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One of the best resources in tracking the credit so during the discussion). For systemic
dimension of the unfolding drama of stable price stability—certainly including asset
instability1 is Doug Noland's excellent Credit Bubble markets and the Current Account—the
Bulletin, in the latest issue of which he offers some Federal Reserve must take an active role in
choice excerpts from a panel discussion at a recent regulating Credit expansions and system
meeting of the Western Economic Association:2 liquidity (“monetary” in the broadest
meaning of “finance.”). Special attention
Question from the audience: “Professor
must be given to monitoring and disciplin-
(Milton) Friedman, do you think there’s a
ing the marketplace in the event of
role for the Fed in identifying and managing
heightened leveraging and speculating.
asset price bubbles?
Admittedly, this would be a complex,
Friedman: “No.”
radical and challenging departure from
Questioner: “Could you elaborate?” simply pegging short-term rates (or even
“inflation targeting”), but one I believe is
Dr. Friedman: “The role of the Fed is to necessary. And Dr. Poole may believe that
preserve price stability. Period. And price a Fed role in “controlling” asset markets is
stability in a broad aggregate—in a broad “incompatible with a market economy.”
index. It should not be concerned with the Yet, pegged interest rates, Fed assurances
asset markets as such, only as they effect of abundant marketplace liquidity, and
indirectly—somehow—the price stability as consequent inflating asset markets are
a whole.” these days dictating our system’s (gross
Federal Reserve Bank of St. Louis President mis)allocation of resources and “capital.”
William Poole: “If I could just add to that. I The current Monetary Disorder, and its
absolutely agree. And one of the reasons I perversion of system pricing mechanisms,
take that position—I’m really a hardliner on is anathema to our Capitalistic system.
this. Let’s suppose that the Fed—as you Having asset markets as a prime focus of
would want with any good policy central bankers is not a “good policy
instrument—had perfect control over asset instrument”—but an all-important process
prices. I think it is incompatible with a we’ll have to learn to live with. The
market economy to have a government Creation and Flow of (contemporary)
agency setting asset prices that are meant Finance is no longer manageable under the
to allocate capital.” current system.
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problematic in that it ignores the Fed’s potential reason for monetary policy but to effect some major
role in facilitating asset price bubbles prior to any change in the outcomes that would have otherwise
such identification. resulted in a market economy without a centralized
means of monetary inflation and credit creation.
Recalling the basic architecture of stable instability
Therefore, if we can see that monetary policy has
—the competitive/cooperative dynamic between
been inflationary for several years and we can see
centralized intervention policies of the state and
that certain asset prices have been rapidly appre-
decentralized exchange strategies in the market—
ciating in the wake of this policy and all the more so
we can see that asset prices are influenced by both
when increasingly-easy-to-acquire credit financing
forces simultaneously. Just as important as these
is being used to purchase these assets (e.g.,
objective asset prices are the subjective strategies
housing, mortgages, and mortgage-backed securi-
of investors and the subjective policies of bankers,
ties), then it is not much of a leap in logic to
which constitute the actionable knowledge base
conclude that the Fed is in part responsible for
with which they design their actions, interpret their
these asset prices, bubble or no bubble.
results, and learn from experience. Through this
experience-based learning process, these asset
prices then inform the gradual development of more By definition, everything the
effective investor strategies and monetary policies central bankers say and do is
which, in turn, guide future actions by investors and
designed to produce prices in
bankers. These single-loop and double-loop learning
processes are therefore essential to both the short- assets and other goods that are
term performance and the long-term sustainability different from those that would
of asset prices.5 have resulted in the absence of the
central bankers’ interventions.
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in the prices of many assets—e.g., stocks, bonds, distortion of market prices—the observable,
houses—which are often touted by government measureable results of past market decisions—in
economists as the increasing savings balances that order to incent market participants to make future
more than offset any downside associated with the market decisions that they would not have made if
decreasing saving rates. In other words, as long as they could have based these decisions on valid
wealthier householders see the value of their market prices. Thus, as the model above suggests,
houses, stocks, bonds, and others assets rising, monetary interventions in the credit dimension of
even in the absence of any new saving, then all asset markets can, through the distortion of asset
householders as a group are considered to be prices, undermine even leveraged speculators’
relatively secure. efforts to learn from their market experiences and
create more adaptive and sustainable market
strategies.
If this self-reinforcing dynamic
between monetary inflation and If rising asset prices appear to confirm the validity
of leveraged speculation while not disconfirming the
leveraged speculation does not at
validity of monetary inflation, thereby encouraging
least give central bankers and more of both, then we have a self-reinforcing
leading economists pause to reflect, dynamic, the limits to which are as psychological as
then it would seem that there is they are financial. If this self-reinforcing dynamic
very little learning of the double- between monetary inflation and leveraged specula-
loop variety to be expected tion does not at least give central bankers and
leading economists pause to reflect, then it would
in the near future. seem that there is very little learning of the double-
loop variety to be expected in the near future.
Absent a conscious second-order, frame-changing,
Overall, with more consumption and more
double-loop revision in central bank policy or mass
investment, both funded with increasing degrees of
investor strategy, this self-reinforcing dynamic
leverage, we are seeing rates of US economic
would likely build into a crisis sufficient to force
growth that are higher than what they would have
such changes.
been absent the monetary policy interventions.
Furthermore, US economic growth appears to be
increasing all the more so because of the growth in
deficit-spending by the federal government, which
has been fueled by lower interest rates for its own This July 2005 work is licensed under a Creative Commons
Attribution-Noncommercial-No Derivative Works 3.0 License.
debt obligations as well as the seamless
monetization of its budget deficits as a critical
component of the Federal Reserve's inflationary 1
Daniel O'Connor. (2005). “Stable Instability.” Catallaxis.
monetary policy. http://www.catallaxis.com/2005/02/stable_instabil.html.
Retrieved July 10, 2005.
Such is the basic argument for the use of monetary 2
Doug Noland. (2005). Credit Bubble Bulletin.
and fiscal policies—increases in the supply of money http://www.prudentbear.com/archive_comm_article.asp?categ
and credit and increases in deficit-financed ory=Credit+Bubble+Bulletin&content_idx=44645. Retrieved
government spending—to drive economic growth, July 10, 2005.
3
Daniel O'Connor. (2005). “The Economic Philosopher’s
particularly in the midst of recession. So much the
Stone.” Catallaxis. http://www.catallaxis.com/2005/03/
better if the US government can get foreign central the_economic_ph.html. Retrieved July 10, 2005.
banks to play along with them because of the US 4
Daniel O'Connor. (2005). “Unprecedented Fundamentals.”
dollar's unique status as the leading global reserve Catallaxis. http://www.catallaxis.com/2005/04/
currency. unprecedented_f.html. Retrieved July 10, 2005.
5
Daniel O'Connor. (2005). “Stable Instability.” Catallaxis.
The critical weakness in this proto-global-Keynesian http://www.catallaxis.com/2005/02/stable_instabil.html.
policy, it seems to me, is that it relies on the Retrieved July 10, 2005.
Daniel O'Connor is the managing director of Integral Catallaxis explores the potential for a more integral
Ventures, a strategy consultancy committed to foster- approach to the business and economic challenges of
ing more innovative and sustainable ways of doing our time. It features original articles and essays,
business. He has been a pioneer in the development of thoughtful reviews and commentary, and referrals to
integral praxis in business and economics, having other work in the field.
authored numerous articles and essays in this
emerging field. To search the archives and subscribe to future
issues, visit www.catallaxis.com.
email: daniel@integralventures.com
website: www.integralventures.com
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