James Galbraith on the 'Collapse of Monetarism'

Hyman Minsky, John Kenneth Galbraith and John Maynard Keynes take center stage as James Galbraith throws down the gauntlet to contemporary mainstream economists. Speaking at the 25th Annual Milton Friedman Distinguished Lecture at Marietta College, Marietta, Ohio, Jamie Galbraith asks Fed Chair Ben Bernanke and a host of others to embrace the " intellectual victory of John Maynard Keynes, of John Kenneth Galbraith, of Hyman Minsky." — else to explain "why not". We will search and update on any "why nots" if and when they surface. To Galbraith:

The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus [PDF], by James K. Galbraith, March 31, 2008 : … I come to bury Milton [Friedman], not to praise him. But I would like to do so on the terrain that he favored, where he was strong, and over which he ruled for many decades. This is monetary policy, monetarism, the natural rate of unemployment and the priority of fighting inflation over fighting unemployment. It is here that Friedman had his largest practical impact and also his greatest intellectual success. It was on this battleground that he beat out the entire Keynesian establishment of the 1960s, stuck as they were on a stable Phillips Curve. It was here that he set the stage for the counter-revolution that has dominated academic macroeconomics for a generation, and that – far more important — also dominated and continues to influence the way in which most people think about monetary policy and the fight against inflation.

What was monetarism? Friedman famously defined it as the proposition that "inflation is everywhere and always a monetary phenomenon." This meant that money and prices were tied together. But more than that, Friedman believed that money was a policy variable — a quantity that the Central Bank could create or destroy at will. Create too much, there would be inflation. Create too little, and the economy might collapse. There followed from this that the right amount would generate the right result: stable prices at what Friedman came to call the natural rate of unemployment.

The intent and effect of this line of reasoning was to defend a core proposition about capitalism: that free and unfettered markets are intrinsically stable. In Friedman's gospels government is the lone serpent in Eden, while the task of policy is to stay out of the way. Just as this was the vulgar lesson of "Free to Choose" so it turns out it was also the deep lesson of the larger structure of Friedman's thought. Friedman and Schwartz's Monetary History for all its facts and statistics carried a simple message: the market did not fail; the government did.

Friedman succeeded because his work was complex enough to lend an aspect of scientific achievement to his ideas, and because the ideas played to the preconceptions of a particular circle. As Keynes wrote of Ricardo:"The completeness of [his] victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely…to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority."

Friedman's success was similar to Ricardo's but not in all respects. Yes he also explained away injustice and supported authority. But the logical superstructure was not vast and consistent. Rather Friedman's argument was maddeningly simple, yet slippery. He would appeal to short run for some effects and to the long run for others, shifting between them as it suited him. … His money growth rules promised stable employment without inflation. Their promise was not austere, but happy. Ricardo was Scrooge. Friedman was more like the Pied Piper.

Friedman's success was consolidated in the late 1970s. [Then] Stagflation happened. … At the same time, I played a minor role in bringing monetarist ideas to the policy market. My responsibility was to design the Humphrey-Hawkins hearings on monetary policy from 1975 through their enactment into law in 1978. In a practical alliance with monetarists on the committee staff, we insisted that the Federal Reserve develop and report targets for monetary growth a year ahead. The point here was not to stabilize money growth as such: it was to force the Fed to be more candid about its plans. But the process certainly lent weight to monetarism.

It was on the policy battleground, shortly after, that monetarism collapsed. From1979, the Federal Reserve formally went over to short-term monetary targets. The results were a cascading disaster: twenty-percent interest rates, a sixty percent revaluation of the dollar, eleven percent unemployment, recession, deindustrialization through the Midwest including here in Ohio, and in Indiana, Illinois and Wisconsin, and ultimately the debt crisis of the Third World. In August 1982, faced with the Mexican default and also a revolt in Congress — which I engineered from my perch at the Joint Economic Committee — the Federal Reserve dumped monetary targeting and never returned to it.

By the mid-1980s, the rigorous monetarism Friedman had championed also faded from academic life. Money growth became high and variable, but inflation never came back. Perhaps inflation was "always and everywhere a monetary phenomenon." But monetary phenomena could happen without inflation. This vitiated the use of monetary aggregates as an instrument of policy control. At the Bank of England Charles Goodhart stated his law: when you try to use an econometric relationship for purposes of policy control, it changes. Friedman himself conceded to the Financial Times in 2003: "The use of quantity of money as a target has not been a success. I'm not sure I would as of today push it as hard as I once did."

What remained in the aftermath was a sequence of doctrines. All were far more vague and imprecise than monetarism but they carried a similar policy message: the Fed should place inflation control at the center of its operations, it should ignore unemployment except if that variable fell too low. Further, there was a sense that instability in the financial sector should be ignored by macroeconomic policymakers except when it could not be ignored any longer. The first of these doctrines, the "natural rate of unemployment" or "Non-Accelerating Inflation Rate of Unemployment," originated with Friedman and Edmund Phelps in 1968 and had the fatal attraction of incorporating expectations for the first time into a macroeconomic model. Macroeconomists fell for it wholesale. But it proved laughably defective in the late 1990s, Alan Greenspan, bless his heart, allowed unemployment to fall below successive NAIRU barriers — 6 percent, 5.5 percent, 5 percent, 4.5 percent, and finally even 4 percent. Nothing happened. No inflation resulted. This was good news for everyone except economists associated with the NAIRU who were, or ought to have been, embarrassed. Some retreated from Friedman to Knut Wicksell: there was a brief vogue of something called the "natural rate of interest" an idea unsupported by any actual research nor any theory since the demise of the gold standard.

And then we got Ben Bernanke and ostensible doctrine of "inflation targeting." This idea — Dr. Bernankenstein's Monster — rests on something Professor Marvin Goodfriend of Carnegie-Mellon University calls the "new consensus monetary policy." This is a collection of ideas framed by the experience of the early 1980s but adapted, at least on the surface, to changing conditions since then. These are, first, that "the main monetarist message was vindicated: monetary policy alone...could reduce inflation permanently, at a cost to output and employment that, while substantial, was far less than in common Keynesian scenarios." "Second, a determined independent central bank can acquire credibility for low inflation without an institutional mandate from the government…." and "Third, a well-timed aggressive interest-rate tightening can reduce inflation expectations and preempt a resurgence of inflation without creating a recession." Let us take up each of these alleged principles in turn.

