The Stock Market Crash of 1929

In the 1920s, many people felt they could make a fortune from the stock market. Disregarding the volatility of the stock market, they invested their entire life savings. Others bought stocks on credit (margin). When the stock market took a dive on Black Tuesday, October 29, 1929, the country was unprepared. The economic devastation caused by the Stock Market Crash of 1929 was a key factor in the start of the Great Depression.

A Time of Optimism

The end of World War I in 1919 heralded a new era in the United States. It was an era of enthusiasm, confidence, and optimism, a time when inventions such as the airplane and the radio made anything seem possible. Morals from the 19th century were set aside. Flappers became the model of the new woman, and Prohibition renewed confidence in the productivity of the common man.

It is in such times of optimism that people take their savings out from under their mattresses and out of banks and invest it. In the 1920s, many invested in the stock market.

The Stock Market Boom

Although the stock market has the reputation of being a risky investment, it did not appear that way in the 1920s. With the country in an exuberant mood, the stock market seemed an infallible investment in the future.

As more people invested in the stock market, stock prices began to rise. This was first noticeable in 1925. Stock prices then bobbed up and down throughout 1925 and 1926, followed by a “bull market,” a strong upward trend, in 1927. The strong bull market enticed even more people to invest. By 1928, a stock market boom had begun.

The stock market boom changed the way investors viewed the stock market. No longer was the stock market only for long-term investment. Rather, in 1928, the stock market had become a place where everyday people truly believed that they could become rich.

Interest in the stock market reached a fevered pitch. Stocks had become the talk of every town. Discussions about stocks could be heard everywhere, from parties to barbershops. As newspapers reported stories of ordinary people, like chauffeurs, maids, and teachers, making millions off the stock market, the fervor to buy stocks grew exponentially.

Buying on Margin

An increasing number of people wanted to buy stocks, but not everyone had the money to do so. When someone did not have the money to pay the full price of stocks, they could buy stocks “on margin.” Buying stocks on margin means that the buyer would put down some of his own money, but the rest he would borrow from a broker. In the 1920s, the buyer only had to put down 10–20% of his own money and thus borrowed 80–90% of the cost of the stock.

Buying on margin could be very risky. If the price of stock fell lower than the loan amount, the broker would likely issue a “margin call,” which means the buyer must come up with the cash to pay back his loan immediately.

In the 1920s, many speculators (people who hoped to make a lot of money on the stock market) bought stocks on margin. Confident in what seemed a never-ending rise in prices, many of these speculators neglected to seriously consider the risk they were taking.

Signs of Trouble

By early 1929, people across the United States were scrambling to get into the stock market. The profits seemed so assured that even many companies placed money in the stock market. Even more problematic, some banks placed customers’ money in the stock market without their knowledge.

With the stock market prices upward bound, everything seemed wonderful. When the great crash hit in October, people were taken by surprise. However, there had been warning signs.

On March 25, 1929, the stock market suffered a mini-crash. It was a prelude of what was to come. As prices began to drop, panic struck across the country as margin calls—demands by the lenders to increase the borrower’s cash input—were issued. When banker Charles Mitchell made an announcement that his New York-based National City Bank (the largest security-issuing entity in the world at the time) would keep lending, his reassurance stopped the panic. Although Mitchell and others tried the tactic of reassurance again in October, it did not stop the big crash.

By the spring of 1929, there were additional signs that the economy might be headed for a serious setback. Steel production went down; house construction slowed, and car sales waned.

At this time, there were also a few reputable people warning of an impending, major crash. However, when months went by without one, those that advised caution were labeled pessimists and widely ignored.

Summer Boom

Both the mini-crash and the naysayers were nearly forgotten when the market surged ahead during the summer of 1929. From June through August, stock market prices reached their highest levels to date.

To many, the continual increase in stocks seemed inevitable. When economist Irving Fisher stated, “Stock prices have reached what looks like a permanently high plateau,” he was stating what many speculators wanted to believe.

On Sept. 3, 1929, the stock market reached its peak with the Dow Jones Industrial Average closing at 381.17. Two days later, the market started dropping. At first, there was no massive drop. Stock prices fluctuated throughout September and into October until the massive drop on Black Thursday.

