Liquidity, Default, Risk

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Cato Unbound: Liquidity, Default, Risk:

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Liquidity, Default, Risk

**J. Bradford DeLong
University of California at Berkeley and NBER
brad.delong@gmail.com; http://delong.typepad.com; 925-708-0467

December 6, 2008

Larry White is the Best of the Austrians—the most persuasive, the most thoughtful, and the most knowledgeable of the economists working in the Austrian monetary theory tradition, which is an essential part of our collective diversified intellectual portfolio in our age in which economic theory is so underdeveloped that, as John Maynard Keynes wrote in an earlier and somewhat similar episode, “[w]e lack more than usual a coherent scheme…. All the political parties alike have their origins in past ideas and not in new ideas…. It is not necessary to debate the subtleties of what justifies a man in promoting his gospel by force; for no one has a gospel…”

Nevertheless, I think that what Larry White has written misses the big point about what really has happened. So let me try to lay out what the situation looks like to me:

Think of it this way: two years ago we lived in a world in which the wealth of global owners of capital was some $80 trillion—that was the market value of all of their property rights to dividends and contract rights to interest, rent, royalties, options, and bonuses. Now over time the wealth of global capital fluctuates, and it fluctuates for five reasons:

1. Savings and Investment: Savings that are transformed to the investment add to the productive physical—and organizational, and technological, and intellectual—capital stock of the world. This is the first and in the long run the most important source of fluctuations—in this case, growth—in global capital wealth.

2. News: Good and bad news about resource constraints, technological opportunities, and political arrangements raise or lower expectations of the cash that is going to flow to those with property and contract rights to the fruits of capital in the future. Such news drives changes in expectations that are a second source of fluctuations in global capital wealth.

3. Liquidity Discount: The cash flowing to capital arrives in the present rather than the future, and people prefer—to varying degrees at different times—the bird in the hand to the one in the bush that will arrive in hand next year. Fluctuations in this liquidity discount are a third source of fluctuations in global capital wealth.

4. Default Discount: Not all the deeds and contracts will turn out to be worth what they promise or indeed even the paper that they are written on. Fluctuations in the degree to which future payments will fall short of present commitments are yet a fourth source of fluctuations in global capital wealth.

5. Risk Discount: Even holding constant the expected value and the date at which the cash will arrive, people prefer certainty to uncertainty. A risky cash flow with both upside and downside is worth less than a certain one by an amount that depends on global risk tolerance. Fluctuations in global risk tolerance are the fifth and final source of fluctuations in global capital wealth.

In the past two years the wealth that is the global capital stock has fallen in value from $80 trillion to $60 trillion. Savings has not fallen through the floor. We have had no little or no bad news about resource constraints, technological opportunities, or political arrangements. Thus (1) and (2) have not been operating. The action has all been in (3), (4), and (5).

As far as (3) is concerned, the recognition that a lot of people are not going to pay their mortgages and thus that a lot of holders of CDOs, MBSs, and counterparties, creditors, and shareholders of financial institutions with mortgage-related assets has increased the default discount by $2 trillion. And the fact that the financial crisis has brought on a recession has further increased the default discount—bond coupons that won’t be paid and stock dividends that won’t live up to firm promises—by a further $4 trillion. So we have a $6 trillion increase in the magnitude of (3) the default discount. The problem is that we have a $20 trillion decline in market values.

The problem is made bigger by the fact that for (4), the Federal Reserve, the European Central Bank, and the Bank of England have flooded the market with massive amounts of high-quality liquid claims on governments’ treasuries, and so have reduced the liquidity discount—not increased it—by an amount that I estimate to be roughly $3 trillion. Thus (3) and (4) together can only account for a $3 trillion decrease in market value. The rest of that decline in the value of global capital—all $17 trillion of it—thus comes by arithmetic from (5): a rise in the risk discount. There has been an increase in the perceived riskiness (not a fall in the expected value, an increase in the spread holding the expected value constant) of income from capital. And there has been a massive crash in the risk tolerance of the globe’s investors.

