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Why You Really Shouldn’t Like The Fed

September 28, 2011 8 comments

I want to try to say very simply, hopefully without too much economics, why I don’t support the current financial system despite noticing the flaws in the Austrian story.  To get the context watch Peter Schiff’s video blog from last week after the Fed announced “operation twist.”  There is a part of this that is right and a part that is wrong.  The wrong part is what I have been talking about already, namely that these policies will result in inflation (and higher gold and silver prices).  The right part is that the whole thing is to get people to borrow and spend more.  In fact this is the whole point of the entire financial system.  The whole mechanism by which money is created is basically a process of creating a shortage of loanable funds and filling it with new money (debt).  This is the peice that Austrians tend to overlook but it is the real reason why it is so terrible.

The system perpetually increases the degree to which our lives are leveraged.  They promise to stimulate the economy through monetary policy.  To do this, as I said, they create money by creating a shortage in the market for loanable funds which they fill with money by lending it out.  But this is not permanent money, it has to be paid back, and it has to be paid back with interest.  So this causes price inflation and increased economic activity.  But when the money has to be paid  back the money supply starts to shrink which causes prices to fall which causes another economic crisis.  To solve the crisis they have to expand the money supply by even more to replace the money they created before, plus the interest, plus enough to make the money supply even larger to keep prices rising.  This requires an even greater shortage in the market for loanable funds.  So they have to do something to either increase borrowing or decrease saving or usually both.  The most common method is to lower interest rates.  (Of course sometimes this just goes on smoothly for quite some time with no crisis but it’s the same process of increasing the money supply by creating increasing shortages in the loanable funds market and filling them with more and more debt.)

Ok so what’s the problem?  Well have you noticed how we don’t own anything any more?  There is a comercial on TV that starts out like this: “You’re proud of the fact that you support yourself and you don’t need to borrow money.”  And then they say “But did you know that if you _________, you actually are borrowing money.”  Guess what goes in the blank.  If you said “have a mortgage” then sorry, thanks for playing.  If you said “own stock in a company that is highly leveraged” then you’re way off but nobody said that because nobody thinks about that.  The answer is “carry a balance on your credit cards.”  America! Do we not know that carrying a balance on our credit cards is borrowing money now?  Hopefully most of us are not that far gone yet.  But look at the way we treat our houses.  If you have a mortgage you don’t own your house, the bank owns it.  This doesn’t mean you shouldn’t have a mortgage but we are in a place where practically nobody owns their house because even people who have paid off their house go and get a second mortgage and use it for consumption (or worse: investment….)  And that’s not the worst of it.  We don’t own our cars any more.  We take out loans to buy boats.  We buy stocks on margin.  We count on social security and public or private pensions to provide for our retirement and these are mostly hopelessly underfunded and counting on their ponzi-game (yes I said it!) structure to keep them going.

This is not an accident.  Our solution to every economic problem since the great depression (when our solution was to keep prices from falling by passing laws making it illegal) has been to try and get people to borrow and spend more.  And if you can do it, it works… for a while.  But eventually all those loans still have to be paid back and that means to keep it going we have to find more and more ways to borrow.  The real problem with this economy is that we are running out of stuff to hock for more credit.  And the Federal Reserve is doing their best to get the last hold-outs to take out another mortgage.  They are even forcing Fannie and Freddie to lend 25% more than a home’s value.

So why am I against this system?  First, because the contractionary nature of it is inescapable.  But more importantly because when we can’t put it off any longer and it collapses we will look around and realize we don’t really own anything.  When we can’t pay our mortgages the banks will take our houses.  When we can’t pay our car loans the banks will take our cars.  When our companies can’t pay their bonds the banks will take their capital.  In short we will “wake-up homeless on the continent our fathers conquered.”