First, is the proposition that monetary policy can reduce inflation permanently and at reasonable cost the "main monetarist message"? The idea is absurd. The main monetarist message was that the control of inflation was to be effected by the control of money growth. We have not even attempted this for a generation. Money growth has been allowed to do whatever it wanted. The Federal Reserve stopped paying attention, and even stopped publishing some of the statistics. Yet inflation has not returned. The main monetarist message is plainly false. As for the question of cost, no one ever doubted that a harsh recession could stop inflation. But in fact the monetarists’ recession of 1981-82 was by far the deepest on the postwar record. It was far worse than any inflicted under Keynesian policy regimes. In misstating this history, Goodfriend also completely overlooks the catastrophe inflicted by the global debt crisis on the developing world.

Second, is the anti-inflation "credibility" of a "determined central bank" worth anything at all? This idea is often asserted as though it were self-evident: that workers will restrain their wage demands because they recognize that excessive demands will be punished by high interest rates. There is some evidence for such a mechanism in the very specific case of postwar Germany, where a powerful union, the Metallgesellschaft, implicitly bargained with the Bundesbank for a period of some years. But in that case, the Bundesbank held a powerful, targeted weapon: a rise in interest rates would appreciate the D-Mark and kill the export markets for German machinery and metal products. This was a credible threat. Such a situation does not exist in the United States, and there is no evidence whatever that American labor unions think at all about monetary policy in their day-to-day work. It would not be rational for them to do so: in a decentralized system, restraint in one set of wages just creates an advantage for someone else. Moreover, and still more telling, there of course never existed any oil company that ever failed to raise the price of petroleum, when it could, because it feared a rise in interest rates might afflict someone else later on.

Third, can we safely state that a "well-timed aggressive tightening" can avert inflation "without creating a recession"? That statement is surely the lynchpin of the new monetary consensus. It was published in the Journal of Economic Perspectives — a flagship journal of the American Economic Association, in the issue dated Fall 2007. The article, by Professor Goodfriend, is entitled, "How the World Achieved Consensus on Monetary Policy." It therefore represents a statement of the highest form of expression of economic groupthink we are ever likely to find. Let me quote further, just so the message is clear. Goodfriend writes: "According to this "inflation-targeting principle," monetary policy that targets inflation makes the best contribution to the stabilization of output. … [T]argeting inflation thus makes actual output conform to potential output." Further: "This line of argument implies that inflation targeting yields the best cyclical behavior of employment and output that monetary policy alone can deliver. Thus, and here is the revolutionary point delivered by the modern theoretical consensus–even those who care mainly about the stabilization of the real economy can support a low-inflation objective for monetary policy. …[M]onetary policy should [therefore] not try to counteract fluctuations in employment and output due to real business cycles."

This statement was published, hilariously, around August, 2007. It is the economists' equivalent of the proposition that the road to Baghdad would be strewn with flowers. For as of that moment, the Federal Reserve was at the crest of an "aggressive tightening" underway since late 2004, aimed precisely at "pre-empting inflationary expectations" while "averting recession." On July 19, 2006, Chairman Bernanke so testified: "The recent rise in inflation is of concern to the FOMC.... The Federal Reserve must guard against the emergence of an inflationary psychology that could impart greater persistence to what would otherwise be a transitory increase in inflation." On February 14, 2007, he repeated and strengthened the message: "The FOMC again indicated that its predominant policy concern is the risk that inflation will fail to ease as expected." On July 19, 2007, this is again repeated: "With the level of resource utilization relatively high and with a sustained moderation in inflation pressures yet to be convincingly demonstrated, the FOMC has consistently stated that upside risks to inflation are its predominant policy concern."

Before the fall, Chairman Bernanke made occasional reference to developments in the financial sector. On May 23, 2006, these were actually enthusiastic. Bernanke testified: "Technological advances have dramatically transformed the provision of financial services in our economy. Notably, increasingly sophisticated information technologies enable lenders to collect and process data necessary to evaluate and price risk much more efficiently than in the past." And: "Market competition among financial providers for the business of informed consumers is, in my judgment, the best mechanism for promoting the provision of better, lowercost financial products." As for consumers, education was Bernanke's recommendation and caveat emptor was his rule: " …one study that analyzed nearly 40,000 affordable mortgage loans targeted to lower-income borrowers found that counseling before the purchase of a home reduced ninety-day delinquency rates by 19 percent on average."

On February 14, 2007, Bernanke was still optimistic: "Despite the ongoing adjustments in the housing sector, overall economic prospects remain good." And: "Overall, the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes." On March 28, 2007, he was less cheerful: "Delinquency rates on variable-interest loans to subprime borrowers, which account for a bit less than 10 percent of all mortgages outstanding, have climbed sharply in recent months." Still, "At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained." Only on July 19, 2007, do we hear that previous assessments were a bit rosy. Only then do we hear that "in recent weeks, we have also seen increased concerns about credit risks on some other types of financial instruments." That was three weeks before all hell broke loose on August 11, 2007.

What in monetarism, and what in the "new monetary consensus," led to a correct or even remotely relevant anticipation of the extraordinary financial crisis that broke over the housing sector, the banking system and the world economy in August 2007 and that has continued to preoccupy central bankers ever since? The answer is, of course, absolutely nothing. You will not find a word about financial crises, lender-of-last-resort functions or the nationalization of banks like Britain's Northern Rock in papers dealing with monetary policy in the monetarist or the "new monetary consensus" traditions. What you will find, if you find anything at all, is a resolute, dogmatic, absolutist belief that monetary policy should not — should never — concern itself with such problems. That is partly why I say that monetarism has collapsed. And that is why I say that the so-called new monetary consensus is an irrelevance. Serious people should not concern themselves with these ideas any more. Meanwhile central bankers caught in the practical realities of a collapsing financial system have had to re-educate themselves quickly. To some degree and to their credit they have done so. What they have not done, is admit it.

What is the relevant economics? Plainly, as many commentators have hastily rediscovered, it is the economics of John Maynard Keynes, of John Kenneth Galbraith and of Hyman Minsky, that is relevant to the current economic crisis. Let say a word on each.

