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Österreich in Kanada?

In today's green-eyeshade-y column for the Post (second in a row!), I read between the lines of a recent speech by the governor of the Bank of Canada and find hints of Austrian-influenced policy aggression that other domestic finance reporters might have missed. Or, that I'm totally imagining. There's no Post on Boxing Day so this is it for columns from me this week: back on the 30th.


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But the bank’s actual mandate, he adds, is to “promote the economic and financial welfare of Canada.”

So if I read this article correctly, you're in favour of an increased interventionist approach from our Central Bank? Call me an old fashioned free market capitalist, but I'm weary of any proposal that suggests that some centralized authority would be better at allocated financial resources than the private market.

And far from advocating an "Austrian approach" to Central Banking, I'd suggest that Carney is arguing for the exact opposite. Austrian theory, in its most simple form, states that artificial interference (be it the government or Central Banks) should be kept to a minimum, that private markets are the best allocators of capital, and that business cycles are necessary in order to kill off weaker industries and to ensure that financial resources are allocated to industries where they will earn the highest returns.

Carney seems to think that with a sufficient amount of prudence, Central Banks can help prevent severe market downturns and in effect "smooth out" out the business cycles that are inherent to capitalist economies. This sounds far more Keynesian to me than Austrian, but perhaps I have misread you.

In a few other countries, central banks have actually been given rights to adjust capital requirements, loan criteria and exposure limits for big lenders on the fly.

Why anyone thinks this is a positive development is totally beyond me. The suggestion that a centralized authority, separated from the everyday realities of the market, would prove to be a better manager of capital than the private market strikes me as being an idea that has been rejected by historical experience countless times. The suggestion that this authority would be able to correctly identify every "bubble" and address it accordingly also strikes me as being naive.

Look, I'm not some unadulterated free market capitalist that thinks there's no place for the government guidance or central planning in the development of a nation's economy. A cursory read of history will show that centralized planning played a significant role in the establishment of many modern economies, be it the United States, Japan, South Korea ect. But having said that, I am far more comfortable with the private market occasionally spinning itself into speculative bubbles and blowing itself up, than I am with Mr. Carney telling me he knows exactly how much liquidity, and risk, and speculative capital there should be in an economy at any given time.

If this market downturn has taught us anything, it's that we need more transparency in capital markets, not more centralized intervention.

I take no particular view on the development I describe in today's piece. I think there are very great merits to keeping the focus of central banks on inflation.

It is awkward for any Austrian-influenced theorist to have a view on how fiat money ought to work at all, for obvious reasons. Austrian business-cycle theory dictates that a fiat-money regime will inevitably create a "wrong" rate of interest and consequent malinvestment. The White/Carney idea, if I've understood it, is that a central bank might as well be able to look at actual lending practices (or even just monetary aggregates, which went ignored in the runup to this crisis) and behave countercyclically when people start to do things that are obviously dumb. Like, let's say, making politically motivated, heavily backloaded home loans to people who have no hope of affording them.

Parameters like reserve ratios are state-regulated anyway: the question before us is perhaps whether they ought to be regulated by elected officials or by people beyond the reach of base electoral incentives.

Garth Wood:

Indeed.  A friend of mine who runs an investment fund in SoCal told me in July of '07 a little story about a "salesman" (for that, at bottom, was all this person was) who tried to sell his fund a swack of ABCP in '06.  My friend asked the simplest of questions: "What're the assets?"

To which the salesman replied "We don't know — they're anonymous."

And that was the end of the meeting.

His requirement for simple knowledge of the type of asset underlying the paper he might be buying would've gone a long way to nipping the present crisis in the bud.  Transparency or its lack (as well as the desire for transparency, which was something a lot of the purchasers of ABCP should have had) was all he needed to make the correct decision.


"we need more transparency in capital markets"

You're not necessarily going to get that from a "free" market. The smartest people involved in capital markets have an incentive to DECREASE transparency. Why? Because if only rocket scientists can figure out what the situation is, they can demand more money for their enlightening services. Indeed, investment bankers do not compete on price (good luck on trying to successfully run "I Can't Believe It's An Investment Bank!" a la Lionel Hutz). Investment banking is largely a cartel interested in maintaining a high barrier to entry, the barrier being whether one tipples at Manhattan or London's Harvard Club or not.

I say this as an economist. From an economic point of view, people who are smarter at pricing capital should be rewarded, so there is an incentive to price it efficiently. But much of the money is flowing to people who price derivatives, which do not price capital. Derivatives DERIVE their prices from underlying securities. In terms of financial taxonomy, derivatives are parasites. And the biggest rewards are going to the creators and pricers of second or even third order derivatives of derivatives. This diverts resources from pricing of the primary market for capital, and it's the primary market that matters with respect to macro investment levels. A medium sized enterprise can't get capital today, because banks lost so much money playing the shell game of derivatives, a game that, unlike the primary market, is zero sum.

Diversifying risk is good if it increases the supply of capital. But when investment bankers came in and sliced, diced, and repackaged mortgage based products for distribution, they ultimately did their clients a disfavour. The financial sector would've been better off having those exposures still clearly and plainly on bank books since originating banks would have monitored that account. As it turned out, we ended up with a "tragedy of the commons" when the risk was spread across the field. No one was minding the store.

A "tragedy of the commons" is what economists call a negative externality, and is a serious, rational argument for the occasional restricting of "free markets".

In my time at Finance Canada I saw Carney in action in person, and become increasingly convinced that if there was a command economy under Carney, it would actually do pretty well just as a benevolent dictatorship would do better than a demagogue-ridden democracy given the right dictator. The biggest problem with command economies to date is that the commanders didn't understand or simply defied economics.

....the evidence of that being that they tried to command it, of course. So that's a bit circular.

But what if transparency is defined, not as "Market-relevant information gets shared broadly and firms have oodles of regulatory filing requirements", but "All information is allowed to flow through to price signals"? Legalizing "insider" activity and taking the regulatory manacles off of short-sellers might do as much to prevent malinvestment and bubbles as anything.


As usual Colby is crisp, correct, and considerably overweight. What does a fat man understand of a measured response?

There is no Crisis. The crisis of the 80s was like three or four times worse. WE didn't have bloggers or amateur newsmen in the 80s.

I've become fucking sick of the word crisis. My personal rule is you don't use the same word or phrase within convenient eyeshot, for me that can be pages away depending on the language.


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