Economic reality Mehrling tweeted a link to a BIS paper: What are capital markets telling us about the banking sector? On page 6, the author, Jaime Caruana, writes:
In general, leverage is influenced by the combination of the perceived creditworthiness of the borrower and the overall tightness of credit in the financial system. If the system as a whole offers ample funding liquidity, even thinly capitalised banks can borrow on easy terms. Since banks borrow in order to lend, easy borrowing conditions translate into easy lending conditions, reinforcing the already easy financial conditions. By the nature of the interactions between liquidity conditions and leverage, the boom phase traces an apparent virtuous circle of greater leverage and easier liquidity. But this virtuous circle is only apparent, not real. Reality returns when the easy conditions go into reverse, and the amplification mechanism traces a downward spiral.
--- The "Reality" cited is psychological, not physical. Why did funding liquidity dry up in 2007-2008? There was no physical scarcity, no shortage of food or building supplies. There was a scarcity of bankers willing to create money at the pace they had been. The Fed stepped in with unlimited liquidity. Insurance claims on toxic assets were backstopped so the fully hedged players such as Goldman Sachs got their money despite AIG's illiquidity. Again, there was no physical component to the Fed's actions: they saved the world's markets by manipulating bits in a computer. I suppose there was a minimal physical cost in terms of the electrons used to flip the bits, the storage media, etc. However there was never any shortage of electrons, comouters, etc. that caused the 2008 crash. Thus it is strange to see Caruana use the word "reality" when referring purely to psychology. Psychology can change easily, quickly. No psychological reality is set in stone as it were. There was no physical reason for "Reality" to set in. Economists treat psychological reality like physical necessity. But they should be trying to change the perverse psychology that causes pro-cyclical banking policies. Instead, economists bow down before the sociopathic psychology of panic and hoarding, acknowledging themselves powerless before it, impotent to effect change, gladly surrendering themselves to a morally-hazardous ethic without even considering the possibility that it is arbitrary and fickle and not something we should base policy on. --- We should be creating policy to fight the current "reality" of economic psychology. We should create money for a basic income, manage the sociopathy of inflation expectations through indexation, and foster a culture of citizen science and individual disruptive innovation through challenges, drug legalization, open borders, dropping iphones instead of bombs on ISIS territories, and encouraging usufruct. Reiterating: The policies for a new psychological reality: * Basic income funded by money creation * Indexation to eliminate inflation fears * Challenges to stimulate innovation and the advance of knowledge * Right to usufruct. Right to camp on public land. * Open borders. * Drug legalization. * Drop iphones not bombs from drones. Beam in free uncensored internet and let individuals talk amongst themselves, spread their stories, fight ISIS with words in encrypted channels.