Here is Keynes, who wrote in 1931 that we live "in a community which is so organized that a veil of money is, as I have said, interposed over a wide field between the actual asset and the wealth owner. The ostensible proprietor of the actual asset has financed it by borrowing money from the actual owner of wealth. Furthermore, it is largely through the banking system that all this has been arranged. That is to say, the banks have, for a consideration, interposed their guarantee. They stand between the real borrower and the real lender. … It is for this reason that a decline in money values so severe as that which we are now experiencing threatens the solidarity of the whole financial structure. Banks and bankers are by nature blind. They have not seen what was coming. Some of them have even welcomed the fall of prices towards what, in their innocence, they have deemed the just and 'natural' and inevitable level…, that is to say, to the level of prices to which their minds became accustomed in their formative years. In the United States, some of them employ so-called 'economists´ who tell us even today that our troubles are due to the fact that the prices of some commodities and some services have not yet fallen enough… A 'sound banker,' alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him."

In The Great Crash, published in 1955, my father rejects the idea, later embraced by Friedman, that bankers and speculators were merely reflecting the previous course of monetary policy. As of summer 1929, "[t]here were no reasons for expecting disaster. No one could foresee that production, prices, incomes and all other indicators would continue to shrink for three long and dismal years. Only after the market crash were there plausible grounds to suppose that things might now for a long while get a lot worse." And, "There seems little question that in 1929, modifying a famous cliché, the economy was fundamentally unsound. … Many things were wrong, [including] …the bad distribution of income… the bad corporate structure… the bad banking structure… the dubious state of the foreign balance… [and] the poor state of economic intelligence." On the last, he also wrote, "To regard the people of any time as particularly obtuse seems vaguely improper, and it also establishes a precedent which members of this generation might regret. Yet it seems certain that the economists and those who offered economic counsel in the late twenties and early thirties were almost uniquely perverse." On this point, JKG is now disproved. I refer you back to the "new monetary consensus."

Finally Hyman Minsky taught that economic stability itself breeds instability. The logic is quite simple: apparently stable times encourage banks and others to take exceptional risks. Soon the internal instability they generate threatens the entire system. Hedge finance becomes speculative, then Ponzi. The system crumbles and must be rebuilt. Governments are not the only source of instability. Markets, typically, are much more unstable, much more destabilizing. This fact that is clear, in history, from the fundamental fact that market instability long predates the growth of government in the New Deal years and after, or even the existence of central banking. We had the crash of 1907 before, not after, we got the Federal Reserve Act.

On November 8, 2002, then-Fed Governor Ben S. Bernanke spoke in Chicago to honor Milton Friedman on his 90th birthday. Bernanke said, "As everyone here knows, in their Monetary History Friedman and Schwartz made the case that the economic collapse of 1929-33 was the product of the nation's monetary mechanism gone wrong. Contradicting the received wisdom at the time they wrote…Friedman and Schwartz argued that 'the contraction is in fact a tragic testimonial to the importance of monetary forces.´" In that era, Bernanke argued, the Fed tightened to thwart speculation. One would argue that in 2005-7 it tightened to pre-empt inflation. No matter. You can see the difficulty without my help. At the close of his speech, Bernanke stated, "Let me end my talk by slightly abusing my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

Less than six years later, Chairman Ben Bernanke faces an intellectual dilemma. He can stick with Milton, in which case he must admit that the only possible cause of the present financial crisis and evolving recession is the tightening action of the Federal Reserve …. Or he can stick with the so-called "new monetary consensus," which holds that the Fed should now return to its inflation targets, pursue a much tighter policy, and that no recession will result. If Bernanke chooses the first, he must of course assume responsibility for the unfolding disaster. He cannot, logically, stay with Friedman without admitting the error of the late Greenspan years and his own first months in office. If he chooses the second, he must repudiate Friedman, and hope for the best. The two courses are absolutely in conflict.

My own view is that Friedman and Schwartz were right on the broad principle — monetary forces are powerful — but wrong in its application. The Federal Reserve alone did not "cause" the Great Depression. Intrinsic flaws in the financial, corporate and social structure, combined with bad policy both before and after the crash, were jointly responsible for the disaster, while the crash itself played a precipitating role. The danger, today, is that something similar could again happen. Thus I do not think that rising interest rates alone caused the present collapse, and I do not think that cutting them alone will cure it. They did so in conjunction with the failure to regulate sub-prime loans, with the permissive attitude to securitization, with the repeal of Glass-Steagall, and with the general calamity of turning the work of government over to bankers.

But if Friedman was wrong, the "new monetary consensus" is even more wrong. That consensus, having nothing to say about abusive mortgage loans, speculative securitization and corporate fraud, is simply irrelevant to the problems faced by monetary policy today. Its prescriptions, were they actually followed, would lead to disaster. Its adherents, who of course never had a consensus on their side to begin with, have made themselves into figures of fun. There is, mercifully, no chance that Ben Bernanke will actually choose to follow their path.

And if both sides of Bernanke's dilemma are wrong, what is a beleaguered central banker to do? I have an answer to that. Let Ben Bernanke come over to our side. Let him acknowledge what is obvious: the instability of capitalism, the irresponsibility of speculators, the necessity of regulation, the imperative of intervention. Let him admit the intellectual victory of John Maynard Keynes, of John Kenneth Galbraith, of Hyman Minsky. Let him take those dusty tomes off the shelf, and broaden his reading. I could even send him a paper or two.

Thank you very much indeed.

****
James K. Galbraith holds the Lloyd M. Bentsen, jr. Chair in Government/Business Relations at the LBJ School of Public Affairs, the University of Texas at Austin, and is a Senior Scholar at the Levy Economics Institute. His next book is entitled The Predator State: How Conservatives Abandoned the Free Market, and Why Liberals Should Too, forthcoming from The Free Press.

HT: Mark Thoma

Comments

[bailey]

"Yet inflation has not returned." Excuse me?

[Dave Iverson]

Yep, Bailey.. General price Inflation has returned, after long lags in terms of oil, precious metals, gems, and most recently in terms of basic food grains. All else will follow, to some extent, except for asset inflation which bubbled up in front of general inflation. James Galbraith ought to have made that point.