Black Thursday, October 24, 1929

On the morning of Thursday, Oct. 24, 1929, stock prices plummeted. Vast numbers of people were selling their stocks. Margin calls were sent out. People across the country watched the ticker as the numbers it spit out spelled their doom.

The ticker was so overwhelmed that it could not keep up with the sales. A crowd gathered outside of the New York Stock Exchange on Wall Street, stunned at the downturn. Rumors circulated of people committing suicide.

To the great relief of many, the panic subsided in the afternoon. When a group of bankers pooled their money and invested a large sum back into the stock market, their willingness to invest their own money in the stock market convinced others to stop selling.

The morning had been shocking, but the recovery was amazing. By the end of the day, many people were again buying stocks at what they thought were bargain prices.

On “Black Thursday,” 12.9 million shares were sold, which was double the previous record. Four days later, the stock market fell again.

Black Monday, October 28, 1929

Although the market had closed on an upswing on Black Thursday, the low numbers of the ticker that day shocked many speculators. Hoping to get out of the stock market before they lost everything (as they thought they had on Thursday morning), they decided to sell. This time, as the stock prices plummeted, no one came in to save it.

Black Tuesday, October 29, 1929

Oct. 29, 1929, became famous as the worst day in stock market history and was called, “Black Tuesday.” There were so many orders to sell that the ticker again quickly fell behind. By the end of close, it was 2 1/2 hours behind real-time stock sales.

People were in a panic, and they couldn’t get rid of their stocks fast enough. Since everyone was selling, and since nearly no one was buying, stock prices collapsed.

Rather than the bankers rallying investors by buying more stocks, rumors circulated that they were selling. Panic hit the country. Over 16.4 million shares of stock were sold on Black Tuesday, a new record.

The Drop Continues

Not sure how to stem the panic, the stock market exchanges decided to close on Friday, November 1 for a few days. When they reopened on Monday, November 4 for limited hours, stocks dropped again.

The slump continued until Nov. 23, 1929, when prices seemed to stabilize, but it was only temporary. Over the next two years, the stock market continued to drop. It reached its low point on July 8, 1932, when the Dow Jones Industrial Average closed at 41.22.

Aftermath

To say that the Stock Market Crash of 1929 devastated the economy is an understatement. Although reports of mass suicides in the aftermath of the crash were most likely exaggerations, many people lost their entire savings. Numerous companies were ruined. Faith in banks was destroyed.

The Stock Market Crash of 1929 occurred at the beginning of the Great Depression. Whether it was a symptom of the impending depression or a direct cause of it is still hotly debated.

Historians, economists, and others continue to study the Stock Market Crash of 1929 in the hopes of discovering the secret to what started the boom and what instigated the panic. As of yet, there has been little agreement as to the causes. In the years after the crash, regulations covering buying stocks on margin and the roles of banks have added protections in the hopes that another severe crash could never happen again.

Author: Jennifer Rosenberg

How Does 2 Billion Dollars Go Missing?

Wirecard slumps 40% as search for missing billions turns to ...

An online payment company who was once the darling of Germany’s Fintech industry lost nearly 12 million dollars of market value and filed for insolvency just days after revealing a 2 billion dollar hole in its balance sheet.

The missing Wirecard money was supposed to be held in 2 trust accounts but auditors investigating the company said they couldn’t find it.  Now everyone is wondering, where did that money go? Even better, did it even ever exist?

What is Wirecard?

Wirecard is a global Fintech company with over 20 years of payment experience, the German company specializes in providing software and systems that link retailers with consumers as well as the financial system.

They collect payment details from people who make purchases, online, or in store. They form the role of confirming settling processing, that whole transaction when you buy anything online. Their background was a lot in gambling and adult entertainment.

Over the years, the company began to bloom as commerce shifted to online and away from cash payments, it attracted interest from giants like SoftBank and Credit Suisse, their stock grew 6 fold between 2016 and 2018 but some have questioned their business model and some have question if they’re actually worth their market valuation.

Wirecard thinks US$2.1b was a fiction in growing 'disaster ...

