Thursday, September 25, 2008

Not quite there

Bryan Caplan struggles to understand the credit crises:
My conjecture: If Paulson's bail-out were funded by a permanent tax increase sufficient to raise $700B in present value terms, it wouldn't stand a chance. The minimal public outcry, therefore, hinges on "debt illusion" - the mistaken view that debts, unlike taxes, never really have to be paid.

Am I right?
Caplan is wrong, and suffering from the "'debt illusion' illusion". Debts never really have to be paid, they can be defaulted on, or inflated away. Caplan does not fully realize that the dollar is a fiat currency. But, people who care about such things, have totally noticed.

Arnold is struggling too.
1. It's not the 1930's.

In the 1930's, the economy had many fewer industries than it has today. If the auto industry slumped, there was no computer industry to pick up the slack. Much of the economy was still agricultural, and the farm economy was in the process of transition. The dust bowl and advances in transportation displaced many farmers, who joined the ranks of the unemployed.

Today, we have a very diverse real economy. Some sectors are in a downturn, but many other sectors are not. The ability of any one sector to bring down the rest of the economy is much reduced.
Except when that sector if the financial sector, because the financial sector controls money supply. Suppose m1 collapsed to m0 because the financial sector folded up all the credit it had been extended. Does Arnold really believe it would have no impact on the real economy? If anything, today's economy is more susceptible to credit crises simply because more of the economy runs on credit. It gets worse.
2. The bailout blends finance with government.
Pray tell what does the Fed do? And the Treasury? And the SEC? FDIC? Are they part of the Government?Are they part of the Financial system? Also, who has been buying US Treasuries, and holding the long end of the yield curve down? Is that part of the Financial system? Are those buyers part of A government (albeit not THE Government)? The current financial system is entirely a product of regulation. The financial system IS part of the government--that's what fiat currency means.


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