Still Galbraith's main messages linger and await counter arguments: 1) ideas/theories from John Kenneth Galbraith and Hyman Minsky deserve more positive attention by mainstream economists, along with revisiting John Maynard Keynes ideas as illuminated by Minksy, and 2) Rising interest rates alone did not cause the present collapse, and cutting them alone will not cure it. Problems arose "in conjunction with the failure to regulate sub-prime loans, with the permissive attitude to securitization, with the repeal of Glass-Steagall, and with the general calamity of turning the work of government over to bankers."

[bailey]

It's pretty obvious to me we're not going to win many arguments with cultists, they just can't hear what's outside their frame of reference. I'm not familiar with Wm. Anderson, but he makes a few very strong points, common sense points.

Must Government Inflate Home Prices?
by William L. Anderson

Henry Hazlitt once wrote in his famous Economics in One Lesson that "Economics is haunted by more fallacies than any other study known to man." Indeed, I am supposed to teach fallacies in my classroom as part of modern economic orthodoxy.

Along with Hazlitt’s declaration comes the opening line in Carl Menger’s path breaking 1871 edition of Principles of Economics: "All things are subject to the law of cause and effect. This great principle knows no exception, and we would search in vain in the realm of experience for an example to the contrary." The key issue here is understanding the difference between cause and effect.

I write this because we are seeing a lot of supposedly intelligent people confusing cause with effect and declaring that the effect is the cause, and government must act upon that "cause" immediately. That, not surprisingly, is a recipe for disaster.

Many times a day, I receive emails from an outfit called Newsmax, and while I usually trash those mails quickly, I received one from its financial division that declared:

Bond guru Bill Gross says the government must move in support of home prices to make sure the credit markets don’t melt down.

Gross manages Pacific Investment Management Co.’s Total Return Fund, the world’s biggest bond fund. Gross has increased his weighting of mortgage debt to the highest level since 2000, betting against Treasuries in the biggest way since at least that year.

In his April letter to investors, Gross blasts his competitors in the credit markets.

"In my opinion, the private credit markets have forfeited their privileged right to operate relatively autonomously because of incompetence, excessive greed, and in minor instances, fraudulent activities," he writes.

"As a result, the deflating private market’s balance sheet is being re-nationalized, in some cases with increased regulation, in others with outright guarantees and agency lending.

"Ultimately, government programs which support private credit market assets may be required in order to prevent an asset deflation of significant proportions."

Translation: the government must act to lift home prices – and quickly.

"Since homes are the most highly levered and monetarily significant asset that American consumers own, if they decline much further, they will drag the rest of the economy with them," Gross argues.

"Home price declines of 20 percent are in fact much more of a shock to the American economy than the popping of the Internet bubble and the NASDAQ 5000, because the amount of homeowner leverage is so much greater."

Bottom line, according to Gross: "The [home price] decline needs to be stopped quickly to avert additional crises."

How to do it? Why, through inflation, of course! Thus, we read from a "financial guru" that like Vietnam and Iraq the government must destroy the economy via the printing press in order to save it.

Now, I make no claims of being a "bond guru," and I am sure that Mr. Gross’ financial knowledge is much greater than my own, and I am sure his net worth would exceed mine by an infinite number. However, the "guru" has confused cause with effect, and in so doing is calling for the equivalent of nuking New York in order to fix a leak in the sewer system.

Before going farther, however, I will say that I agree with Mr. Gross in that home prices are falling, including my own. (We purchased a house last summer and I have no doubt that I could not sell it today for what I paid for it, but we do hope to live in it for a long time, so I have no plans to walk away because of the fall in equity.) That is a given.

However, the fall in home book values is an effect, not a cause of the current economic downturn, and to miss that simple but profound principle is to miss what is going on. In fact, his subsequent statements regarding his belief that "the private credit markets have forfeited their privileged right to operate relatively autonomously because of incompetence, excessive greed, and in minor instances, fraudulent activities" further express his economic ignorance.

If one is to be a guru, one must understand not only the inner workings of markets, but also the outer structure that guides their activities. This man has made millions in trading of bonds, but he also fails to understand why the credit markets plunged over the cliff.

It is politically popular to blame "greed and incompetence" and the like for the failings here, but the "greed and incompetence" of which he speaks did not suddenly appear like magic. Instead, it was government-created. And, it was inevitable, given the perverse incentives that government has created in those markets.

How did the freefall in housing book values come about? If you read Gross, you would think that it just happened, or if there was a problem, it was due to "greedy markets." Instead, we are seeing the classic effects of a financial bubble, be it in housing, the stock market, or the infamous Tulip Mania in the Netherlands nearly 400 years ago. Furthermore, this particular bubble could not have occurred without the backing of the government.

The government has covered the mortgage markets in a number of ways. First, to promote home ownership, Congress during the New Deal created the Federal National Mortgage Association ("Fannie Mae") in 1938 and 30 years later created the Federal Home Loan Mortgage Company ("Freddie Mac") to bolster the mortgage industry by offering guarantees and to create so-called mortgage securities. These "securities" really are mortgages sold in the secondary market at their present value, and then bundled into larger securities to be sold to the public.

The principle behind these securities is to spread the risk, as they are based upon the assumption that most people will pay their mortgages in a timely manner and defaults will be random, so the good mortgages would outweigh the bad ones. However, one wonders why if this is such a good investment idea, why did private investors did not seek to create such companies themselves?

(Private investors have made much money on these securities, and while both outfits now are officially private organizations, nonetheless they exist only because the government guarantees their financial backsides. We shall see just how credible that "guarantee" really is.)

Both Fannie Mae and Freddie Mac have made Austrian economists quite nervous, given their huge unfunded liabilities, but as long as people could pay their mortgages, those outfits could operate in relative peace. Unfortunately, the past several years have been anything but peaceful in mortgage markets, and only now are the real bills coming due. How we got to this point is instructive.

In 2001, the U.S. economy had fallen into recession. The Clinton-era stock bubble had burst, but the dollar still was strong against foreign currencies. Then came the 9/11 attacks, which I believe had much more effect than most people understand.

After the attacks, the American economy was stagnant, which should not have been surprising, since the economy still was in recession on top of the vicious hit that it received from the terror attacks. Yet, at this point, the George W. Bush Administration could have been heroic and dealt correctly with the situation at hand. First, it should have done nothing to "stimulate" the economy as opposed to what it did do: convince Alan Greenspan to have the Fed lower interest rates to ridiculous levels (1.0%).

