Tuesday, February 05, 2008

Yes, We Disagree

My response to Desmond Lachman:

Yes, we disagree on at least two points. I do believe there is a role for regulation however I think it needs to be very minimal. 1907 is actually a great example for both our cases. The panic of 1907 involved a real estate crash followed by two stock market crashes so it correlates well with today’s market conditions. It was also, in my opinion, a result of the National Bank Act (of what year? 1880 something I think?) and the Gold Standard Act of 1900 both of which were a result of lobbying by banking interests (primarily JP Morgan). So 1907 demonstrates a need for regulation but also demonstrates the need for caution. Regulations are often written to favor private entrenched interests (Morgan and Rockefeller in this case) and so one must be careful that regulation doesn’t stifle competition to the detriment of the consumer. Obviously, I have grave doubts as to whether regulations can be written that will not favor those with an interest in the outcome and the means to hire lobbyists by the dozen. I would also point out that the panic of 1907, as bad as it was, lasted less than a year and was ended by the same private interests who started it (again primarily Morgan - with an assist from Jesse Livermore).

1907 is also a good parallel to today for another reason – in both cases the cause of the crisis was monetary inflation caused by the banking system. Since the likelihood of changing our banking system, abolishing the Federal Reserve and adopting a true gold standard are exactly zero we are left to argue whether the Fed is charting the proper course given the system we have. The US economy has been marked by rising debt for a very long time and that is a direct result of a Federal Reserve that has too often opted for monetary inflation rather than suffer a temporary (and natural) slowing of growth. This will continue until debt has reached proportions that no longer allow for a further expansion of the debt bubble. Has that time come? I don’t think so. If you read my market commentaries, I have said that the Fed will be able to rescue us once again with monetary policy, but that doesn’t mean that they should. As an investment advisor, I am happy to spend my days trying to figure out where the bubble goes next, but as a citizen, I am distressed that we are merely putting off the day of reckoning.

You argue that a hands off approach by the Fed could result in a nasty and prolonged recession. I don’t think we are in a recession right now and have argued for some time that we won’t have an official recession from this housing and credit crisis. That prediction is based, at least in part, on my expectations of Fed action. However, from a long term economic perspective, maybe what we need right now is a nasty and prolonged recession. At some point we as a nation will have to pay the price for all this debt. Wouldn’t it be better to start the process now rather than wait until the debt burden is even larger than it now stands? As for the possibility of a lost decade like the Japanese or another Great Depression, I don’t believe monetary policy was the primary culprit in prolonging the pain in either case. On the other hand, I have very little faith that our politicians would act any differently than the politicians of Japan or FDR. They would take actions that would prolong the recession and do little to foster the recovery. They would interfere with the market and make things worse. The Japanese politicians spent most of that lost decade propping up failed banks and raiding the public treasury for questionable public works projects. They should have let the banks fail, de-regulated the economy (especially financial services) and cut taxes and public spending. Our politicians are already talking about extending unemployment benefits - with the unemployment rate at 4.9%. God only knows what they would propose if we had a nasty and prolonged recession. And that is, by far, the best argument for aggressive Fed action that I can muster.

Again, thanks for the response and rest assured that I will keep reading. I love a good debate….

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