Monetary Realism

Understanding The Modern Monetary System…

Asset Bubbles and Growth

makes a great point:

“The fundamental cause of instability is the feed-back loop caused by debt use to speculate on rising asset prices. As an asset price rises, which makes the asset a better form of collateral, in turn increases the demand for more borrowing based on that collateral, which in turn boosts the asset price.

This feedback loop requires fuel to maintain and or accelerate its growth. As with all debt the main fuel is income, but this is always relative to amount of leverage a lender will allow the borrower to have on the collateral and the rate of interest they charge for the debt.”

This is very, very true. Rising asset prices increases their usefulness as collateral.

It’s important to note that we only reach our full productive capacity during asset bubbles, or massive government intervention. We had huge, huge growth during WWII – 26% annualized growth in one quarter- due to pushing our economy to the absolute limit.


I won’t claim we can do this level of growth forever. But it seems as though we don’t even bother trying to think about ways we can make our economy really hum. Instead, we wait for the stars to align and for some sector to offer massive windfall profits to a few people before we let our best efforts show.



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8 Responses

  1. Greg says

    “I agree, but it is not the job of the govt to micromanage the economy.”

    It IS their job to macro- manage the economy though. Really they are the only one who can. Private actions are always zero sum. The only non zero sum actor is the govt.

    • Erik V says

      Yes, that’s the point of getting the deficit to the full employment level.

  2. Erik V says

    I like to use word games to trick my many conservative friends/family to implicitly admit that they support higher govt deficits. For example I will say: “In a modern monetary system you can either be against govt debt or you can be against private debt, but you can’t be against both”. Then I go on to explain how if we want to prevent future debt/asset bubbles like the housing bubble and still have a full-employment economy, the only way is for the govt to provide the demand and NFA creation via deficits.

    It’s part of a long-term battle to change minds and someday get rational policy.

    • Oilfield Trash says


      Would agree

      “if we want to prevent future debt/asset bubbles like the housing bubble and still have a full-employment economy, the only way is for the govt to provide the demand and NFA creation via deficits.”

      However if these deficits do not stimulate productive output in the economy or a reasonable distribution of the income flow on the productive output it does generate, then I do not see how you get full employment with manageable inflation.

      • Erik V says

        I agree, but it is not the job of the govt to micromanage the economy. I’m simply saying that the reason people borrow is because they want to consume in excess of their income, so by simply raising incomes we can get people to buy thing more with equity and less with debt–a much more sustainable system than what we have now.

  3. Tom Hickey says

    Right, the banks extended too much credit on housing prices they themselves inflated through what Bill Black calls the “criminogenic environment” that prevailed and involved a conspiracy machine with many levers and gears, including the appraisers, the rating agencies, and regulators, running all the way up the line to the CEOs. Chief regulator Alan Greenspan blew off the FBI warning of massive fraud occurring in the mortgage industry when it was issued in 2005.

    Much of that dodgy collateral turned out to be worth a lot less than loaned against, which would have taken down the entire financial system if government had not stepped in with a bailout, granted regulatory forbearance, and revised the accounting rules, and the Fed had not provided rolling liquidity to mask insolvency.

    • Oilfield Trash says


      If you were ever a boy scout you should remember the “Boy and the Rattle Snake Story”. To me if you want to minimize the economic deflation when an asset bubble pops just legislate the amount of leverage a borrower can use to collateralize a private debt at loan origination.

      I have a hard time believing that the severity of the BSR would have been the same if all RE loans required 15-20% down payment to qualify.

      Of course when you decrease leverage for private debt used for speculation, and do not get increase incomes with productive output into the economy with public spending; I do not think you can expect to see in the long view a robust growing economy with full employment and manageable inflation.

    • Michael Sankowski says

      It makes it easier to become a criminal when the rewards are so high, and the highest monetary authority in the land is literally giving money away to help your crime.

      Part of the problem with relying exclusively on monetary policy is that it can create an environment where all of the incentives are aligned to become a semi- or outright white collar criminal.

      It’s like putting lead in gasoline and then wondering why crime is so high – using the current form of monetary policy exclusively must create a situation where there is a real estate bubble or total gloom. Imagine the 2000’s without a real estate bubble – the economy would have been in a depression in 2001 instead of 2008.

      This to me is the worst part – we create an institutional environment where we must have a criminal, ponzi-scheme in credit to even get close to maximum output.