Thus we have an impulse—a $2 trillion increase in the default discount from the problems in the mortgage market—but the thing deserving attention is the extraordinary financial accelerator that amplified $2 trillion in actual on-the-ground losses in terms of mortgage payments that will not be made into an extra $17 trillion of lost value because global investors now want to hold less risky portfolios than they wanted two years ago.

From my standpoint, the puzzle is multiplied by the fact that we economists have what we regard as pretty good theories about (4) and (5), and yet those theories do not seem to work at all. As far as the liquidity discount (4) is concerned as long as we love our children as ourselves (and most of us do) and as long as we have access to and can credibly pledge collateral for financial transactions (and we can) the magnitude of the liquidity discount should be roughly equal to the technologically- and organizationally-driven rate of labor productivity growth divided by the intertemporal elasticity of substitution. The technologically- and organizationally-driven rate of labor productivity growth is a fairly steady 2 percent per year. The intertemporal elasticity of substitution is in the range from 1/2 to 1. The liquidity premium should be in the range of 2% to 4% per year in real terms—and no central bank should be able to drop it to –2% per year by a few open-market operations: big moves in the liquidity premium should require big moves in expected future growth rates of consumption. Perhaps in the old days—back when banknotes and demand deposits backed fractionally by gold or central-bank reserves were the only liquid stores of value, the only means of payment, the only mediums of exchange, or the even older days when the king’s picture on a disc of gold was it and when the torturers of the Mint and the Tower were standing by—things were different and credit expansion via the use of the seignorage power could have greater effects. But today the ability of central banks to swing the liquidity discount as they have in the past year and a half is a mystery.

Things are even worse as far as the risk discount is concerned. In normal times, our models predict, with the ability to diversify portfolios that exists today the risk discount on assets like corporate equities should be around 1% per year. It is more like 5% per year in normal times—it is more like 10% per year today. And our models for why the risk discount has taken such a huge upward leap in the past year and a half are little better than simple handwaving and just-so stories. Our current financial crisis remains largely a mystery: a $2 trillion impulse in lost value of securitized mortgages has set in motion a financial accelerator that we do not understand at any deep level that has led to ten times the total losses in financial wealth of the impulse.

Thus my dissatisfaction with Larry White’s piece: he talks only about the impulse, while it is the propagation mechanism—the financial accelerator—that is the important part of the story. $2 trillion shocks to global wealth do, after all, happen every several years, everytime there is a recession or a big rise in the prices of natural resources. But financial distress of the magnitude we see today happens once a century. Since the Bank of England developed its lender of last resort doctrine in the 1830s, we have only had two episodes this bad: the Great Depression and today.

Moreover, I do not think that Larry White has gotten the part of the story that he does cover right. I am not convinced of his account of the origins of the trouble in the housing finance market. Larry White blames government subsidies: the implicit government guarantee offered to FNMA and FHLMC, the explicit guarantee to the FHA, the requirements of the CRA, and the subsidy to borrowers provided by the Federal Reserve’s credit expansion—i.e., its open-market operations that bought Treasury bills for cash.

From the start of 2002 to the start of 2006 the Federal Reserve bought $200 billion in Treasury bills for cash. This $200 billion reduction in ourstanding bonds and increase in cash surely did lead to an increase in demand for private bonds. but recall the magnitudes here. We have $2 trillion of losses on $8 trillion in face value of mortgages that ex post should not have been made. Are we supposed to believe that $200 billion of open-market purchases by the Fed drives private agents into making $8 trillion of privately-unprofitable loans? Not likely. I can see how monetary contraction can make previously profitable loans unprofitable. But I see no way that this amount of monetary expansion can force private agents to make that amount of unprofitable loans. The magnitudes just do not match.

The requirements of the CRA also appear to me to be a red herring. Larry White writes that those who blame the crisis on greed are wrong because “greed… is always around” and you cannot explain a variable result by a constant cause “just as one can’t explain a cluster of airplane crashes by citing gravity.” I say that the same is true of the CRA. It has been around in more-or-less its current form for a generation.