At first, the boom in the housing market started very slowly – as these things usually do. Soon, however, Americans were being bombarded with calls at the dinner hour and in their emails by mortgage brokers to refinance their houses, and then the cascade began. It seemed quite reasonable at the beginning. Interest rates were quite low, and it made sense to borrow money against the increasing equity of one’s house, and maybe even borrow a few thousand more to buy cars, vacations, refrigerators, or whatever – and still have lower house payments.

Columnist Steven Greenhut three years ago understood what was happening in California and other "hot" real estate markets, and said so:

Now, everyone is banking on appreciation. One friend, shopping for a house in Palm Desert, told me the $875,000 price is a bargain because it will be worth a million next year. I don’t know, but I warned that it could just as likely be worth $500,000. Yet, people are tapping into their home equity, which is driving a consumer-based economy. It’s also creating a false sense of wealth. People might not always use their equity to buy things, but knowing it is there helps them justify buying those $75,000 BMWs, Hummers and Mercedes that I drive by in my Ford Focus every day. My suspicion is the opposite will happen this time around. Instead of the economy killing home prices, falling home prices will kill the economy.

As booms always go, this was unsustainable. What made it unique, however, was the fact that the Fed and its acolytes in the financial markets were throwing newly-printed dollars around, and people selling things overseas were willing to hold them. Although we hear the neoconservatives regularly bash China, nonetheless the central bank of China was willing to scoop up billions of dollars of U.S. bonds that were being floated, in part, to pay for a war that China says it opposes and that the neocons support.

Chinese consumer goods have flowed ever since to these shores, while Americans have sent the Chinese and Japanese and others green pieces of paper that the holders have hoped to redeem sometime in the future for something. Indeed, the housing boom really was driving the U.S. economy, much more so than anything else, including the false "stimulus" that came from the disastrous war in Iraq.

At first, the new mortgage money was spent mostly refinancing existing mortgages, but soon enough, Americans got real estate fever, and there was no stopping the lemmings as they raced toward the cliff. I could see the effects where I lived, and ours was not a "hot" market by any means. However, as "investors" found housing prices around Washington, D.C., accelerating, they decided that places like Cumberland and Frostburg were virgin territory and proceeded to bid up prices well beyond the reach of average-income families here. By 2005, even backwaters were part of the frenzy.

By 2006, it should have been obvious in places like California and elsewhere on the two coasts that the party was over. The tipoff was that companies were dealing almost exclusively in the "interest-only" mortgages with their special "teaser" rates. Would-be homeowners would borrow huge sums of money, but start out paying only the interest at low introductory rates.

The reason they put themselves in such vulnerable positions was that this was the only way that most of them could begin to afford the sky-high house payments that with the accelerating housing prices. Borrowers would console themselves with the false belief that within a year, they would "flip" their houses, have new equity, and have money to put down on a new place, with a conventional mortgage and lower payments.

Unfortunately, for most of these late-comers, "later" never arrived, at least in the version of the phantom house "flip." Instead, "later" meant that the teaser rates morphed into substantially higher interest, and principal payments came due. The "almost-affordable" payments rose to payments that were ridiculously unaffordable, and the foreclosure rush was on.

As in all financial bubbles, those who enter at the top of the bubble have the most to lose, as the value of the asset in which they spent so much to obtain falls well below that original amount. Those of us who purchased houses near the end of the frenzy are well aware that the current values are not what our mortgages say they are supposed to be, and in some places, people have just walked away.

Yet, to deal with the original purpose of this article, we have a "financial guru" claiming that unless government finds a way to prop up the housing values to prices that existed at the top of the boom, the economy is doomed. To that I say, "Nonsense."

Gross makes the false assumption that declining prices are a never-ending spiral of misery. Now, if one is a disciple of John Maynard Keynes, such beliefs are fundamental tenets of what we call Keynesianism. However, if one is not a Keynesian or even a True Believer in that fiction called "aggregate demand," then there are plenty of very good reasons to believe that it is necessary to permit housing prices to fall to their true market values.

To take my disagreement with this "financial guru" one step farther, I will say that if the government follows his advice and tries to prop up housing prices to unsustainable levels, the fallout will be far worse than what he can imagine. The last time the U.S. Government aggressively attempted to prevent falling prices across the economy was the 1930s, a time which the ancients once called the Great Depression.

The reasoning here brings us back to Menger and the "law of cause and effect." Declining prices, whether they be in the housing market or the stock market in 2000, or commodities markets in 1982, are a market response to the real-live conditions that exist after a period of malinvestment in those particular markets. Austrian economists recognize that government attempts to pump up particular markets only invite inevitable havoc. Falling prices are an effect of markets re-adjusting after the previously unsustainable booms ran their course and had nowhere to go.

According to Paul Krugman, the real problem is lack of regulation, and it seems that the talking heads, plus some people on Wall Street, heartily agree. I would dissent from that point of view, noting that the problem was not that markets were free, but rather that financial markets constantly had Uncle Fed whispering, "Got your back!" We are about to find out the very hard way that our rich "uncle" cannot sustain any market with just a printing press.

(I remind my students that every time Ben Bernanke promises even more "liquidity" to the markets, gasoline prices tick upward. We now see the same in food prices and other commodities. The new money must go somewhere, and investors realize that the only game in town is pork bellies and the like.)

If we want the economy to become viable again, the last thing the government needs to do is to try to pump up housing prices, as the markets will make sure that every new attempt to "create liquidity" will translate into even higher commodity prices – even as housing prices continue to tank. Murray Rothbard and other Austrians have had the right prescription, one that the Bill Grosses of the world don’t want to hear: Governments should do nothing except permit the markets to adjust to levels that are sustainable. Anything else only will prolong the financial agony and ultimately make the economic downturn even worse.

Unfortunately, policymakers are listening to the Grosses and not the Rothbards. And for that, we will pay dearly.

April 26, 2008
William L. Anderson, Ph.D. [send him mail], teaches economics at Frostburg State University in Maryland, and is an adjunct scholar of the Ludwig von Mises Institute.He also is a consultant with American Economic Services.

