Austrians, poker and bubbles



I suspect that I am less of a disciple of the Austrian School of economics than many readers and many of the other writers on this blog. However, a recent game of cards has changed my mind.

Every fortnight I play poker with banker friends. Recently I asked them why asset values are increasing so much when there’s so much uncertainty and bad news. Looking at me as if I were stupid, they said something along the lines of “of course they’re going up; the Fed has effectively guaranteed very low interest rates for the foreseeable future and so we’re borrowing money for practically nothing and investing in anything which is obviously increasing in value because of the reduced interest rate expectation; we thought as an actuary you understood how to value assets using discounted cash flows.” 

In addition to making profits in a rising market, anecdotal evidence also suggests that, because of the collapse of the securitised market, there is a high demand for credit, so banks are not passing on the low interest rate to their customers. So by setting low interest rates, central bankers are delivering super-profits to banks, the results of which have been widely publicised in the media.

But who is paying for these profits? Let me hypothesise that, without the interference of the central banks, there would be a market interest rate, and let us say for argument’s sake that it is 4%. The effects of the artificially low interest rate on the economy are manifold and complex, but let us just isolate a couple of groups who are directly affected. Savings in the UK are £1.2 trillion, so that’s an annual lost income of £40 billion and people who are purchasing pensions annuities would be losing about a quarter of the value of their pension. So this represents a wealth transfer from savers and pensioners to bankers – I leave the reader to decide on the fairness of this.

But worse still is what my poker friends have accurately described as an asset bubble blown by the world’s central bankers. The Austrian Business Cycle Theory envisages central bankers running low interest rates causing economic bubbles followed by recession. Even this pre-supposes some wisdom from the central bankers in allowing the situation to rectify itself. But Greenspan and his followers, more reckless even than my poker, have bet their economies on the markets with a seemingly never ending succession of bailouts – the East Asia crisis, LTCM, dot-com, sub-prime. However, with interest rates near zero and governments with no balance sheet left, when the current asset bubble pops there will be no more bailouts.

What happens after that will be interesting indeed. My consolations are few; my banker friends currently have more money to lose than me at poker, but I have the schadenfreude of knowing that everyone will get their just deserts in the end.

4 thoughts on “Austrians, poker and bubbles”

  1. Posted 15/09/2010 at 12:00 | Permalink

    Indeed – but don’t forget the inflationary effects of such activity.
    If only everyone did get their just deserts – unfortunately, the power of government and its bidability means that some will be able to avoid their just deserts whereas others will suffer more greatly than they deserve. But that’s the discriminatory effect of government interference in the economy!

  2. Posted 15/09/2010 at 13:34 | Permalink

    Whig makes a good point. Government bailouts (including QE) create moral hazard and also tend to raise time preferences. Those that steered clear of the bubbles will soon learn that their prudence is not rewarded – instead the government will appropriate their property to prop up the reckless.

  3. Posted 15/09/2010 at 16:58 | Permalink

    The outstanding mortgage debt in the UK is also about £1.2trn, so perhaps we should just call it a wash?

  4. Posted 24/09/2010 at 07:20 | Permalink

    […] IEA’s Nick Silver explained it well last week, Every fortnight I play poker with banker friends. Recently I asked […]

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