FHA and FNMA and FHLMC make up the last of the actors to whom Larry White attributes the impulse—the $8 trillion in unwise mortgage loans made over the past five years. Once again the problem is that they have been around for a while. White tried to deal with this by saying that the GSEs changed their policies by cutting severely on down payment requirements—and that the private-sector mortgage lenders had no choice but to match them.

This claim provokes two immediate reactions. First, as your mother says: "If Freddie jumps off a cliff is that a good reason for you to follow him?" The answer to your mother's question is: "No." Just because GSEs are leading the market in making stupid money-losing loans did not force private financial companies to follow them and so lose their money too.

Second, Freddie and Fannie and FHA were not the first to jump off the cliff. They lost huge amounts of market share in the mid 2000s. We don't have a crisis which started when private mortgage lenders losing market share cut back on the quality of the loans they were willing to make. We have a crisis which started when private mortgage lenders cut back on the quality of the loans they were willing to make and so gained market share. The sequence is the opposite of what would have happened if White were correct.

Moreover, if ill-judged loans by the GSEs were the problem, we would expect to see a crisis in which FNMA and FHLMC failed first—which they did not, their troubles coming back in the line well after the Countrywides and the Bears Stern. And we would expect the failure of FNMA and FHLMC to take the form of them leaking cash as the number of mortgage payments they received crashed with defaults and consequent foreclosures. Instead Fannie and Freddie are still cash-flow positive—as long as they can borrow at nearly the Treasury rate. Fannie and Freddie crashed not because their revenues collapsed but because their borrowing costs ballooned. At it looks right now as though government ownership of 80 percent of Fannie and Freddie will bring money into the Treasury over the next five years.

So why does Larry White’s diagnosis of what is going on differ so much from mine? I think that what is going on is a characteristic weakness of the Austrian tradition: the baseline assumption that all evils must have their origin in some form of government misregulation. If government could be drowned in the bathtub, then an Eden in which people indulged in their natural propensity to truck, barter, and exchange would emerge. And this automatically rules out what I regard as the most likely and fruitful road to walk down to understand this financial crisis: the road that starts from investigating how human psychological limits lead to bad private-sector contract design that then magnifies psychological biases.

I am not happy with the state of such explanations—they seem to involve, at the moment, a great deal of handwaving. But in my judgment it is less handwaving than required to make the case that our current financial crisis is the result of our abandonment of a proper gold standard and our embrace of fractional-reserve banking and government-sponsored mortgage lending enterprises.

References

Lawrence White (2008), “What Really Happened?” Cato Unbound (December 2) http://www.cato-unbound.org/2008/12/02/lawrence-h-white/what-really-happened/

Comments

[Tyler Cowen]

Single best essay on the crisis so far.

[mk]

I don't know nearly enough economics to agree or disagree with Tyler's assessment, but there is a real surplus of theories about what happened, and a real shortage of focus on what specifically we don't understand. I'm thankful that you devoted an essay, more or less, to the latter topic.

It's especially helpful for an outsider like me who doesn't have the knowledge to read an economist's or financier's assessment of what's wrong and mentally annotate each claim with its degree of certainty or provenness.

[Ginger Yellow]

Brad, could you elaborate your thoughts on the liquidity risk premium? I don't understand why it's such a puzzle, or why you dismiss its input to the $20tn figure.

"As far as the liquidity discount (4) is concerned as long as we love our children as ourselves (and most of us do) and as long as we have access to and can credibly pledge collateral for financial transactions (and we can)"

I would dispute both of those points, as far as market participants go. This latter phase of the credit crisis has been characterised by a breakdown of even overnight collateralised lending. Market participants have an extreme liquidity preference - central banks may be flooding "the market", but that money is just being deposited back with the central banks.