April 26, 2008

[Dave Iverson]

Via Bailey, Anderson (above) says: "...[I]f one is not a Keynesian or even a True Believer in that fiction called 'aggregate demand,' then there are plenty of very good reasons to believe that it is necessary to permit housing prices to fall to their true market values.

"To take my disagreement with this 'financial guru' [Bill Gross] one step farther, I will say that if the government follows his advice and tries to prop up housing prices to unsustainable levels, the fallout will be far worse than what he can imagine. The last time the U.S. Government aggressively attempted to prevent falling prices across the economy was the 1930s, a time which the ancients once called the Great Depression.

"The reasoning here brings us back to Menger and the 'law of cause and effect.' Declining prices, whether they be in the housing market or the stock market in 2000, or commodities markets in 1982, are a market response to the real-live conditions that exist after a period of malinvestment in those particular markets. Austrian economists recognize that government attempts to pump up particular markets only invite inevitable havoc. Falling prices are an effect of markets re-adjusting after the previously unsustainable booms ran their course and had nowhere to go.

According to Paul Krugman, the real problem is lack of regulation, and it seems that the talking heads, plus some people on Wall Street, heartily agree. I would dissent from that point of view, noting that the problem was not that markets were free, but rather that financial markets constantly had Uncle Fed whispering, 'Got your back!' We are about to find out the very hard way that our rich "uncle" cannot sustain any market with just a printing press. ..."

I think, by contrast, that Gross, echoing many others, isn't suggesting that the gov. reinflate the housing mkt, but instead that the Gov. (in concert with Govs around the world) attempt to stop the US (and other) housing market from collapsing way below whatever might seem a prudent median (or whatever) housing price. If they fail, likely we get the Depression that Anderson (and Gross) fear. If they succeed, then we will get the re-regulation of the financial system (particularly margin and capital requirements, and perhaps more structured exchange mechanisms) that Krugman, Gross, and many others (me too) want to see happen. In the meantime we get some inflation. If hyperinflation seems likely, then I suspect that the Fed and others will kill the money machine before it gets too far out of hand. Hyperinflation is certainly a risk, but I don't think it will be allowed.

Anderson and other "Austrians" (I used to call myself one too before I met up with the Minsky-Keynes twist) believe that money and banking ought to be strictly privatized. I don't. Our experiment with "structued finance" hasn't been all good, but compared to what preceeded it it has been, on balance, good. But it needs to be made much better.

Anderson and I agree that the Bush neo-Cons (emphasis on the "Con") have pretty much destroyed the extant systems of gov. Question now is do we go with "free markets" and limit gov. to, defense and civil remedy (presuming that citizens like you and I can go head-to-head with big corporations, i.e. "transaction costs" are as easily bourne by individuals as by Corps.)? Or do we improve the systems of Gov./private money and banking, i.e. "stucutered finance"? I'm in line with those who believe that the better course is the latter -- in part, because I believe like my friend who says, uber "free market capitalism" is a great system as long as you are willing to let people die (en masse) in the streets. I add, along with Helibroner that even then capitalism as a dominant regime works itself into dark corners as wealth concentrates to the clever and lucky few, and then kills the system--a system that requires a large, vibrant middle class to survive.

[Dave Iverson]

Harvard’s Niall Ferguson on Friedman:

"...[I]t will be for monetarism — the principle that inflation could be defeated only by targeting the growth of the money supply and thereby changing expectations — that Friedman will be best remembered.

"Why then has this, his most important idea, ceased to be honoured, even in the breach? Friedman outlived Keynes by half a century. But the same cannot be said for their respective theories. Keynesianism survived its inventor for at least three decades. Monetarism, by contrast, predeceased Milton Friedman by nearly two.

"The death of monetarism is usually explained as follows. In the course of the 1980s, pragmatic politicians and clever central bankers came to realise that it was difficult to target the growth of the money supply. As Chancellor of the Exchequer, Geoffrey Howe preferred to raise interest rates and reduce public sector borrowing. His successor Nigel Lawson targeted the exchange rate of the pound against the deutschmark.

"At the Federal Reserve, too, Friedman’s rules, once zealously applied by Paul Volcker, gradually gave way to Alan Greenspan’s discretion. And, for all the praise he heaped on Friedman last week, Greenspan’s successor Ben Bernanke is dismissive of monetarism. Earlier this year the Fed ceased to track and publish M3 (the broadest monetary aggregate). It is the inflation rate that today’s central bankers want to target, not money (though the President of the European Central Bank, Jean-Claude Trichet, recently came out as a neo-monetarist).

"Anti-monetarists point out that the relationship between monetary growth and inflation has simply broken down. Inflation is low nearly everywhere. The latest figure for the annual growth in American core consumer prices is just 2.3 per cent, down from 3.8 per cent in May. Yet the annual growth rate of M3, which diehard monetarists have continued to track unofficially, is just under 10 per cent. Last year, according to the IMF, M2 increased by nearly 13 per cent in the UK. In some emerging markets the figure was higher. Russia’s money supply grew 25 per cent.

"Yet simply because consumer price inflation has remained low, money has not become irrelevant. On the contrary: it is the key to understanding the world economy today. For there is nothing in Friedman’s work that states that monetary expansion is always and everywhere a consumer price phenomenon.

"In our time, unlike in the 1970s, oil price pressures have been countered by the entry of low-cost Asian labour into the global workforce. Not only are the things Asians make cheap and getting cheaper, competition from Asia also means that Western labour has lost the bargaining power it had 30 years ago. Stuff is cheap. Wages are pretty flat.

"As a result, monetary expansion in our time does not translate into significantly higher prices in shopping malls. We don’t expect it to. Rather, it translates into significantly higher prices for capital assets, particularly real estate and equities. The people who find it easiest to borrow money these days are hedge funds and private equity firms. Through leveraged buy outs, the latter can easily acquire companies and, by improving their cashflow, boost their valuations. These guys then buy houses in Chelsea with the millions they make.

"It makes sense. Consumer goods are plentiful: the supply of computing power has grown even faster than the supply of credit to consumers. But shares in Chinese banks and houses with Chelsea postcodes are scarce, while the supply of credit to their potential purchasers seems almost infinite.

"No one can say for sure what the consequences will be of this new variety of inflation. For the winners, one asset bubble leads merrily to another; the key is to know when to switch from real estate to paintings by Gustav Klimt. For the losers, there is the compensation of cheap electronics. ..."

