The Humility of Realism 22 comments
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The audacity of hope:
- All we need to do is restore the confidence of investors, and everything will be fine.
- We must take measures to make sure that the nominal value of assets that have been borrowed against do not fall further.
- There is nothing to fear except fear itself.
- There is nothing to fear except an aggressive government with idealists who think they know how to prevent a second depression, but really don’t.
Okay, the last one is what I think. I have new sympathy for the liquidationist philosophies of Andrew Mellon, Secretary of the Treasury for Harding, Coolidge and Hoover. Depressions occur because of economy-wide debt levels being too high, which leads to a self-reinforcing negative cycle when asset prices can no longer be supported by debt, because the cash flows from the assets become less than the cash flows needed to finance the debts.
There are two choices in such a situation. The government can interfere and cause a Japan-style malaise, not all that much different from the last depression, or we can liquidate, which is really, really hard. Think of what Poland went through with their “Big Bang” post-communism.
Most Americans, particularly Baby Boomers, do not like hard things (I would have loved to have written that article). Well, who does? But pain is a normal part of life, and mature people embrace it when it unavoidably comes their way.
In a depression, everything fights against the one trying to restrain it. Ask the Japanese how successful they have been in restoring normality to their financial system. Or, how good the economy was when the measures our government is applying today were tried during the last depression. Then consider:
- Our troubles with the auto industry, and why it might be better to not rescue Detroit.
- The level of historical equity volatility today versus the Great Depression.
- The deteriorating conditions at Fannie and Freddie. Oh, AIG, too.
- How the lure of cheap capital is luring all manner of institutions to become banks and line up for bailout capital. (American Express, CIT, various life insurers, etc.) Seemingly free money brings out the worst in all of us.
- That cities are applying to be covered by the TARP. (How will they offer ownership interests?)
- Modest efforts to stop home foreclosures may just delay the inevitable.
- The degree to which homes are underwater in the California Bay Area (among other places) is astounding.
- How overvalued housing remains in much of the developed world.
- In a depression everything fights against you at the same time. Consider seniors trying to tap home equity using reverse mortgages. Sorry, door closed. Or consider trying to avoid bankruptcy when debts are high going into this slump.
- What it would take to go back to a gold standard. Not likely, but the price of gold could be 8-9x what it is now.
- And finally, my biggest bugaboo: can the US government continue to borrow aggressively without something significant going wrong. (I.e., dollar troubles, steep curve, or crowding out.)
Confidence exists because there is enough transparency and lack of overall leverage that people can have assurance that marginal institutions will not get pulled down in a self-reinforcing cycle of failure. We are nowhere near that now — if we can get the Debt/GDP down from 3.6x to 1.5x, we would have a chance. Until then, regardless of the confidence building measures attempted by the Treasury/Fed, we will not get to that level of transparency.
There are a few things different now versus the Great Depression. The US went into the Great Depression with a clean balance sheet. We come into this situation with a lot of debt, explicit and implicit (entitlement promises). On the other hand, we don’t have protectionism yet. We have an aggressive monetary policy, but one designed to stimulate hurting areas, and not the economy as a whole. The same is true of fiscal policy. It’s happening a lot faster than the government response during the Great Depression, so this will give a chance to see who was truly correct about what to do then versus now.
Are depressions caused by panics leading to a loss of confidence in the system because a few key areas have failed, and if we patch those up using government/central bank help, everything will go back to normal? That’s the view of the political powers that be, both now and before the Great Depression. Or, are they caused by Debt/GDP levels being too high, such that asset values get pushed significantly above their market clearing levels, and incremental new debt is not capable of financing those asset prices anymore? That’s my view, the view of Mellon, many pre-Great Depression economists, and a number of others today that argue that the problem is not that the markets have failed.
Yes, the markets have failed because we let the credit creation inherent in a fiat money system run out of control. For the last 20 years, the Fed would never let a recession be severe enough that it would bring debt levels down, as the Fed did from the forties to the mid-eighties. So the debt levels grew and grew without bounds, because no discipline was imposed in the interests of permanent prosperity. Congress and the Presidency went along with it happily. Who wants to get in the way of a perma-boom?