And the cure may be worse than the disease–government spending.  Sure, it’s ture if we allow the government to run ever-expanding deficits without any end, they could fill the gap with this borrowed money and spend it on whatever they want.  But this puts ever-increasing control of the economy in the hands of the federal government.  This is not a recipe for either prosperity or liberty.  And in this manner we become more-and-more collectively in debt to the monetary authorities.  Isn’t that fantastic!  So even if you figure it out and do things right individually who do you think they will come after with the taxes to pay back the government debt once everyone else is broke?

Just so that I am not misunderstood let me say that I don’t mean to point the finger at your hometown banker.  When things fall apart, they are hit as hard as anyone because all of their loans are stacked on top of an account with the Fed.  And the Fed has the power to come in and decide whether or not they are “solvent” and if they decide in the negative, to seize their assets and distribute them however they wish among the other banks.  Ever notice how Goldman Sachs and J.P. Morgan Chase always come out of these things just fine?  There is nothing wrong with banking per se.  The problem is when you create a centralized authority with special government powers (powers of coercion) to control a whole industry, set prices, and manipulate the currency.

When precious metals took a dive last week I couldn’t help but wonder how many vehement supporters of individual liberty have bought gold on the advice of Peter Schiff and the Austrians while meanwhile they have a mortgage on their home and a balance on their credit cards…

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Some Thoughts on the Debate

September 23, 2011 6 comments

Since I’m in blog mode lately here are some things I was thinking to myself last night during the Republican primary debate.

1.  Social Security is a Ponzi scheme.  I just heard Mitt Romney say on television that social security isn’t a Ponzi scheme for the people who have been getting it for the past forty years, the problem is that it doesn’t work for future generations…….!  That’s exactly the definition of a Ponzi scheme!  The people who get in at the start benefit but eventually it falls apart and someone gets screwed.  Calling it a Ponzi scheme doesn’t mean that nobody has ever benefitted from it, it means that they have/and are benefitting at the expense of some future generation.  Can we please just call it what it is?  If you still like it then fine, say that.  But this guy is jumping all over someone else for saying something that is factually accurate because he knows most people don’t know what it means and will react negatively based on some general threatening feeling that they he might stop the checks from coming in.  Furthermore he says that it was not forced on the people.  This is proof that Romney is a progressive I think.  He sees us as “the people,” a collective.  Somehow in his mind we collectively wanted this so it wasn’t forced upon us.  But I don’t want it!  And yet the money comes out of my paycheck every month anyway.  Anyone who looked at the people as a collection of individuals would find it quite obvious that it is in fact forced upon me.

2.  People don’t understand what education does.  Newt Gingrich says 99 weeks–the amount of time some Americans have been unemployed–is enough time to get an associate degree in medicine (or something like that).  So he wants to make them get trained while on unemployment and thinks this would fix our unemployment problem.  The difference between a doctor and a non-doctor isn’t just that one happened to go to medical school.  There is an interesting economic theory about education that says it might actually have very little to do with increasing someone’s productivity and a lot to do with identifying their underlying ability.  As someone with some experience in education I can tell you it’s some of both but the idea that you can just take the unemployed and train them to be doctors and lawyers and solve the problem is misguided.  This is without even addressing the more obvious argument that this would misallocate the labor in the first place anyway.  Interestingly this is usually the sort of thing that comes from the left.

3.  Ron Paul is awesome.  This is not news but Hannity was actually pretty decent to him afterward which I was a little surprised by.  Paul did dodge an abortion question though.

4. Rick Santorum made Rick Perry look like a chump on immigration.  Unfortunately he (Santorum) lacks poise.

5.  There seems to be a lot of support for ditching the department of education.  This is fantastic, although I bet nothing comes of it.  But it even won the online poll of departments to cut.  I would love to see that issue come up in a general and see if the public is capable of standing up to Democrats saying Republicans don’t care about the children (and no doubt especially minority children).  Interestingly Perry made this argument with regard to immigrants but it didn’t go that well for him (see above).

6.  I feel sorry for Gary Johnson.  If you think Ron Paul has it bad you should talk to “the other libertarian.”  He was asked a question about Cuba and completely ignored it and talked about balancing the budget.  Normally I hate it when they do this but he’s go a point.  He gets like two questions and one is about flights to Cuba?  Come on.  By the way, our Cuba policy is ridiculous.

