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Debt and Delusion

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Robert Blumen discusses Peter Warburton's "Debt and Delusion: Central Bank Follies that Threaten Economic Disaster" at the Ludwig von Mises Institute Website.

"Published in 1999, the work rapidly went out of print but has since become a cult classic among financial contrarians. Although not written from an Austrian point of view, the argument parallels an Austrian view of money and banking in many aspects.  My purpose in writing this article is to present Warburton's main argument and to interpret it through an Austrian lens." -Robert Blumen-

Its central premise concerns the lessons learned from the 1970s when the developed world flirted with hyper-inflation. "Warburton's story begins in the aftermath of Volker's triumph. The conundrum facing governments at the time was: how to enable governments to continue to live beyond their means, without suffering inflationary consequences?"

What follows is a very plausible explanation about how, "Central bankers offered a program to solve this dilemma, the centerpiece of which was a change in the method of financing government debt.   Deficit finance bonds would be sold to private investors through existing financial markets. This would place the bonds in the hands of investment funds, rather than on the books of commercial banks as would have been the case had they returned to the old style of monetization.  The subsequent explosion in the size and breadth of bond markets is illustrated by a few snapshots of gross issuances: less than $1 trillion in 1970; $23 trillion by 1997 and nearly $43 trillion by 2002.

The conundrum:

As he wryly noted:

"Periodic bouts of price inflation, the tell-tale signs of a long-standing debt addiction, have all but vanished.  The central banks, as financial physicians, seem to have effected a cure. . . . Few have bothered to ask how the central banks have accomplished this feat, one which has proved elusive for more than 20 years. As long as inflation is absent, who really cares exactly what the central banks have been up to.

The solution to this puzzling anomaly is to identify the source of demand for government bonds. For this, we must examine "what the central banks have been up to."

"Debt and Delusion argues that the institutional changes...have confined the price adjustments resulting from monetary expansion to the financial system. The character of the 80s and 90s inflation differed from that of the 70s. In recent decades, price changes following money quantity changes have been in stocks and bond prices, rather than wages and consumption goods prices."

Very good read,

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