Crack-up Booms

[doodle]

I'm am doing a little more reading about crack-up booms and came across this quote from Austrian school economist which I thought was relevant:

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crises should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

I think that this quote describes exactly the situation we find ourselves in today. The credit expansion bubble bursting of 2008 should see a natural deflationary situation form as we write off overvalued investments and find a new and lower base to build upon. Businesses and banks fail, assets are bought up for pennies on the dollar, wages decline in response to high unemployment etc. This natural tidal ebb and flow of prices that wants to find an equilibrium however is being interrupted by central banks. For example, the Fed chairman Bernanke the other day in front of congress stated that QE3 is definitely on the table if we see continued weakness in the system. Liquidity injections into the system might temporarily prop of asset prices and give people the illusion of productive economic activity but the Austrians contend that eventually the game must end at some point.

There is no question in my mind that there are a few ways out of our current situation..difficult..bad..and worse. Well, I guess it is possible for the Fed to walk the tightrope like a cirque du solelil acrobat and see us through this mess, but so far the true economy and unemployment has not responded to their monetary policy. From what I gather from Bernanke's testimony they are a bit baffled by what to do next as well.

What do others take from the quote above?

[MediumTex]

Von Mises' "Human Action" is available free online (that's where that quote came from).

I think the quote is simply an accurate description of reality.  Credit fueled asset booms of course must collapse sooner or later, since the money used to fuel the speculative bubble never even existed in the first place.

If you aren't aware, von Mises was very influential on Harry Browne's thinking.

[stone]

doodle, I think it is very easy to point out the stupidity of our system but much much harder to come up with politically acceptable alternatives. Under a gold standard system with fractional reserve banking, economic development got predominantly financed by credit creation out of thin air that was defaulted on. That created short sharp business cycles with people loosing their bank deposits and periods of mass unemployment but railways got built and sewers got laid etc. I also am not sure to what extent financing of the industrial revolution was dependent on the legacy of profits from the slave trade.
We now have a system that is supposidly granting us a permanent boom with unlimited backing behind endless credit expansion. The cracks do seem to be showing.
If the monetary system had no capacity to expand, then nothing could be done except at the discretion of money holders. Personally I wouldn't have a problem with that so long as every citizen was a money holder of roughly equal wealth. For such a system to come about, there would need to be a constant redistribution of wealth. My guess is that the political unacceptability of such wealth redistribution is what makes such a system unlikely. Under such a set up companies would probably have to be more like partnerships (such as John Lewis in the UK or New England Biolabs in the US). Rather than wages, workers would get a profit share. Prices would have to be very flexible and variable. Instead of banks, loans would have to come from institutions that would be more like present day venture capital funds.
If such a "hard money" system was in place without wealth redistribution, there would be a constant demand for credit money creation even if that were illegal. If credit money creation were successfully banned then some people would soon own everything and there would be no customers able to afford any goods or services anyone offered. Haiti would seem like an economic powerhouse in comparison to such a set up.

[doodle]

I think this offers a pretty good explanation of the dynamics that have the potential to overtake us if we don't allow natural deflationary pressures to take root: http://crackupboom.net/2009/03/what-is-a-crack-up-boom/

[doodle]

Good radio interview....all speculation of course  but in my mind an interesting and compelling argument: http://crackupboom.net/2011/02/marc-fab ... k-up-boom/

[doodle]

Reading very interesting Lew Rockwell article: http://www.lewrockwell.com/north/north600.html The primary purpose of gold in Rockwell's article is not to get rich during an inflationary bout (which would require timing a sell perfectly) rather it is to protect oneself against a crack up boom and thus have assets on the other end of the restructuring with which to buy more traditional investments again. In other words....to avoid being wiped out entirely.

Mises continued to describe the crack-up boom.

The characteristic mark of this phenomenon is that the increase in the quantity of money causes a fall in the demand for money. The tendency toward a fall in purchasing power as generated by the increased supply of money is intensified by the general propensity to restrict cash holdings which it brings about. Eventually a point is reached where the prices at which people would be prepared to part with real goods discount to such an extent the expected progress in the fall of purchasing power that nobody has a sufficient amount of cash at hand to pay them. The monetary system breaks down; all transactions in the money concerned cease; a panic makes its purchasing power vanish altogether. People return either to barter or to the use of another kind of money.
This is the end result of every expansion of money that is not halted earlier by the monetary authorities. But if they do call a halt, then there will be a recession or a depression. Mises described why in Chapter 20.
The problem is, central bankers and politicians are unwilling to accept this result. So, they reinflate. The march toward the crack-up boom continues.

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.
This is our present situation. The public still prefers the boom effects of monetary inflation to the recessionary effects of monetary stabilization.
But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against real goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.
We are nowhere near this yet. But this is the end result of a policy of monetary inflation.
What Mises described is a breakdown in the exchange economy. Once again, I cite him.

The monetary system breaks down; all transactions in the money concerned cease; a panic makes its purchasing power vanish altogether. People return either to barter or to the use of another kind of money.
This is the equivalent of a depression. It is an inflationary depression.

I think at the moment that we have passed through public preference for monetary inflation and will be experiencing the pain of the economic contraction again soon that come from our current desire for austerity. We will see how long that lasts with high unemployment though....  