7. I can’t shake the feeling that we are going to end up with a Douche and a Turd Sandwich again.

Categories: Uncategorized

“Overleveraged Society”

September 22, 2011 2 comments

Of course I don’t want to make too much out of one data point but it’s interesting that the day after my hyperinflation post the dow is down____ gold is down 2.5% and silver is down 9.5%, oil is down 6.4%.  Not exactly inflation expectations running away with themselves.  And I heard a reporter on the news say (paraphrasing) “Everything is down.  The only thing that is up–this might surprise you–is the U.S. dollar.” People just don’t get inflation/deflation…..

Well some people do.  Here is what  Bob Worthington, president of Hatteras Funds, had to say in a WSJ article today (emphasis added).

The problems that exist here in the U.S. and Europe, in terms of an
overleveraged society, have not been resolved in the past two to three years.
Credit bubbles, when they burst, take a long time, for any economy to really fix
those problems,

Maybe Wall Street is finally reading my blog.

This move by the Fed is actually an interesting test of my theory.  Supposedly (there is some doubt about whether it will really go down like this) they will keep the size of their portfolio the same but change the structure of it to lower longer-term rates.  If my theory is correct and it is really about the quantity of money, this should have a limited effect.  If it is really about interest rates then this will help.  It’s worth mentioning beforehand that there may be some effect on velocity (or to look at it another way an increase in higher order measures of the money supply with no change in base money) brought about by increased borrowing due to this change in term structure.  In this case it could have some effect even when my theory is right.  I’m guessing this is more or less what the Feds have in mind–to get the money out of the bank vaults so to speak.  However, I will go on record as saying I don’t expect a significant positive effect.  Of course, I wish I had made this prediction yesterday….

Hyperinflation?

September 22, 2011 44 comments

Note: I’m too tired to do a thorough proofread of this so sorry if there are a lot of typos.

Ok so I tried to argue that Austrians are too fixated on hyperinflation on Mises.org and got told

Download the pdf file from Henry Hazlitt’s book. Should help in your dilemma.

So I did that.  I didn’t read it front to back but I perused it and it actually did help with “my dilemma.”  My dilemma, just to clarify, was my inability to understand why the author of the post had spent the whole time explaining why so-called expansionary monetary policy is really contractionary and then at the end suddenly predicted hyperinflation.  And I think I know why now.

There is a fundamental inconsistency with the way Austrians (I’m taking Hazlett along with some people on blogs and that I see on tv and other places who seem to share this view and calling them “Austrians.”) treat inflation.  It has to do with expectations.  Do people expect the inflation or not?

To see the inconsistency take their moral treatment of inflation:

It reminds us that inflation is nothing but a great swindle, and that this swindle is practiced in varying degrees, sometimes ignorantly and sometimes cynically, by nearly every government in the world. This swindle erodes the purchasing power of everybody’s income and the purchasing power of everybody’s savings. It is a concealed tax, and the most vicious of all taxes. It taxes the incomes and savings of the poor by the same percentage as the incomes and savings of the rich. It falls with greatest force precisely on the thrifty, on the aged, on those who cannot protect themselves by speculation or by demanding and getting higher money incomes to compensate for the depreciation of the monetary unit.

Here, apparently he assumes that people are unaware of this inflation, at least at some point–that it is “concealed.”  At this point, let me head off the argument that I know will come if any Austrian reads this.  I know that the payments fall unevenly on different people and it therefore redistributes wealth, and I know Hazlitt makes that argument later.  I’m not trying to say inflation is perfectly moral I’m just pointing out the implicit assumption about expectations that he seems to be making.  This assumption is even more clear when he talks about the public debt.

