Can You Find the Crisis?



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Can You Find the Crisis?

November 13, 2015

A strategist from Societe Generale, Albert Edwards, admits he likes to pick on central banks. And he has good reasons. In a recent note to his clients, published on Business Insider, he explains why the Fed’s interest rate policy has led to a bubble in corporate debt since the global financial crisis in 2008:

Free Fed money has led to an unprecedented corporate credit binge of excess spending, especially on share buybacks. This is even bigger than it was at the time of the 2000 technology and telecom bubble. The rotten fruit of the Fed’s seemingly innocuous inaction will now be clear to onlookers as it is ripped to shreds on the battlefield by the powerful credit monster. The global economy will be thrown into chaos.

Edwards’ statement brings to mind two arguments that Austrian Business Cycle Theory makes with regards to the financial crisis. First of all, boom and busts do not necessarily occur in the same sectors or with the same magnitude from one monetary expansion to the next. The last financial crisis was concentrated in mortgages on the U.S. housing market, but this time around a bubble is forming in corporate spending, where monetary expansion is used to fund mergers, acquisitions, and to invest in one’s own company by buying its shares off the market. As Joseph Salerno (2012, 6) argues, the shape and size of the boom, and the areas in which it forms, albeit underlined by the same economic laws, “is determined by concrete historical circumstances.” In light of this, recent discussions of the Fed’s interest rate hike, which only revolve around unemployment and consumer price levels, seem at best childish, and at worst—and more likely—deceptive.

Second, Edwards’ foresight highlights the role entrepreneurial quality plays in the formation of a boom. It is obvious from his statement that the crisis is far from being an unpredictable black swan. But as Evans and Baxendale (2008) and Engelhardt (2012) show in detail, monetary inflation makes fools out of good entrepreneurs, as well as allows fools to become entrepreneurs, thwarting the market’s ability to stay away from ghost profits. Some more highly qualified entrepreneurs, able to foresee the looming bust, refuse to play the game and get out. But this only allows the newly created money to enable unskilled entrepreneurs to squander their resources on unsustainable, unprofitable investments.

Last but not least, in academic circles, many economists take the validity of Fed’s actions for granted—and their inaction too—and make great efforts to justify its failures with complicated new theories about why monetary policy isn’t effective. But for Edwards, Yellen’s reluctance to budge on current monetary policy is only “seemingly innocuous”. It goes to show that one does not need fancy models to understand basic economics.


HT to Bogdan Glavan and Logica Economica for the news. 

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