In 2016, a report accused Wirecard of malpractice, the main accusation was that they were instrumentally involved in the process of illegal gambling (online), the company denied the allegations. Starting early in 2019, a new wave of Financial Times articles on the company’s global operations led to Wirecard calling in KPMG for a special audit which was supposed to demonstrate to the doubters that their business was legitimate.

However, KPMG said they weren’t able to determine the answer to some of those questions. One such question was; why was there a bunch of money supposedly in some trustee account, and whether the money was really there? When auditors went looking for the 2 billion of cash that Wirecard said was in 2 trust accounts in the Phillipines, what they found instead, was a gaping hole. Electronic scans of documents confirming the accounts had been sent to Ernst & Young (EY). EY finally said that these documents weren’t reliable and they thought they been deceived by Wirecard.

Wirecard's former CEO Markus Braun arrested in Germany - CNN

The Wirecard story then began to unravel rather rapidly, which led to CEO Markus Braun stepping down. Wirecard then came out and said that the missing 2 billion probably didn’t exist, and not long after, Markus Braun was then arrested in Munich, on his way back from Vienna. What he stands accused of right now, is inflating the value of the company by feigning business with these “3rd party acquirers”. He has consistently denied wrongdoing. The partner company in question was supposed to process payments for Wirecard in countries it didn’t have full license to operate in. But it couldn’t be determined whether they actually generated revenue for the company at all. In a matter of days, the company had filed for insolvency proceedings, citing over-indebtedness as the reason.

Two. Trillion. Dollars? Here's where all that coronavirus stimulus ...

So where exactly did the 2 billion go you might be wondering? Wirecard executives have proposed 2 theories, 1st being that the numbers were made up, the revenue was never there and that Wirecard was simply trying to inflate the value of its business in order to make its shares more attractive, in order to borrow money. Their other theory is that this “business” did exist, but for some of the “business” wasn’t really being done on behalf of Wirecard, and the money was never put into where it should’ve been put. Instead, they believe that it has been in all or in parts taken by some other people, some where.

Enron's former CFO Andrew Fastow once saw himself as 'a hero ...

Those who are familiar with the Enron Case that happened a decade ago may see the similarities between them. It’ll be interesting to see how this story develops and what else is revealed in the process.

FIXATING ON CONSUMER PRICES WHILE IGNORING ASSET PRICES

For most fields of study, the goal is to progress ideas and seek truth. This doesn’t seem to be the case in economics.

It’s not just the Fed; it’s the entire global community. The Central Bank of Sweden recently shared a press release showing they have similar concerns to the Fed and want to facilitate the “supply of credit” while striving to hold market rates down. The bank further stated the difficulties faced with interpreting its inflation statistics during times of pandemic, noting:

For one thing, prices have been lacking for certain goods and services, as these have not been consumed, and for another thing the actual consumption by Swedes during the pandemic does not correspond to the weights in the consumer price index. Quite simply, the Swedish people have bought more toilet paper and fewer trips abroad than the weights in the consumer price index imply.

The problem with measuring “inflation” has also been expressed by the Bank of Canada. It’s not just the relative weights which are problematic, but also the volatility of the data that impacts the “inflationary experience” of the Consumer Price Index sample size, making interpretation difficult:

in any given month, the CPI can be quite volatile and not reflect its long-term trend. That’s because prices of items such as fresh fruit and vegetables or gasoline can jump around a lot, affecting the CPI.

Especially since “these aren’t normal times,”

Canadians are spending much less on gasoline and air travel, and more on food purchased from stores. And until very recently, they weren’t spending anything on haircuts. The implication is that the CPI isn’t fully reflecting people’s current inflationary experience.

In formulating an arbitrary basket of goods to include items such as gasoline, fruits, vegetables, and toilet paper and then assigning an arbitrary weight of relative importance to these items, central bankers obsess over consumer prices while ignoring asset prices such as those of stocks, bonds, and real estate.

Author: Robert Aro

The Good Economist vs. The Bad Economist

Frederic Bastiat made a clear distnction between the good economist and the bad economist. For him, the good economist looks beyond what is immediately apparent and instead looks much further into the future. In this world, however, we have many bad economists, and as Bastiat writes in “That Which Is Seen, and That Which Is Not Seen,” “It almost always happens that when the immediate consequence is favorable, the ultimate consequences are fatal, and the converse.” As a result, Bastiat warns, “It follows that the bad economist pursues a small present good, which will be followed by a great evil to come.”