When it was pointed out to the Eisenhower Administration, as it was to its Democratic predecessors, that our huge national debt continues to mount, a favorite defense was that it had not risen as a percentage of the national income. Such a reply ignores the fact that the national income has gone up (in dollar terms) in large part because prices have gone up, and that prices have gone up because of the currency debasement brought about partly by the very deficit financing that increased the debt. What this defense amounts to, in short, is a boast that the burden of the national debt has not increased because it can now be paid off in debased dollars.

See it’s a simple moral argument: the government borrows money then “debases” the currency, the pays back the loan with less valuable dollars, thereby stealing some amount of wealth from the public.  But this is only the case if the public doesn’t expect the devaluation.  If they do, then they lend knowing full well that the dollars they receive will be worth less and understanding the real rate of return that this implies, in which case it is a mutually voluntary exchange which surely no true Austrian could object to.

But this is altogether different from the assumption about inflation expectations that leads to the conclusion of hyperinflation.  Look what he says.

He was at times indiscreet enough to suggest that a price rise of 2 or 3 per cent a year would be about right. It has been pointed out, however, that even if we could control an inflation to a rate of 2 per cent a year it would mean an erosion of the purchasing power of the dollar by about one-half in each generation.

Even so, this would not accomplish Slichter’s announced purpose. He thought prices must go up this much in order to meet the unions’ annual wage demands. But the moment Slichter’s inflation scheme was openly put into effect, as I have already pointed out in Chapter 27, union leaders would simply add 2 per cent (or whatever the planned annual inflation was) on top of the demands they would have made anyway. In fact, lenders, investors, manufacturers, retailers, speculators would all mark up their demands or change their operations to beat the inflation, which would thereupon race to a crack-up. A declining currency must eventually obey the law of acceleration that applies to all falling bodies

Here he assumes that if there is a little inflation, it causes expectations to adjust and that causes all prices to account for the inflation and that causes expectations to adjust further causing prices to adjust further and this process gets out of control and causes hyperinflation.  So the treatment of expectations is not very consistent here.  Furthermore, this seems to be the same logic that Polleit falls into in the post.

Rising interest rates threaten to bring down leveraged banks. Defaulting banks would reduce the fiat-money stock. So to prevent the fiat-money stock from declining in a bust, the central bank has to keep market interest rates low.

However, the outlook of ongoing debt monetization through the central bank could provoke selling pressures in bond markets: investors, concerned about higher inflation, start dumping bonds, thereby pushing up market interest rates.

The central bank would then have to purchase ever-greater amounts of debt, thereby issuing ever-greater amounts of fiat money. The ongoing attempt to keep down the interest rate to prevent the fiat-money stock from declining could easily lead toward a policy of high inflation, even hyperinflation.

Here we can pinpoint a more important mistake.  As I said before, he is saying pretty much exactly what I have been saying up until the end of the first paragraph above.  Most essentially that “to prevent the fiat-money stock from declining in a bust, the central bank has to keep market interest rates low.”  The reason they are keeping them low is to keep the money stock from declining.  This highlights the confusion which I think is often present in both Austrian and more mainstream schools between policy goals and policy methods.

The whole objective of the central bank is to sustain moderate positive inflation (in prices).  This is what the economy expects (because they tell us to expect it) so if inflation is less than that it causes problems (I’ve been over this before so I won’t try to do it again here).  The problem is that in order to maintain that inflation they have to offer lower and lower interest rates for all the reasons Polleit explains in his post and I explain in this one.   The low interest rates are not the goal they are the means.  The point of the policy is to inflate the money supply.

At this point notice that the demand and supply for loans need not be equal here.  In fact the whole money creation mechanism requires them to not be equal since the new money comes in basically to fill the gap.  The Fed picks an interest rate and then buys whatever quantity of securities achieves it “in the market.”  This is the same as saying they pick an interest rate and create money in the amount of the resulting shortage of loanable funds.  This is why they need to keep lowering the rate because when the contractionary forces start catching up with them they have to create more and more money which means they have to create a larger and larger shortage in the market for loanable funds.  If they fail to do this prices will start to fall as the money supply dries up and then the expectations of inflation will fall as well (most likely) and you will get a deflationary spiral.

