Tuesday, November 18, 2008

Thinking About the Next Bubble

Gerald P. O'Driscoll, Jr. tells us, "To Prevent Bubbles, Restrain the Fed."

It is time to think past the crisis. When Alan Greenspan worried about deflation (falling prices), he kept interest rates too low feeding the investment bankers in the great credit over expansion of the mid-2000s.

How will we soak up all the excess liquidity that could fuel the next bubble?


Anonymous said...

This wall street journal article was fascinating. I agree with the author that a nation printing money should have to print that backed by some intrinsic worth is a valuable practice. In fact, the notion that currency should be backed by some sort of value is plain common sense. In the fiat system, the only guarantee on the value of money is the promise of the government.

A popular example that has been used in this economics class is that antebellum banks held more reserves than do modern banks. This is because, before the Federal Reserve System was established, banks were responsible for their own solvency and couldn't rely on a lender of last resort like the Fed. However, in our current system, banks have become overleveraged and created a financial crisis. It is obvious that banks should have held more capital. The notion that currencies shouldn't be backed by the same promise is ludicrous. A currency backed by gold prevents overexpansion of currencies and promotes sound monetary policy, unlike the current system.

T. Rowland said...

I have to agree with the author on this topic. Mr. Obama must be very careful about his monetary policy as to not create another bubble, burst scenario. It is important that we the fiscal and monetary stimulus are not simultaneous during the boom. This could create another unsustainable bubble and put us back in a mess such as the one we are in now. That means like the author said, the Fed cannot concentrate on deflationary measures for too long like they have in the past, but must keep a handle on all fronts.

Also, I think it would be wise to back currency with a commodity if it will predict when a bubble is imminent. I don't believe the analysts when they say they have no way of knowing when a bubble is approaching, its a load of you know what.

Gentz said...

This future boom could be bad if Obama keeps stimulating our economy into a bull market. I am sure he will use discretion in dealing with future bubbles that maybe inflating too fast.

I hope that Obama urges banks to hold more capital to prevent a future similar crisis. More so, I would urge that we push lenders to solely lend to people that are more likely to pay back. By that, I mean we should not have used “ARMs.” Who would really lend to someone without a deposit, and tell that person that they, “do not need to start making payments for two years.” It just seems irresponsible on the banker/lenders part.

Abby Sorensen said...

I also agree with the author that it is important for the nation that is printing money should have it backed by some intrinsic worth is a valuable practice.

Anonymous said...

But there is too much money printed at the moment to be put back on the gold standard, and while I'm not saying that counterfeiting is a huge problem at the moment, the notion that all of the work that they would do being worth the same throughout time would lead to more counterfeiters.

Neither of those are a good reason not to go back on the gold standard, I just don't think we need to try and work around either of them. I don't think that we will see the collapse of the United States anytime soon, nor do I think that the Fed will lend to the point of making the Dollar worthless, so the question of how to prevent the next bubble should be about the lending policies of the Fed when using its power as a lender of last resort. My understanding, which could be flawed, is that our central banks are all in the business of making money. If they need to lend more than is possible they go to the treasury, which then ties the Fed to congress. So, if we decide that Congress should place more restrictions on the Treasury they could, in a way, place some restrictions on how often the Fed could use it lender of last resort.

On the flip side, we don't want to cause major financial institutions too much stress, so lending the money needed isn't a bad thing, so long as the Fed dramatically increases rates when it is felt that they are back within 'normal' lending habits.