A refusal to look beyond the immediate and “seen” to the “unseen” also leads to bad economic theory, which, beyond the mere foibles of individual economists, solidifies the practice of ignoring the hidden future effects of economic policies. These bad theoretical frameworks inevitably lead to bad policies and eventually the destruction of wealth via misallocation of resources within the economy.

This phenomenon is certainly common enough in modern economic policies and their underlying theoretical frameworks. For example, we have a large body of economics built on pseudo-facts and unrealistic assumptions. This has been characterized in part by the over-mathematization of economics. As a result, economic analysis relies only on those phenomena that can be quantified, measured, and fit within certain types of models. Other information is ignored.

In other words, policies built on these theoretical frameworks and mathematical models focus heavily on what is seen, such as prices, wages, volume, GDP, and other such metrics. A decline in these factors, it is believed, must immediately be remedied by other measurable activities, such as injection of money and credit into the economy, regulations, subsidies, and so on.

These have an immediate short term and “seen” effect. But, as they are hard to observe, the long term and “unseen” consequences are often ignored, disregarded, or outright denied.

However, the long term and unseen consequences of these may include changes in and the distortion of the market structure, inflation, stifled trade, destruction of capital and wealth, and misallocation of labor, capital, and production capacity. These factors may be very hard to observe, although they have deeper and lasting effects on the growth and sustainability of the economy.

These unmeasurable distortions of the economy often destroy capital and give rise to zombie companies and sectors that end up suffocating the economy by driving out productive companies and sectors.

Bastiat continues, “The true economist pursues a great good to come, at the risk of a small present evil.” Good economics looks to the long term and it confers great importance to what is unseen due to the fact that it almost always has longer lasting, more severe, and deeper consequences. For example, excessive borrowing by government and then the handing out of welfare is seen. But the entrepreneur who is crowded out of the credit market, the potential jobs, and the increase in national wealth that he could have contributed are unseen.

So how to practice good economics?

The good economist takes a very different view, recognizing the importance of uncovering hidden effects and relationships. This can be facilitated with less attention to mere quantitative analysis and more attention to sound theory and qualitative analysis. This, however, requires prudence and restraint on the part of the economist. It requires he or she allow natural market structures and mechanisms to follow their natural trajectories so as to organize the market in the most efficient and productive way. How or when this is done cannot always be directly observed, and thus it becomes difficult to tinker endlessly with the machinery of the economy.

The good economist, however, will not be discouraged by this, and will instead pursue a greater understanding of the economy that includes the unseen and well as the seen.

The Problem with Idolizing “Efficiency”

Radical Markets has at least one virtue. The book contains many unusual proposals, and I propose to concentrate on one of the strangest of these. Eric Posner, a legal scholar, and Glen Weyl, a principal researcher at Microsoft, call for speculative boldness, and they have given us that; but sound argument is another matter.

The authors agree with prevailing leftist dogma on one matter, but differ with it on another. They accept the conventional wisdom that inequality in the world economy is extreme. “Together, the trends of rising inequality and stagnating growth mean that typical citizens in wealthy countries are no longer living much better than their parents did. … These trends pose the same problem for the neoliberal economic consensus that stagflation posed for the Keynesian consensus before it. We were promised economic dynamism in exchange for inequality. We got the inequality, but dynamism is actually declining.”

Posner and Weyl do not discuss skeptics about the rise of inequality, such as Thomas Sowell and the authors of Anti-Piketty. Let us leave that point, vital as it is, to one side. They also fail to address this question: why is inequality bad? Like almost all egalitarians, they just assume that it is and proceed from there. Though they continually call for fresh thinking, they never question this prevailing shibboleth of our age.

They differ with the left, though, in their view of markets. For Posner and Weyl, the market deserves praise: “Our premise is that markets are, and for the medium term will remain, the best way of arranging a society.”

Posner and Weyl support markets and favor equality. The free market does make the poor, along with everyone else, better off; but this does not for our demanding authors suffice. The market allows too much inequality.