Now the payment for this folly has come due, and the question sits before us: do we take it short and sharp, a Big Bang? Or, do we eat the elephant one bite at a time, a la Japan, which is still not quite out of its bubble woes after almost 20 years? I say Big Bang, but that’s not the nature of our culture, so be humble, be realistic, and be ready for a long slump or series of slumps as we enter the not-so-great depression.
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This article has 22 comments:
Not really. The same approach is being taken now as then, with the exceptions you note. The results will be the same or worse.
One area you didn't mention is the fact that today's economy relies much more on the division of labor than it did in the 1930s. Back then a vast majority of Americans either lived on, or grew up, on a family farm. They knew how to grow their own food, feed themselves, and generally how to get by without much outside help.
By contrast today's "average" citizen has probably never had to drag themselves out of bed at 4am to milk the cows or work 17 hours a day for days on end to bring in the crops. If the grocery store ran out of food they wouldn't have any idea what to do about it nor have the capability to address the situation. You can't grow enough food to feed yourself on the balcony of your luxury condo overlooking the ocean.
As your artilce points out, our problems have resulted from attempts by the gub'mint trying to press the 'fast forward' button on the prosperity machine by liberal use of the printing press. While that worked for a while, we now find ourselves in the situation where the tape has come off the reels and is thoroughly tangled in the machine's innards bringing 'prosperity' to a grinding halt.
It's going to take time to untangle the mess. Pressing the fast forward button ever harder won't help and may wind up being much worse in the long run.
1. Prevent or delay liquidation.
2. Inflate further.
3. Keep wage rates up.
4. Keep prices up.
5. Stimulate consumption and discourage saving.
6. Subsidize unemployment.
Since all government spend is consumption according to Rothbard,
number 5 implies cuts in taxes and government spending.
I agree that Americans, myself included, do not like hard things. Worse, we want to convince ourselves that easy things are hard, and then drag the entire world through our bouts of both angst (during the "crisis") and celebration (when the "crisis" has been "solved"). I believe we must be the most self-absorbed people on the planet. And while we're capable of doing great things, we are a bit like a gifted relative with bad habits. After a time, the relative just isn't worth the aggravation to the rest of the family.
RE: Cheap capital bringing out the worst. The sharpies in New York, Chicago, and elsewhere will run circles around the bureaucrats in Washington. Any and all taxpayer-funded schemes will be gamed to the advantage of others. The taxpayer will get the shaft.
Still, I'll take a reprise of 1932. From 1932-1937, the DJIA increased approximately fourfold.
Actually, monetary policy has been the only facet used to attempt to fix this problem and like the Great Depression, it was realized afterward that to reduce debt required increasing revenues, no different then a business. The other solution not mentioned on this article is exactly that, to increase business and government tax revenues by bringing a crucial export in-house. Specifically energy. Another option is to subsidize small business which is 51% of our GDP and rapidly dying. Small businesses cannot be banks and credit is shut off.
To subsidize small business, you put XXX B into regional banks that were responsible these last four years and the Small Business Administration guarantees 50% of the loan. In addition, the SBA has a lot of retired business talent that volunteers to assist start-ups and entrepenuars polish financial plans and help small businesses get in touch with additional funding. The SBA and bank determine whether a start-up plan is viable, or an existing Small Business that has nicks in it's credit is worthy of investment, has decent management, etc.
The innovators can increase the efficiency of our markets but these are not large companies with poor, lazy management and the ability to all become "banks" and get direct government funding, it comes from entrepenuars who are hungry and have been shut out of the market for the last five years while VC was out hunting for the next gadrillion dollar opp like waiting for the next Google which doesn't happen.
For larger businesses like the automakers, allow them to go bankrupt and shed and restructure the unsustainable pensions, then fund them in tranches based on rolling out an electric vehicle. Build more nuke plants which also creates jobs. Can't have an energy independent America without the nuclear equation while wind, gas, solar and hydrogen power are utilized to slowly but surely begin replacing petroleum.
I do wonder about your second to last paragraph which starts, "Yes, the markets have failed because we let the credit creation inherent in a fiat money system run out of control. For the last 20 years, the Fed would never let a recession be severe enough that it would bring debt levels down, as the Fed did from the forties to the mid-eighties."
The Federal Reserve is **NOT** "the markets" no matter how big Alan Greenspan's ego ever gets. Alan Greenspan failed, just as he failed as a private economist. You argued quite effectively that it was the "Greenspan Put" that failed.