" Perhaps in the old days — back when banknotes and demand deposits backed fractionally by gold or central-bank reserves were the only liquid stores of value, the only means of payment, the only mediums of exchange, or the even older days when the king’s picture on a disc of gold was it, and when the torturers of the Mint and the Tower were standing by — things were different and credit expansion via the use of the seignorage power could have greater effects"

But we are more or less back there. US Treasuries and cash are just about the only liquid stores of value, as far as institutional participants are concerned. Everything else is suspect.

[y]

If everything but the most conservative assets is suspect, then that's a matter of risk discount, not liquidity discount. Risk discount seems like the most likely candidate anyway, because it's something we didn't understand in the first place (that 1% predicted vs. 5% actual bit).

Why has the risk discount jumped so much? I don't know, but I'd look at the transparency of corporations and the nature of their relationship with their employees. When it becomes clear that the employees of many major financial corporations have been betting their companies on risky transactions (presumably because they were highly profitable in the short term for the employees concerned), that corporate management all the way to the top has been cheering them on, and that none of this has been adequately reflected in financial statements--isn't it then reasonable to suspect that many other corporations might be doing the same thing, and just haven't been found out yet? That would be enough to drive anyone into holding cash.

[bigTom]

Despite Larry's claim that we have had no news on resource constraints, wasn't last spring and summer's commodity price spike telling us that yes the world was running into serious resource constraints? How much of that spike was speculative, and how much physical remains to be sorted out. But as long as at least some market participants believe we were hitting such limits, and that they constitute a resource constrained ceiling on any global recovery, shouldn't such constraints (real or perceived) be influencing the market? Financial panic induced cutbacks in investment in resource extraction are now lowering those constraints even further.

[dilbert dogbert]

y,
The old wall street saying about cockroaches: If you see one there are thousands that you don't see.

[politicalfootball]

White is pretty much incoherent on the subject of Fannie. I'm no economist - just an interested layman - but this seems like very poor logic from White:

---------------------------------

"Fourth and likely most important, implicit taxpayer guarantees allowed the dramatic expansion of the government-sponsored mortgage buyers Fannie Mae and Freddie Mac, at a time when Congress and HUD were pushing Fannie and Freddie to promote “affordable housing” through ever-expanding purchases of non-prime loans to low-income applicants. The two mortage giants grew to hold or guarantee around $5 trillion in mortgages, about half of the entire U.S. market. Institutional investors were willing to lend to the government-sponsored mortgage companies cheaply, despite the risk of default that would normally attach to private firms holding such highly leveraged and poorly diversified portfolios, because they were sure that the Treasury would repay them should Fannie or Freddie be unable. (It turns out that they were right.)"

---------------------------------

Note the key parenthetical phrase at the end: "It turns out that they were right." White contends that the "likely most important" factor in the collapse of the whole house of cards was the fact that institutional investors accurately assessed their risks.

Lots of reasonable people have argued for a long time that the implicit government guarantees given to Fannie and Freddie were a bad idea - and certainly those people can claim a measure of vindication given current events. But the Fannie and Freddie problems are clearly a result of the credit crisis, not (in any important sense) a cause of it.

And (I would argue) to the extent that their collapses were the result of their own imprudent behavior, the evidence seems to be they were motivated by the same thing that motivated Bear Stearns and AIG: The desire to make money and an indifference to the systemic risk they were creating. Bear Stearns' desire to aid poor people has never been documented, but Fannie's greed is well-known.

[Bernard Yomtov]

A very helpful essay.

[Maynard Handley]

Brad I think you meant to have the labeling of your 5 causes as
(3) Default discount
(4) Liquidity discount
(5) Risk discount

Not only is this ordering more logical, but it better fits the subsequent discussion, where you refer to (4) at the same time you are discussing liquidity.

[tjallen]

Applause! Quite good!

Much better than last week's non-argument, where you simply declared the austrian's insane.

Thank-you for a fuller and humble explanation, including "what we don't know."