From: The Telegraph, London, Nov. 19, 2006
http://www.telegraph.co.uk/opinion/main.jhtml?xml=/opinion/2006/11/19/do1904.xml&sSheet=/opinion/2006/11/19/ixopinion.html

[Dave Iverson]

And here is a Mark Thoma "Economist's View" spotlighting James Galbraith, along with Benjamin Friedman, and Alan Metzler testifying before Congress in July 2007--just before the August Credit Collapse..
http://economistsview.typepad.com/economistsview/2007/07/benjamin-friedm.html

Thoma didn't comment on any of it. Now we await Thoma's response to his recent Galbraith/Friedman post.

In the July 2007 hearing, Chairman Frank opened with a strong statement that "distribution questions", i.e. wealth concentration to the few is now a big concern.

One highlight from Friedman, that talks to inflation risks, and needs to restructure our financial systems:

"...The fact that the inflation of the 1970s died in the 1980s does not mean that we face no inflation risks. Inflation accompanies war, and the Iraq War has had some inflationary impact, mainly through the extraordinary rise in the price of oil. Inflation may also recur, if the international monetary system enters a crisis, causing a sharp further fall in the value of the dollar. That is a risk of any unipolar currency system: it is a great privilege to issue the world’s reserve currency, but only for so long as it lasts.

"In this connection, I realize that many favor placing strong pressure on China, to sharply revalue its currency. Let me urge caution. Such a step could risk destabilizing the 'nominal anchor' that has kept dollar prices reasonably stable in the world economy. And the benefits to American workers are fairly remote. The world is full of countries to which the employers of low-cost labor could turn if it became too expensive to continue operations in China. The clear winners from a sharp Chinese revaluation, on the other hand, would be those now speculating on the Shanghai real estate and stock markets.

"In short, if the international dollar reserve system must eventually be changed, we should not try to do it with ad hoc measures. Rather, we should begin to design a new system capable, if possible, of greater enduring stability than the present one."

Redesign we must, else retreat to Ruthless Capitalism a la Milton Friedman and others, including many self-proclaimed Austrians.

PS. I still like to read Paul Kasriel and a few others who still claim to be Austrian in their economic outlook.

[bailey]

And here-in is my dilemma, "a system that requires a large, vibrant middle class to succeed." My read is that Bill Clinton moved us perilously close to a one-party system. Where were our "vibrant" top-tier Economists when Dean Baker sttod virtually alone before the Glass-Steagall & Boskin Congressional Commission hearings? Isn't this a role of a "vibrant" middle class? Truth is we both can recall way too many recent outrageous attacks to our long-term economic viability to let this statement go unchallenged.
I'm not one to debate theory. I ask simply, why did so many Economists (of so many doctrines, who were in position to short-circuit the mess we face) not question the actions of so few BEFORE they thoroughly trashed our Economy?
p.s. I don't think we're facing a "new" variety of inflation, I think inflation is generational and that we should not take anyone seriously who postmodernizes it for short-term gain - especially those who refuse to consider why any construct for measuring "inflation" shouldn't correlate to a population sampling. This is 2008, isn't it?

[Dave Iverson]

Bailey.

It IS maddening that so few economists stood up, spoke up, or even seemed to care that our middle class was slipping away and that many were, as Joseph Stiglitz once said, "looting" during our recent "go go" years.

It was during those years that I kept pushing JKG's The Great Crash out to economists (mostly in comments on other blogs) to suggest that we were hell-bent on repeating mistakes made in the 20s. But the likes of Brad DeLong, Mark Thoma, even Paul Krugman would have none of it back then. Now all three seem to get at least some of it. Even Nouriel Roubini and Brad Setser didn't seem to see the looting via securitization, leverage, CDS, etc.

John K. Galbraith wrote in THE GREAT CRASH: 1929 about various classes of people blind to the damage set in motion by the 1920 irrational exuberance. He argued that some were blind because they wanted to be for either personal gain or status as cheerleaders. Some were blind because they just didn't understand -- blinded by ideology.

It is the latter type of blindness that I hoped to help people understand better. But I knew then, as now, that Thomas Kuhn was right: paradigms shift as a function of funerals--when generations die off, not as people open their minds to new realities. Instead, disciples cling with bloody fingernails to the tattered remains of the theories of past gurus, prophets, sages. And they cling there mostly 'till they die.

I guess we are back to one of my favorite quotes: Robert Heinlein,paraphrasing, "People don't learn from the mistakes of others. They seldom learn from their own mistakes. ... Never underestimate the power of human stupidity."

Maybe it's me, the two Galbraiths and others who are indeed stupid or blind. Or maybe it is others. Or maybe we are all a bit blind, like those in Plato's Cave.

Interesting Times!

PS.. Give me a better idea what you mean by, "I think inflation is generational and that we should not take anyone seriously who postmodernizes it for short-term gain - especially those who refuse to consider why any construct for measuring 'inflation' shouldn't correlate to a population sampling."

[bailey]

Sure, another day I'll enjoy that. But for now I've got to go find some Thomas Kuhn to take on a leisurely ride up the coast. Thx, as usual. You are one heck of a source.

[bailey]

I think you'll enjoy Yves Smith's (Naked Capitalism) commentary on Milken Coference.

Friday, May 2, 2008
Hubris, Denial, and the Financial Services Culture
I am still recovering from the Milken Conference, and unlike my fellow blog panelists Paul Kedrosky, Felix Salmon and Mark Thoma, have not written any posts on particular sessions. In part, that was because in my other life as a consultant, I am well aware of the dangers of relying on memory even though mine is pretty good, and I had decided to listen rather than take notes.

But the other reason was in almost all the sessions has a strong element of overt pressure on the speakers to maintain an upbeat tone, combined with repeated reinforcement of Republican/Chicago School of Economics ideology. Normally I would not deem that sort of thing worthy of mention if it were a minor and only occasional element of the program; indeed it would have been valuable if other views had been tolerated and some sparks flew. No, the private sector/deregulation cheerleading was pervasive and baldfaced, and made it hard for me to sort out signal from noise. There were enough cases where I knew the data and knew it to be misrepresented so as to call a lot of what I was hearing into question.