The way Hazlitt and Polleit go wrong is to miss the reason the Fed is lowering rates.  Hazlitt treats low rates as the goal of Fed policy and inflation as a side effect.

The expansion of money and credit that is necessary to hold interest rates down also raises commodity prices and wages. Higher commodity prices and wages make it necessary for businessmen to borrow correspondingly more in order to do the same volume of business. Therefore the demand for credit soon increases as fast as the supply. Later on, still another factor comes in. When both borrowers and lenders begin to fear that inflation is going to continue, prices and wages begin to go up more than the increase in the supply of money and credit. Borrowers want to borrow still more to take advantage of the expected further rise in prices, and lenders insist on higher interest rates as an insurance premium against expected depreciation in the purchasing power of the money they lend.

But this is not the case, their goal is to create inflation and low interest rates are the mechanism.  If expected inflation actually increased (which I see no reason to expect in such an environment) it is true, as Polleit says, that the supply of bonds would increase (which is basically the same as saying either the demand for loans increases or the supply decreases).  But this would make the gap between supply and demand in the loanable funds market that much greater for any given interest rate which is exactly what the Fed wants.  This would allow them to accomplish the desired inflation of the money supply at a higher interest rate than otherwise, potentially eliminating the zero interest rate problem.  So there’s no reason to not expect them to just let rates increase if they are able to get the money out there at higher rates.  Low rates are not the goal inflation is the goal.  The rates could be allowed to increase as much as was required to arrest inflation (both real and expected) at the desired level.  The danger is on the deflationary side.

Furthermore, Hazlitt makes an empirical argument:

He (Slichter) declared that it was “incorrect” to believe that “creeping inflation is bound sooner or later to become galloping inflation,” because this had not happened in the preceding twenty-five years in the United States. Yet our cost of living had more than doubled in the preceding seventeen years, which was something more than a creep. Slichter might have taken a look at the French franc, which was then already at considerably less than one-hundredth of its 1914 purchasing power; or at the median loss of one-third of their value by 42 different currencies in the preceding nine years alone (as pointed out in Chapter 24).

But a doubling of the price level in 17 years amounts to an inflation rate of about 4%.  Ok it’s 1 % higher than what  Slichter said would be ideal but it’s certainly closer to creeping than to hyperinflation.  What’s more, even if it had increased five-fold in the same time, this would not be evidence of the hyperinflation-spiral theory.  In order to support that theory we would have to observe increasing rates of inflation which we haven’t, including the 50 years since this article was written.  It goes up and down but it doesn’t look like anything other than a stationary process empirically (of course I’m arguing that eventually it won’t be but in the deflationary direction not inflationary).  And there is no strong evidence of this in the table of countries in chapter 24 either, again, some have high inflation and some low and some have increasing and some decreasing.

Hyperinflation comes from a different kind of monetary system than what we have.  It occurs when the government has the ability to print money directly and spend it.  Ours doesn’t work that way.  The Federal reserve prints the money.  The government is not a king who can add impurities to the coin or a dictator who runs the government via the printing press.  It has to borrow what it spends.  This means that the money is not backed by nothing it is backed by debt and collateral.  In order for a hyperinflation to happen money would have to be freed from it’s association with debt.  And even if it were, there is still no reason to believe that it couldn’t keep it at a “creep” forever only that it probably wouldn’t (I’m not advocating we try it).

The Obsession with Hyperinflation

September 19, 2011 5 comments

Look, this guy is saying the same thing I am!

What, however, if banks (or more precisely: their shareholders) are no longer willing or in a position (because of equity capital shortage) to lend and take additional credit risks?

Or even worse for the adherents of relentless monetary expansionists: What if commercial banks, despite high excess reserves, start calling in maturing loans and contract the credit supply? This would actually lead to a shrinking of the money stock — and cause deflation.

If the central bank purchases bonds, the original issuers of the bonds will have to keep paying interest and principal to the central bank. Such payments reduce the money supply in the form of M1 and M2 over time.