[Maynard Handley]

"As far as the liquidity discount (4) is concerned as long as we love our children as ourselves (and most of us do) "

WIthout wanting to score points and be snarky here, on what evidence, exactly, is this claim based. Yes parents love their children substantially WHILE THEY ARE CHILDREN. But once they are adults living their own lives...? Sure their is a vague warmth there, but is it of much economic value?

I don't know the nature of the models that rely on this claim but surely, if it were even close to true, we would not be seeing, for example, the current ballooning of US debt, or the on-going bitching about greenhouse gases?
And if this particular (apparently faulty) claim about human beings is essential input into the models, then why exactly should we care what the models say?

[Graydon]

Brad --

I think it is obvious to the meanest intelligence that there's a choice of what the financial machinery is set up to do.

I think it's also obvious that the financial machinery in the US has been set up to increase the wealth of the wealthy, rather than to increase general prosperity or behave fairly, and that there is significant political will to keep it that way, no matter how badly it performs.

Given that, and given that those responsible retain a level of personal wealth such that they will never have to worry about rent or food for the rest of their days, while millions of those not responsible but caught in the fallout certainly do and certainly will, it would take a complete idiot to trust the US financial system with anything.

Unless and until it is substantially reformed, and no one is going to believe it's a real reform unless the present financier class is wiped out by the reforms; if they are not, the default assumption is that they retain enough political clout that this is still business as usual.

Basic primate fairness doctrine wetware hardwiring, really.

[Cranky Observer]

> A very helpful essay.

I agree that Mr. DeLong's essay is quite helpful. But I am a bit at a loss as to why I am supposed to take Mr. White seriously if he is advancing the Rush Limbaugh-generated trope that the 31-year-old, very weak Community Reinvestment Act had anything to do with the 2003-2008 financial crisis.

Cranky

[mike]

Thank you, thank you, thank you Brad Delong.

I am so tired of the crazy talk from the Austrians that adds up to nonsense. You've put things so well and so politely. How you managed to be so gracious to boot is almost as impressive as how you've managed to spell things out so clearly.

This really hit the spot.

[nathan]

many are in triage and not in position to fully appreciate musings ...

Faith, hope, love ... And the greatest of these is love

Not

Gold, vodka and diamonds and the greatest is gold

Gold does not get me to work, help me do my job, or cure me when I'm sick

See more on natural resource curse

[algernon]

White & DeLong both focus on (1)just the latest cycle & (2)just the US, & thus miss much of the picture.

Total US debt/GDP has more than doubled in the last 20 years as the FED responds to every economic hiccup the same way: 'print money' to depress interest rates, which in turn discourages saving. The Dotcom bubble collapse was short-ciruited in this way, delaying some that reckoning until now. Massive amounts of money/credit have been borrowed & invested that were never saved but created by central banks & innovative lenders. Massive amounts of resources have been thereby misallocated. Not merely housing but every production process of any length was misguided to over-capacity by artificially depressed interest rates. For instance, is there any possibility that there would exist demand in the US for 16 million autos/annum if interest rates were what they would be if you could only borrow money that someone had actually saved?

Additionally, Asian & petro-state central banks have gotten on the bandwagon & contributed hugely to a global misallocation of resources. In example, China's growth will decline at least as much as the US; it has done its part to create an illusion of a savings surplus with its annual M2 growth of ~18%. It has depressed long-term interest rates in the US & Europe, distorting those economies just as it geared its own production to export goods, the unsustainable demand for which is even now being manifest.

This is basic Austrian Business Cycle Theory.

[egc]

Haven't colossal negative savings resulted from mark-to-market on the $2T mortgage shortfall and a subsequent rush for collateral forcing everyone simultaneously through the exits straight into the burning building next door? Wealth-holders contractually obligated to pony-up have to unload no matter their preferences to time or risk or changes in worthiness to future payers of cash. Stampedes cause their own intrinsic damage. (1) cannot be zero.