What then is to be done? The authors have detected a crucial flaw in markets as they are now constituted. Markets are not perfectly competitive, “meaning that there are a small number of homogeneous commodities, and no individual holds or buys a large fraction of them.” Because of this, most buyers and sellers have “bargaining power.” This wastes time and resources. “Each party works hard to ascertain what the other would be willing to pay or accept and jockeys for the best price possible. Such strategic behavior often causes trades to fail. Even when they succeed, huge amounts of time and effort have been wasted in the process. These problems are magnified in complex business transactions.” In other words: bargaining power withholds vast amounts of resources from the market.

Just as the authors never pose the question, why is inequality bad, they never provide an argument that all resources should at all times be available for sale. Why is it bad to withhold resources in the hope of better terms later? We are never told.

The best the authors manage is this: “How can we measure ‘the greatest happiness for the greatest number’? How is it possible to compare the happiness of one individual to that of another? Many economists have argued that this task is impractical. They suggest that all we can hope for is ensure that no one’s happiness can be increased without decreasing anyone else’s, a condition called Pareto efficiency, and that the total happiness is distributed fairly.”

Now the cat is out of the bag. If an increase in the monetary value of resources is taken as roughly equal to an increase in utility, then bringing withheld resources into the market generates efficiency gains. It is Pareto superior, as neoclassical economists phrase it.

This merely pushes back our question: why should Pareto efficiency be the criterion by which economic

policies are assessed? Murray Rothbard has trenchantly remarked: “there are several layers of grave fallacy involved in the very concept of efficiency as applied to social institutions or policies: (1) the problem is not only in specifying ends but also in deciding whose ends are to be pursued; (2) individual ends are bound to conflict, and therefore any additive concept of social efficiency is meaningless; and (3) even each individual’s actions cannot be assumed to be ‘efficient’; indeed, they undoubtedly will not be. Hence, efficiency is an erroneous concept even when applied to each individual’s actions directed toward his ends; it is a fortiori a meaningless concept when it includes more than one individual, let alone an entire society.”

How do Posner and Weyl propose to curtail bargaining power? Their solution is a “common ownership self-assessed tax (COST) on wealth.” In this proposal, everyone would set a price for each of his assets, and that assessment would be the basis for taxes. If you object that people would set this assessment absurdly low to avoid taxation, here the ingenuity of the scheme emerges. Once someone makes his self-assessment, anyone could purchase the asset at that price. In this way, efficiency goes up, because the purchaser would not buy the asset unless he thought he could generate a greater return than he paid for it. Wealth, our proxy for efficiency, rises, and bargaining power has been curtailed.

To this there is an obvious objection, and the authors have a response to it. The objection is that an investor would not buy an asset he wanted to develop over a number of years if he thought someone else could purchase it from him by paying his assessment price. They answer by lowering the tax rate; people who had to surrender less of their gain to the state would invest more. That is indeed so, but would this not defeat the purpose of the efficiency plan? With lower taxes, people would, in order to deter buyers, raise their self-assessment prices for assets they wanted to keep. You would no longer find it so easy to snatch someone’s assets out from under him. Posner and Weyl respond: “When the tax is reduced incrementally to improve investment efficiency, the loss in allocative efficiency is less than the gain in investment efficiency.” “A fully implemented COST,” they suggest, “could increase social wealth by trillions of dollars every year.” Further, the vast revenue generated by taxes on the added wealth could be used to reduce inequality.

The authors admit a drawback to their plan. What if you have assets that you do not wish to sell at any price? Is the only way to avert the chance someone will purchase your asset to set a price on it that will subject you to crushing taxation? They suggest averting this through exemptions; but they have a more fundamental response: “The COST could also make us think about property in a different and healthier way. A COST taxes objects, not personal relationships. Wouldn’t it be better if people invested less of their emotional energy in objects and more in their personal relationships? … Fetishistic attachment to a privately owned automobile — an extremely expensive durable asset … is, thankfully, becoming a thing of the past. Increasing economic evidence suggests that excessive attachment to homes is inhibiting employment and dynamism in the US economy, a problem a COST would greatly reduce.”

