use their right while few deposits arrive, creating a liquidity problem for the fractional reserve bank.

Celal: Since I am bearish on the stock market and since the USD has recently had a negative correlation with stock markets, this means that I expect the USD to appreciate. I can't say exactly how much, but it will appreciate.

10:02 PM  
Blogger vzeebjtf said...

Please let me explain my question by quoting George Reisman’s book, “Capitalism” (p. 515, first full paragraph):

Under free banking, “any granting of fiduciary media would place the customers of the banks that granted them in a position to expand their purchases from the customers of the banks that did not grant them, … because such customers would have relatively more money to spend.”

What does “relatively more money to spend” mean? What is being compared to what?

I have read that the same principle explains why, when gold is used as money in international trade, countries with more-inflated currency lose gold to those with less-inflated currency. I don’t understand that, either.

12:08 AM  

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