The outcome of raising taxes and cutting spending will cause a further recessionary contraction which will lead to misery and more money printing to try to ease the effects. Bernanke said he would continue with QE3 if conditions warrant. There is of course still time to avoid a crack-up boom....it only requires us to take our medicine and deflate. The question is whether or not that is politically possible....and whether our current overleveraged government balance sheet can sustain a deflationary bout.

[MediumTex]

There is not time to avoid the consequences of a crack up boom.  It has already happened and all we can do now is watch as the effects unfold from the initial cause.

The time to do something about it was in 2003, which was probably the latest that something coud have been done to prevent the conditions we are now experiencing.

We have now locked ourselves into a 10-20 year period of economic unpleasantness (at a minimum).  You can probably start this time period in the second half of 2007, so things should start looking up some time between 2017 and 2027.

The best thing a clever person could probably do in this kind of environment would be to set up a PP, find a relatively politician-proof way of making a living, and watch the news as little as possible.

[doodle]

I'm not sure if you are being facetious or not...

I am pretty convinced that what you described is the path we are on.

You can see the evidence in the wrestling match between gold and long bonds.

Long bonds recognize that we are in a economically vulnerable period with deflationary pressures. Gold on the other hand recognizes that politicians and central banks aren't too keen on deflation and will print money to avoid deflationary depression.

Ultimately the fiat will lose the wrestling match unless politicians and central bankers accept that we need to deflate.

Ironically, gold in our current environment is protection against deflation because of the money printing it would engender. When George Soros sold his gold a few months back he was betting that the deflationary scenario had been taken out of the picture. I wonder if he regrets that now?

[doodle]

By the way, if you are convinced of what you write....why do you still continue to hold 50% of your wealth in an asset class that would be decimated by such a crack up boom?

By the way, I know that this discussion will eventually bring up the question of "What about Japan". I thought that this was a very insightful read:
http://spikejapan.wordpress.com/2011/07 ... scal-mess/

According to the writer we can pick our flavor:

Essentially, there are four ways out of the dire fiscal holes that Japan and many other advanced economies have dug for themselves. The first is growth, which is what saved Western Europe and the US after World War II, during which they ran up liabilities so astronomical they make today’s debt mountains look like molehills in comparison. Sadly, as practitioners of the dismal science like to remind us, growth is not a policy option, and no one respectable expects Japan of the future to limp along at much more than 1% trend GDP growth. The second, as Mauldin says, is to monetize the debt, to unleash the power of the printing presses—and not all fiat currencies have yet trodden the same path to hyperinflationary Hades, as he seemingly believes. The third, and best, is to try for fiscal consolidation—taxes are not “already very high”?, they are relatively low: Japan ranked 25th out of 33 OECD countries by general government revenue as a percentage of GDP in 2009. Relatively low tax rates and relatively high rates of tax compliance, as shown by the modest underground economy (smaller by some calculations than in any major economy except Switzerland and the US) raise hope for consolidation, as does the general lack of corruption: according to Transparency International’s Corruption Perceptions Index 2010, Japan ranks 17th out of 179 countries, above the UK (20th) and US (22nd), while Italy is 67th, just below Rwanda, and Greece is 78th, equal with Colombia. The fourth way out, of course, is default.

[Gumby]

By the way, if you are convinced of what you write....why do you still continue to hold 50% of your wealth in an asset class that would be decimated by such a crack up boom?

Because MT knows that his crystal ball may be cloudy. If he knew what the future held, he wouldn't need a PP.

Doodle, Why constantly worry about the worse case scenario when you know that you could be entirely wrong about what our future holds? What's the point?

And, if you're so convinced that we are headed for a horrible demise, then why aren't you already living in a bunker?

[MediumTex]

By the way, if you are convinced of what you write....why do you still continue to hold 50% of your wealth in an asset class that would be decimated by such a crack up boom?

Because what we are describing could play out over 5 or 50 years, and there will be unexpected surprises along the way.

I am not at all interested in what any individual PP asset does--I am only interested in how the whole portfolio performs.

BTW, I'm note sure which two PP assets would be decimated by a crack-up boom.  The aftemath of a crack-up boom is deflationary, so long term treasuries are probably a pretty good place to be in such a scenario.

[MediumTex]

And it does that while still providing a decent return when the SDHTF ( s*** doesn't hit the fan).  I think that's a pretty good tradeoff. 

It is important to remember that preparing for SDHTF is very important, since that is what happens most of the time.

[KevinW]

Because what we are describing could play out over 5 or 50 years, and there will be unexpected surprises along the way.

Yeah, historically it's taken a very long time for an inevitable-seeming collapse to actually happen.  The writing was probably on the wall in Rome in the 1st century under Caligula, but the city of Rome wasn't captured until the 5th century and the Eastern Empire, renamed Byzantium, made it into the 15th.  The British Empire was in decline at the end of the 18th, but UK is still a major world power and a comfortable place to live here in the 21st century.  If the pattern holds then the US will have a functioning economy for at least another 300-400 years.

So, while I agree that all this stuff is very bad and our best days are behind us, the odds that the entire economic system will go poof during my lifetime are slim to none.  I'm comfortable with the PP's approach of providing some protection in case the SHTF, while still functioning reasonably well in the much more likely scenario that SDHTF.

[HB Reader]

What the PP does is allow a holding of 25% physical gold - that's a great insurance policy for the most dire economic collapse scenario.  And it does that while still providing a decent return when the SDHTF ( s*** doesn't hit the fan).  I think that's a pretty good tradeoff. 

I very much agree with that (and the comments by Gumby and MT).