In other words, by purchasing bonds, the central bank just postpones the inevitable — namely, the shrinking of the fiat-money supply through contractual debt (re)payments on the part of borrowers (“deleveraging”).

But then somehow comes to the exact opposite conclusion!!!

The ongoing attempt to keep down the interest rate to prevent the fiat-money stock from declining could easily lead toward a policy of high inflation, even hyperinflation.

……….

 

Categories: Uncategorized

Economics Having Nothing to do with Broken Windows

September 19, 2011 5 comments

Finally, the much-anticipated followup to the wildly popular and controversial “Still More Broken Window Economics.”  For those of you just joining us we find ourselves on an island with one really rich guy who owns all of the means of production except for labor which is owned by a group of peasants.  By assumption there is productive work that the peasants could be doing but they require use of the rich guy’s productive resources in order to do it.  The question is why wouldn’t they be able to come to some mutually beneficial arrangement with the rich guy where they work his land and they split the produce somehow?  And in particular, how can this reason be overcome by a hurricane hitting the island and destroying the rich guy’s stuff?  (To avoid the monopsony problem, going forward I will assume there are several landowners.)

When exchange takes place in real goods (this would include commodity money) in a free market (so without all the things I listed in the last post) there is no reason to think that this would be the case, at least not on a large scale.  Obviously transaction costs aren’t zero and this means you wouldn’t necessarily get the most efficient outcome in every situation but I am quite confident you wouldn’t have a situation like the one described.

The problem stems from the monetary and banking system and to fully understand the problem you have to start from the beginning of said system rather than just look at the downturn.  So take our island economy and imagine it is in a condition of free markets, property rights and commodity money and that the workers are employed at the efficient level.  This means that the marginal cost to them of their labor is just equal to the wage which is equal to their marginal product.

In addition to the efficient allocation of labor, there is also an efficient allocation of consumption and investment over time which is brought about by market interest  (both real and nominal) and inflation rates.

Enter the central bank.  The bank goes to the landowners and says “hey landowner, I can loan you money at a nominal rate lower than what currently prevails in the market.” If the landowner is not too economically sophisticated he will say “cool, in that case I will borrow more and invest more.”  If he is particularly sophisticated he will say “ok, but are you offering that rate to everyone and supplying the funds by just printing more money?  Because if you are, then it will just drive up prices in the short run (inflation) and then drive them down in the long run when people have to pay you back (deflation) so the real rate won’t change and I should invest the same amount, but since this is going to drive prices up I will have to borrow a little more in order to do it.”

If everyone said the second thing, there would be no problem just some inflation and then some deflation and all real variables would remain unchanged.  However, the banker doesn’t allow this, he says “don’t worry I know how to control inflation and I will keep it steady and positive.”  So the landowners say “low rates and high inflation huh?  Ok I’ll take a big loan and invest it and hire some more workers.”  This drives wages and the price of capital up.

Meanwhile, the banker goes to the workers and says “hey workers, I can lend you money at a rate below the current market rate.”  And if they were relatively unsophisticated they would say “great, I will cut back on my savings and/or borrow more and use it to buy more consumption.”  If they were very economically sophisticated they would say “ok but since you’re doing that for everyone, it’s just going to drive prices of consumption goods up now and then down in the future when the loans have to be paid back so I will consume the same amount but I will need to borrow a little more (or save a little less) in order to pay the higher prices for consumption today.”

Of course in the latter case, the banker will say “don’t worry I know how to control inflation and I will keep it steady and positive.”  So the workers say “great, low rates and high inflation and my wage is rising!  I’m gonna borrow more/save less and consume more.  Naturally this raises the price of consumption goods.