I did manage to see one session that was free of that, by theoretical physicist Lisa Randall talking about her work (needless to say, it was way beyond me, but she did a good job nevertheless), and putting in the lone plea I heard for government intervention. She said the US was losing its edge in her kind of science due to our inability to make commitments that we will adhere to for large scale experiments, like the one at CERN this summer. And she told us it will not make a black hole that will destroy our universe, since the energy involved will be insufficient to produce anything other than a black hole that would dissipate immediately, and the odds of even that were extremely low. But her session had at most 60 in the audience, while the big presentation later on, with Eric Schmidt of Google, Craig Venter (famed for decoding the human genome) and Muhammad Yunus of Grammen Bank, had frequent comments by Venter about how badly the government funded efforts to decode the genome has performed relative to his efforts (with Milken as moderator making supportive noises). Um, isn't it possible that different types and scales of science require different approaches? And no one seemed willing to acknowledge that our vaunted pharmaceutical industry depends heavily on Federal funding (I've seen estimates in the 40% to 55% range).

Mind you, there were some signs of dissent from the Panglovian posturing. Myron Scholes, both in the large lunch ("Four Nobel Prize Winning Economists) on Tuesday and in a panel discussion on innovation in financial services on Wednesday, attempted at several points to take issue with some of the ideas that might have been oversimplified, and met considerable resistance, as did Edmund Phelps, And I noted what care Scholes took to be precise and non-controversial in his presentation. For instance, in the lunch, Milken, who was the moderator, put up a quote from Joseph Stiglitz which said that we were in the worst financial crisis since the Great Depression. Note that Stiglitz isn't alone in making that sort of observation; Soros and various private analysts (and not just Nouriel Roubini). Even the IMF has been unusually outspoken about its concerns.

So what was the response? The economy is not in a recession, unemployment is low, ergo all this talk is off base. Scholes pointed out that we aren't through this yet and in hindsight things might look different, and was almost hooted down (the response was something like, "we are here to try to forecast the future. Looking back is easy."). Similarly, it was Scholes on the second panel who was the ONLY one I heard mention (and only obliquely) the massive facilities the Fed has implemented, and the efforts made by other central banks.

So this group was also a singularly ungrateful lot. Not only was there NO acknowledgment of the magnitude of the efforts made on behalf of the financial services industry, but every time the government was mentioned, it was with derision and elicited considerable applause.

Not that everyone there drank the Kool-Aid, mind you; in fact, the number of like minded might have been quite substantial (during the dinner the second night, the mention of Obama elicited more applause than the other candidates). I had some very good discussions with some others participants despite the impediment of a conference badge that read "Press." One was quite incensed ("Where's the humility?") and later said the fans were turned up high so no one could smell that they were shitting in their pants. Ouch!

But the example that bothered me the most was the panel on financial innovation. The panel consisted of Lewis Ranieri (who created the mortgage backed securities business), Richard Sandor (who invented financial futures), Myron Scholes, and Milken. Some of the lines of thinking were truly peculiar. What was bad about our financial crisis wasn't that is has and will continue for at least the next couple of years to do damage to people's lives and businesses. No, it was that other countries might become skeptical about financial innovation and thus deny themselves the opportunity to use financial innovation to solve problems like climate change and poverty

Ranieri was far and away the most downbeat on the panel, yet was repeatedly steered away from expressing his views fully. He felt that the problems we witnessed are not inherent to the products (ahem, are the bad incentives inherent or not? How do you separate that out?)He pointed out that the economic difference between doing a mod with a borrower who had some ability to pay was 30% (and in context, he seemed to mean 30% of the value of the original mortgage). He acknowledged that the modifications weren't being made, that the industry needed to cut the Gordian knot and might require legislative relief to do so. He also said that things could get very bad (he invoked the Great Depression) if this path wasn't taken. Mind you, that train of thought came out in snippets, with many attempts to steer him away from it. Milken, by contrast, claimed it was another example of highly regulated banks doing stupid thinks, just like in the sovereign debt crisis of the late 1970s (conveniently forgetting the role Wall Street played in structuring and selling the product, and in repeated and aggressively contacting mortgage orginators and telling them they wanted more product). Milken also maintained that the government should not get involved, the private sector could do a far better job of handling this, again conveniently ignoring the massive subsidies extended by the Fed via negative real interest rates on the short end of the yield curve and an alphabet soup of new facilities. I could go on, but you get the point.

An article earlier this week in the Financial Time by Abigail Hofman focused on the deeply-seated cultural issues that produced the crisis:

I worked for 18 years in investment banking and several aspects of the culture unnerved me. Investment banks are all about making money. At the extreme, this means making money for employees not shareholders. The big revenue producers are revered. It is not considered prudent to upset them by asking too many questions. The subprime meltdown is a perfect example of the "emperor has no clothes" phenomenon. These were complex products, yet obfuscation was considered acceptable. Bank chief executives should have asked more questions. I suspect they saw the juicy profits and hoped underlings understood the risks.

Moreover, investment banking culture has a cult aspect to it. If you work on Wall Street or in the City, you toe the party line. Despite lip-service to "diversity", diversity of thinking is not encouraged. This atmosphere of craven conformity breeds at first complacency and then mistakes.

The Milken conference provided vignettes of how to cultivate conformity: select the likeminded, or at least sympathetic, for high profile roles, and apply subtle and not so subtle pressure to make sure they stay within approved boundaries. But as Hofman's comments suggest, this isn't a Milken conference problem; rather, the conference illustrated certain behaviors found widely in the financial services industry (note also that, at least in my day, most firms were agnostic about their staff's political leanings).

A long time ago at McKinsey, one paradigm they mentioned to me was that people fell somewhere on the spectrum of internalizers and externalizers. Internalizers tend to blame themselves for what happens whether it was their fault or not. They are very conscientious and strive not to repeat their errors. Externalizers blame everyone else for their problems. They are very resilient and well suited to sales jobs. And they are incapable of learning from their mistakes, since they never make any.
Posted by Yves Smith at 2:11 AM

[Arnim Sauerbier]

This confused mass of economobabble is missing the root causes.

1) Fractional reserve banking
2) The central bank inflation-machine which is required to sustain 1
3) Government intervention in and regulation of markets.

Galbraith is a twisted freak. To understand what causes these 'bubbles' and the inevitable crashes that follow, go to mises.org, which predicted all of this long ago.