Here the difference between the position of Mises and Rothbard and the “radicalism” of Posner and Weyl emerges with complete clarity.  Mises and Rothbard accept people as they are: from that starting point, they argue that the free market permits mutually beneficial trades. Posner and Weyl are “Progressives” who want to remold people in their own image.

When I read the authors’ account of COST, I wondered: if the authors are so concerned to increase social wealth, why allow individuals to choose their occupations? What if you could generate more revenue in a different occupation from the one you prefer? Suppose that a writer could earn vastly more money as a stockbroker. Should he be free to deprive society of all the taxable wealth he would earn in the higher paying job?

Sure enough, the authors head in this direction, though they draw back from its implications. “Consider a very radical extension of the COST: to human capital …  imagine that individuals were to self-assess a value of their time, pay a tax on this self-assessed value, and stand ready to work for any employer willing to pay this wage … in principle, A COST on human capital would be immensely valuable.”

Unfortunately, society is not yet ready for this proposal. “A COST on human capital might be perceived as a kind of slavery — incorrectly in our view, at least if the COST were properly designed. Still, we can see the problem.” For now, the proposal is premature.

Whatever the defects of their ideas, though, do not Posner and Weyl deserve credit on one score? They do, after all, say that markets “are … the best way of arranging a society.” Alert readers will have noticed, though, a qualification in the passage where they say this, quoted earlier in this review: “and for the medium term will remain.”

What do they mean by this? They pay generous tribute to Mises’s socialist calculation argument, but unfortunately they misunderstand it: “The brilliant economist Ludwig von Mises argued that the fundamental problem facing socialism was not incentives or knowledge in the abstract but communication and computation.” Mises’s socialist critics argued that there was “no difficulty in principle with solving a (very large) system of equations relating the supply and demand of various goods, resources, and services.”

Mises was right. “Yet the later development of the theory of computational and communications complexity vindicated Mises’s insights. What computational scientists later realized is that even if managing the economy were ‘merely’ a problem of solving a large system of equations, finding such solutions is far from the easy task that socialist economists believed.” New developments in parallel and distributed processing, though, may enable these problems to be solved, and the market as we know it may be superseded. Mises is thus a pioneer in computer science. One can only quote, on Mises’s behalf, Eliot’s lines in “The Love Song of J. Alfred Prufrock”: “That is not what I meant at all;/ That is not it, at all.

Author:

David Gordon is Senior Fellow at the Mises Institute, and editor of The Mises Review.

Price Controls Mean Shortages, Even during Pandemics

The COVID-19 pandemic has impacted the lives of billions and has put many Americans and others around the globe in compromised financial situations. As the COVID-19 virus (also known as the coronavirus) has continued to spread, this has led to feelings of anxiety, panic, acrimony, and uncertainty for a lot of Americans, even leading to altercations in stores due to the shortages of hand sanitizer, toilet paper, disinfectants, etc. In keeping with the laws of supply and demand, the exponential demand for the aforementioned products, mainly hand sanitizer, led to price hikes by some retailers and sold-out inventory because of individuals and companies purchasing in bulk in order to resell. There were common consumers who rushed in droves just to purchase hand sanitizer for themselves and their families. The strong demand for hand sanitizer caused so much volatility in the economy that retailers began charging up to $80 for forty ounces of hand sanitizer. Governor Cuomo has announced that in New York State the state government will crack down on retailers and punish them with fines and possible incarceration for “price gouging” in the midst of the coronavirus. New York City has already issued 550 violations equaling $275,000 for the rise in pricing of face masks, disinfectant wipes, and hand sanitizer. In the state of New Jersey, eighty stores have been warned to “stop price gouging” or face $10,000 in fines.