[a]

"$80 trillion—that was the market value of all of their property rights to dividends and contract rights to interest, rent, royalties, options, and bonuses."

Does market value (i.e. market in the real world) really depend on the five features mentioned? Isn't there an assumption that the market is efficient (which the market in the real world is not)?

[Robert Waldmann]

Brad you should have put it here before going live. There are typos.

First in three, you have switched "present" and "future".

3)

Liquidity Discount: The cash flowing to capital arrives in the *present* rather than the *future*, and people prefer—to varying degrees at different times—the bird in the hand to the one in the bush that will arrive in hand next year. Fluctuations in this liquidity discount are a third source of fluctuations in global capital wealth.

Second you changed the numbering of 3 and 4, but in the text refer to time preference as 4) and default risk as 3. (too many cases to list).

Also why do you call time preference liquidity preference ? They aren't the same. Active traders want liquid assets so they don't lose on bid/ask spreads. That has nothing to do with their time preference. This is important as the liquidity of assets can change quickly. For an asset to be liquid it must be either cash or there must be high volumes of trade for reasons other than rationally expected returns (you proved this in high school unless you were in junior high). Since we don't have a good model for noise traders, we can't predict changes in market thickness. This is what has changed. Liquidity preference which is different from time preference.

You have two anomalies and one idiotic assumption. You assert that the intertemporal elasticity of substitution of consumption is between 0.5 and 1. Based on what evidence ??? Empirical estimates are from 0.1 to 0.5. It is just a rule among mainstream economists that one must assume it is between 0.5 and 1 no matter what the data say. Then there is the equity premium puzzle. To be mainstream you must assume that the coefficient of relative risk aversion is between 1 and 2 (corresponds to intertemporal elasticity of consumption between 0.5 and1). Therefore the equity premium is a big mystery. If you accept a reasonable intertemporal elasticity of substitution such as 0.25 both mysteries become less mysterious. Where the hell did you get your "estimate" of the intertemporal elasticity of substitution in consumption ?

[Robert Waldmann]

Footnote and proposed paper topic. We don't have a *good* model of noise traders, but I, for one, have spent the past 20 years living off the OK model which you thought up overnight once upon a time.

With a couple of modifications it works perfectly. We need some forecastability of rho (the noise). And rational but unsuccessful bets on mu (the share of noise traders).

A good model would incorporate noise traders 4 (positive feedback) but that would be hard.

Also what happened to the plan to write a noise traders and the crash working paper in an obscure working paper series every 6 months so that, when the crash came, we could claim we predicted it ? Oh yeah you were too honest to agree to the proposal and I was too lazy to implement it.

* We do, however, have a bad 18 year old model which will work fine. We need to modify DeLong et al 1990 to add investors who have information on next periods noise. Their problem is that they don't know next periods mu (share of people who are noise traders.

My capsule summary is that investment banks and hedge funds were making a killing fleecing the sheep -- tricking uninformed investors into betting against them. The housing bubble bursting was an event so big that noise traders realized that they were better off holding only safe assets or holding the market (I don't know which). The financial operators took losses (not huge but painful) and wanted to de-leverage a bit. They discovered that they couldn't find suckers to buy their risky assets and sell them assets to cover their risky short positions. Thus the whole system collapsed. The Freezing up and melting down and other metaphorical phase transitions can be understood as a decline in the fraction of money traded by uninformed investors.

[zanon]

Robert:

I agree with your points. The definition here of "liquidity risk" is, well, it does not exist at all. I wish "liquidity" would be banished from the lexicon to force people to actually think about what they want to say and say it. It gets bandied about like it's some kind of magical pixie dust -- does Brad mean bid/ask tightness, or rollover short term debt to fund long term liability, or have transactions not impact price much, or something else? I have no clue. I don't think Brad, or other economists, have thought it through clearly at all.

I don't know if I buy your noise trader model btw, but I have not read DeLong's paper on that recently.