So for a while this goes on, prices of everything go up and everyone feels good.  But in a little while people stop borrowing and start paying back loans.  They figured this would be no problem because they figured prices would keep rising.  But since everyone is in basically the same situation they are all trying to pay loans back and not borrowing and this threatens to decrease the money supply which starts putting downward pressure on prices.  If prices fall, the people won’t be able to pay back their loans.  But the banker has a plan.  He offers them even lower interest rates.  And since, again, he promises to keep prices rising, they put off payment of their loans in favor of borrowing even more.  This causes prices to continue to rise fulfilling the earlier promise of inflation.

This goes on for a while but eventually nominal rates hit zero (or very close) and they cannot continue this strategy.  At this point, the money supply starts to fall.  What’s more, it is falling to a point lower than the original (commodity) money supply because all the loans that have taken place were made with interest.  Now everybody is trying to get their hands on some of the shrinking money supply in order to pay back their loans and save their collateral.  The land owners now are not thinking about what could be produced on their land and trading a portion of it for the other resources they need (like labor).  They are thinking about getting some cash to save their land.  If they could produce and sell the produce and get enough to do this they would but there is a problem.  The peasants also have debts which means they are also trying to get their hands on cash to save their stuff which means they are not very willing to pay for the produce of the land owners, they just want to work to get money to pay off their loans.  This means that the landowners can’t profitably employ them because it is no longer about producing real goods, it is about getting money to pay off loans.  Since nobody is willing to buy their produce, the best they can do is shut down (or at least cut back) production and try to hold on to as much of their cash as they can.  In other words you get low interest rates, low inflation, and high unemployment.  Sound familiar?

I know there are some questions that this doesn’t quite answer.  If I had the answers I would be publishing it in the AER not in a third-rate blog.  But hopefully this will get/keep the discussion going so feel free to ask them anyway and maybe we will find the answers.

Still More Broken Window Economics

September 6, 2011 16 comments

Here is a simple explanation of the Keynesian view of “broken window” stimulus.  It makes perfect sense and I agree completely with it (although there is an important distinction between the “economic activity” of a society and the wealth of a society).  But this argument (as all similar arguments I have heard) leave a gigantic question on the table that nobody seems to be talking about.  Why are there so many unemployed subsistence farmers?   In fact, this difficulty is so pervasive that it is inherent in the setup of this example.  After all, a subsistence farmer does not need the wealthy loaner to have work, they work for their own subsistence.  But let’s ignore the reality that a man always has himself (or each other) as the employer of last resort and assume that they do need the rich guy in order to have anything to do.  Maybe he owns all the land and resources that could be used to produce the conveniences and necessities of life.

In this scenario, the peasants represent a resource.  They could be producing things of value to themselves and the rich guy.  Knowing this, why would the rich guy allow them to be idle and starving to death?  By assumption this guy owns land or resources that they could work in order to produce something.  Presumably they would be willing to work on his land to produce something if they got to keep some of it.  Presumably they would be willing to work for less than the full amount that they could produce using his land and/or other resources.  And presumably he would be willing to let them work his land in return for some portion of their produce rather than let the resources (land and labor) go to waste right?  Or is that the rub?  See, this premise seems to assume that the rich guy is completely satiated, that he has no desire for any more stuff.  And not only does he have no desire for any other stuff but he would rather not have any other stuff and he prefers to watch all the peasants starve rather than make any use of his wealth because if he were satiated, he could still let them work and keep all of their produce.  This would make him no worse off, unless of course he just likes to see them suffer.  In this case a hurricane is only a device that undoes the satiation of the rich guy and allows the economy to work again.

So once again we have a model that begins by implicitly assuming there is no scarcity, at least for the rich guy.  Or could there be another reason that there are so many people/resources lying around going unused despite their obvious productive capabilities?  What might account for that?  What if there were a minimum wage that were higher than what they could produce?  Or a union that had the ability to keep them from working for such a low wage?  Or what if the rich guy had to pay taxes and social security and unemployment and medicare and pension and workers comp and liability insurance and hire a lawyer to help him comply with all relevent regulations every time he wanted to hire a peasant?   That would probably have some effect right?  But all that isn’t even the main reason.  The main reason is much more unspeakable than that.