The Disastrous Effects of Price Controls

This strategy is likely to lead to disaster. Whenever the government intervenes in the market and manipulates pricing for the sake of affordability, this leads to a shortage of products that deprives a large number of consumers of the requested goods or services. There are numerous examples of price controls and their disastrous results, such the 1793 famine in France due to the shortage of bread and rent control in Egypt, which led to distressed and dilapidated buildings with generational tenancies mandated by the Egyptian government. In the latter case, there was no incentive to renovate, because landlords couldn’t afford to, thanks to stagnant rents. Additionally, in San Francisco in 2001, three-quarters of rent-controlled buildings were more than fifty years old, while in England and Wales privately built rental housing decreased from 61 percent of all housing in 1947 to just 14 percent in 1977. Another example of price control is the US gasoline shortage during the 1970s, when the Organization of Petroleum Exporting Countries (OPEC) imposed an oil embargo, which led to a decreased output of oil to the United States, which in turn led to a shortage of another commodity, time. In this case, though filling stations had been open for 110 hours a week on average in September 1978, during the shortage, in June 1979, they were decreased to 27 a week! There are other examples of price controls specifically pertaining to shortages, but to extrapolate from these examples, price controls lessen the producer or retailer’s incentive to please the consumer, since their business is compromised due to government manipulation of their prices.

Pandemics Don’t Abolish the Need for Market Pricing

In the case of COVID-19, since retailers aren’t allowed to “price gouge,” this had to lead to immense shortages of hand sanitizer, especially throughout the the tristate area (New Jersey, New York, and Connecticut). I personally went to five different pharmacies, including a Wal-Mart, yesterday and they all stated that hand sanitizer hasn’t been in stock in the past week. In this case, governmental manipulation of hand sanitizer prices has not benefited the masses, since there is a lack of availability of these products in the midst of a globally alarming pandemic.

In an unhampered market, of course, as the demand increases for a product, the price of the supply increases. But there’s an upside for the consumer here: when the price of a good goes up, the quantity supplied goes up as suppliers attempt to meet demand at the higher price. In any case, the price of a product is dictated by the consumer. Sellers can try to sell products at far higher prices, but if the eighty-dollar price for a bottle of sanitizer is too high, then the retailer would either have to lower the price or incur losses for merchandise that isn’t moving. Also, if Retailer A wants to charge eighty dollars for hand sanitizer, this creates an opportunity for competitors to charge less. In this case, the retailer does not suffer from government-imposed fines, but from consumers who abandon it to purchase from lower-priced ones. Manufacturers will redirect production to the most profitable and in-demand products, in this case hand sanitizer.

Whether it’s the coronavirus, the swine flu, the bird flu, Ebola, or any pandemic, we need to understand that the laws of economics still prevail and that governments have never been able to create more goods and services through price controls and other regulations. In fact, such measures lead to shortages and deprivation.

Author:

Baruti “Libre” Kafele

Baruti Libre Kafele is an entrepreneur, commercial real estate broker, public speaker and writer on multiple topics from political science, microeconomics, macroeconomics, international relations, etc. Libre Kafele is an honors alumnus of Kean University and Georgetown University by way of The Fund for American Studies. Libre Kafele has a passion for freedom and liberty in all areas of human activity. You can follow Baruti Libre on Twitter @BarutiLibre.

References: https://mises.org/wire/price-controls-mean-shortages-even-during-pandemics

What If the Central Bank Did Nothing?

——Article Share——-

Austrians and Libertarians are well-established critics of central banking in general, and emergency monetary stimulus in particular. There is near universal agreement that Alan Greenspan should not have cut rates following the Dot-Com Bubble, and that Ben Bernanke and Janet Yellen should not have quadrupled the monetary base following the Housing Bubble.Yet if you mention this to someone who is not persuaded of our position, you will likely get a response along the lines of, “well, what should they have done instead?”

“Nothing,” you reply.

“Well then wouldn’t things have been even worse?”

It’s this last question that I don’t believe we have answered to great effect. What would the effects have been if Greenspan, Bernanke, and Yellen had simply frozen the monetary base during their respective crises? More importantly, what would be the effect today if Powell did so?

We are currently in a situation in which many business’ revenues have dried up. Airlines, retail stores, restaurants and bars, cruise lines, oil companies, and others have seen their cash flow deteriorate over the first quarter of this year. Nonetheless, many of their obligations remain: rent still has to be payed; loan payments still need to be made; salaries still need to be paid, etc. As a result, the demand for loanable funds has gone through the roof. The Fed has responded to this situation by injecting hundreds of billions of dollars (if not yet trillions) into various lending markets such as the markets for repurchase agreements, treasury bills, municipal bonds, and mortgage-backed securities.Don’t be intimidated by the technical specifications of these particular instruments. All of these various open market operations amount to different versions of the same thing: the Fed is responding to the demand for loan-able funds by printing new money and lending it.