[christofay]

"This claim provokes two immediate reactions. First, as your mother says: "If Freddie jumps off a cliff is that a good reason for you to follow him?" The answer to your mother's question is: "No." Just because GSEs are leading the market in making stupid money-losing loans did not force private financial companies to follow them and so lose their money too."

This has been the age where if someone jumps off a cliff, especially if there is enjoyment of outsized bonuses on the way down, then you too should jump off the cliff.

Two examples.

First Tony Blair I think explained his signing on to Bush's crazy Iraq adventure by the analogy if your crazy brother drives through the center of town at 100 mph, he felt it was better to go along rather than stand on the sidewalk yelling to him to slow down.

Then there is that guy at Rubin's bank, Citibank, who said if others are still dancing, you gotta dance.

So, yes, it was the age to jump off the cliff if others do so.

[AWC]

Exceedingly interesting.

One question: what about 1893? Has this financial crisis already eclipsed a downturn that led to five years of double-digit unemployment?

If so, I'm terrified.

[Raph]

Very interesting. Would love to know where you get all these numbers from? For example how do you estimate the 20tn drop in market value when public markets are down 40% YTD globally and Cap Gemini estimates global wealth at ca 100tn.

What role does the lack of information as to who is holding the initial 6tn losses play? Investors reduce all risks in order to buy t bills, lower stock prices lead to margin calls by banks deleveraging, more selling follows. At the same time the interbank and commercial paper market freezes and all companies with short term financing needs aren't going concern anymore. Long term cash flows truly are like birds in a burning bush. Investors revert to liquidiation value and with no buyer any prices go. Isn't it what great buying opportunity are made of?

[MattYoung]

Number four, fear of default. Investors fear that they are investing in old businesses, they fear that something new is on the horizon about which they know nothing.

[ctindale]

more to do with Minksies instability theories, entice folks to borrow short to go long on assets, then pull the rug out by raising the cost of short term borrowings , then we enter Irwins debt deflation , to many money rains via the Real estate asset channel, to much BS statistics about the true state of the economy (Bernanke has referred to it at Princeton as Useful "chap talk"), some money financed tax cuts (again a Bernanke suggestion Princeton 1999) , the labor offshoring to hollow out the guts of your export industry

Brad your brighter than many of the others, their needs to be an integrated theory, the Austrians have got allot of good points, the classical Keynesian have go the largest portion and even though they need to be taken behind the wood shed some of the neo classicals shouldn't be dismissed either, the problem is the fed, they had to provide some stability by telling the political to go jump and they didnt, both fed governors became tsars of centrally planned consumption, they lost the point of the whole exercise , that is maintaining long run economic prosperity, letting the public/private debt to rise ridiculous ratios of GDP then pulling the rug out just tempted Minksy's ghost to rain terror while the reg sheriff was out of town.

You should stop blogging and do some serious work , enjoy this is much as we do its trivializing the problem.

Would Keynes or Schumpter blogged?

[MattYoung]

Well, let's avoid money a little longer.

When we minimize scarcity of goods over time, we would likely have the Austrian minimum of transactions. It is easy to get from there to something like restricted spanning tree combinations of goods flow, nodes being aggregation points.

Towns along the coast, major railroad points, temperate zone harbors, and the like, aggregated oat nodes.

Add in measurement. Why? To measure the relative substitution of like goods, allowing us to create the smooth distribution of variety. Measurement makes the spanning tree into a directed graph.

It has to have increasingly large markets for aggregates of goods. Government sits up there somewhere, so any shock that causes each of the roots to rearrange the variety of goods may or may not meet a constraint.

So, the Austrians would expect whatever accumulates the larger capital estimates wold cause very severe disruptions, as each sub graph has to re-arrange the variety in response to a constraint choice made in the next level up.

Everybody at each layer trying to keep the balance sheet balanced.

In other words, without considering money, we can see major shocks will appear like long term persistent bias at the financial (accumulating) markets, simply because the change comes only when the balance sheet problems propagate up, but the change will be larger.

Maybe we should treat money as just another goods flow.