Minyan Mailbag: Can a Crash Happen Again?
Never say never
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
We were having a debate in class the other day about the Depression and a market crash. Our professor opined that it could / would never happen again for four main reasons:
1) Fiscal policy - stating that Congress and the President wouldn't raise taxes in a recession
2) Monetary policy
a) Fed would never let M1 fall by 25% as it did during that period
b) Fed would never raise the RRR in a recession
c) Open market operations
4) Circuit breakers.
I understand arguments 1, 3 and 4 but I don't understand how having a better understanding of the open market operations can reduce the risk of a depression or crash. My professor stated that after 9/11, the Fed quickly bought Treasury bonds totaling $80 bln. Isn't that just a quick fix and could lead to longer-term problems?
Thank you for your time.
(1) Given the current external imbalances of the U.S. economy, it is quite possible that the U.S. government would actually be forced to cut spending at the worst time. This would occur if foreign lenders balk at more debt.
2) The Fed has no control over the velocity of money, nor do they control interest rates. The only thing they control is the supply of money necessary to keep interest rates stable. If foreign lenders demand higher rates there is nothing the Fed can do about it: they would have to print so many dollars to keep rates low that the dollar would crash. And printing dollars does nothing for a consumer who can borrow no more or for banks that don't lend more (velocity).
3) FDIC could not insure a fraction of deposits if a high percentage went bust.
4) Circuit breakers would only slow a decline. This is perhaps the greatest example of hubris: We do not control markets - they control us.
The Depression was primarily set off by protectionist actions like Smoot-Hawley when our currency began to drop. This stopped the flow of capital abruptly and deepened a recession into a depression. Just try to imagine how much more we are dependent on foreign capital today than then.
And unfortunately we have already seen indications from Congress that they would be just as reactionary now as then.
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