Given our opposition to these actions, it is worth playing through the exercise of describing what would happen if the Fed simply sat this one out. What prices would change? What levers would move? How would normalcy once again be restored?

As businesses begin to demand short term loans in order to meet their obligations, the first thing we would begin to see is that interest rates would rise. Likely they would rise a lot. For the sake of argument, let’s say the short term interest rate shot up to 15 or 20% on an annualized basis. The effect of this rate change would be two-fold: first, it would push the marginal borrower out of the market. This would mean that borrowing for non-essential purposes would be curbed. Credit card rates, for example, would be much higher than normal, and people would be strongly incentivized to pay in cash whenever possible. This would free up funds that could flow to businesses facing financial distress. Second, those who do keep cash balances would be strongly incentivized to enter the lending market. Those who had sidelined cash, and had been missing out on the excellent returns of the stock market would suddenly have the opportunity to return 10% in six months on a Certificate of Deposit (CD) account while the stock market is in a state of precipitous decline. This would add even more funds to the lending market, and provide a further lifeline to businesses in need. All of this, however, starts with the premise that interest rates are allowed to rise. When the Fed suppresses short term rates, this mechanism is broken: there is no incentive to curb short-term borrowing for non-essential purposes, and there is no incentive for those with cash balances to supply short term loans. As of this writing, the yield on CDs at Bank of America is between 0.03 and 0.15% for balances under $10,000andlittle better for balances above that threshold. As a result, a difficult situation is becoming a genuine liquidity shortage, and financial distress for under-capitalized firms has become a financial emergency for the entire system.

A concept that can help keep these conversations grounded is the acknowledgment that there is no free lunch. When the Fed buys treasury bills, and the federal government uses those funds for bail-outs, even though the money is being printed fresh, the purchasing power has to come from somewhere. In this case, it’s coming from the diluted value of cash balances. So as we can now see, regardless of whether central banks intervene, the lifeline to the economy must come from the cash balances of savers. There is nowhere else for it to come from. The question is simply who gets to profit from this state of affairs. In the absence of Fed intervention, it is the savers who profit. They are rewarded with handsome returns for rescuing those firms who did not prepare for the worst. When the Fed does intervene, the reward goes to under-capitalized banks, and over-extended businesses, who get loans at a price that does not at all reflect the cost they are imposing on society.

Needless to say, these incentives are perverse. Not only are we engaging in the ethically dubious practice of rewarding the profligate and punishing the prudent, but with each next iteration, we are incentivizing poor management decisions, and discouraging the very saving that has just been tapped as a lifeline. With each next business cycle; with each next monetary stimulus; with each next round of bail-outs, our society will find itself with fewer and fewer savers who can be squeezed to rescue the economy. Indeed we are approaching this point already, as a Bankrate survey in 2019 revealed that only 41% of Americans would write a check to cover a $1,000 unexpected cost.The longer these incentives remain in place, the smaller that pool of savings will be, and the dimmer our prospects will become of bouncing back from an unexpected supply shock like that brought on by the COVID-19 panic.

So in conclusion, I’ll contrast this dire picture one last time with the question: what would happen if the Fed did nothing? Savers would profit very well over the coming year. Viable businesses would eat the cost of borrowing at higher short-term rates, but would ultimately be able to weather the storm. Some businesses would inevitably fail, and their resources would become available to more productive uses. But most importantly, the signal would emanate through society that it pays to save. It pays to be prepared for a rainy day. And next time, more would be.

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Contact Noah Bonn

Noah Bonn works in consulting as an actuarial analyst for the health insurance industry, and worked previously with retirement savings plans. He is a 2015 alumnus of Mises University.

Original Site: https://mises.org/wire/what-if-fed-did-nothing?fbclid=IwAR19IHshwaLhddiUap1CtoWP4ACT2Xzgmb235fYKH2–x-QRwTyU4K42dko