With all the interference from inept regulators (including Cox at the SEC, the inflating of GSEs by Congress, and Paulson recently) but mostly Greenspan -- we cannot draw any conclusions on the efficacy of markets. They were not allowed to function.
There is no place for a Federal Reserve in a truly free market. One could argue that a lender of last resort (who lends freely but dearly as advocated by Paul Volcker and others) is an improvement over a "pure" free market.
But the constant meddling and goosing and back seat driving of Greenspan cannot be called anything but a disaster. The U.S. is a victim of central economic planning -- the very same stuff that has screwed up so many other economies around the world.
In the end, that is why everything Paulson/Bernanke do to "fix" the problem is just making it worse... Central economic planners were and are the problem.
Younger generations will get their turn, and they might be as bad as baby boomers -- but being young, they haven't yet reached the age where they have the greatest influence. Those positions belong (right now and for the last 15-20 years) to Baby Boomers.
Being fair though, we can't blame the Baby Boomers for Alan Greenspan. He was a failure of an earlier generation
When the Great Depression hit.. had they declared a recession yet?
Larry, speaking as someone from Gen X, I do agree with you that the Boomers have had some speed bumps in their economic history. BUT, I would also like to bring up a couple of things Gen X and after are facing:
First, university tuitions are skyrocketing while incomes of new graduates have flat lined for the past 15 yrs., leading to very problematic debt/income ratios for 20 and 30 somethings paying student loans. Also, 40 years ago it was possible to own a home with about as much money as it costs to buy a decent car today, even with inflation factored in.
Obviously these are only 2 small examples, however they need to be understood if we are to start pointing fingers cross generations. This notion that Gen X and later gens have it so easy is a joke, and I think someone needs to realize this if we are to get going in the right direction. Gen X and later didn't start the fire, but we are getting burned, let's not forget.
That is only part of the problem. Even with fully gold backed money, the individual banks were free to engage in fractional reserve banking to the extent it did not cause a run by their depositors. Absent fractional reserve issuance of 'extra' currency, interest rates for loans would be much higher and the incentives to borrow and engage in speculative frenzies would be greatly diminished.
The speculative frenzies are only part of the problem. It's the use of borrowed money that leads to the slump after the bubble bursts as those who borrowed and bought at the peak cannot recover enough to pay off the loans and are burdened with the debt afterward. If they only used money from savings for the purchase then they will not have the debt afterward, only the loss of previously owned money.
LICENCES TO STEAL ISSUED HERE !
The American people must demand:
Mr. President , TEAR DOWN THIS SIGN !
Until this is done, all other efforts will fail, or be fatally flawed.
Indeed. When creative accounting and fancy stuff are allowed for no other reason than to have more speculation, you know trouble is near. Its not really a matter of method/regulation/dere... that got us here, it is putting the wrong people to guard our wealth and security that is. I would agree going back to the gold standard might help, but I see it more as an act of a limitation/regulation on the banks rather than a structural solution.
Ultimately, it is about putting the right people at the right places, no matter in business or in government, that makes the system good. That includes the people monitoring them. Fiat money or gold standard, if the one in control just wants to control and hoard more money or gold, the same chaos will re-emerge sooner or later.
I would be interested in knowing what you think of the role of the yen carry trade was in this - that wall of money looking for a return not available in it's home market would have been pretty difficult to stop, I think.
"Are depressions caused by panics leading to a loss of confidence in the system because a few key areas have failed, and if we patch those up using government/central bank help, everything will go back to normal? That’s the view of the political powers that be, both now and before the Great Depression. Or, are they caused by Debt/GDP levels being too high, such that asset values get pushed significantly above their market clearing levels, and incremental new debt is not capable of financing those asset prices anymore? That’s my view, the view of Mellon, many pre-Great Depression economists, and a number of others today that argue that the problem is not that the markets have failed."
I agree that it is when debt levels and debt servicing costs exceed asset values and operating profitability, not failure of a few key areas, that causes recessions and depressions. But in any kind of economic system where money enters the system as debt this scenario is inevitable. It is only ever a question of how long debts/money can rise before the system becomes unsustainable. A fast growing economy requires fast growing debt, at interest, so we get there sooner. In a slow growing economy it takes longer. But as history shows, the end is always the same.
The Fed can create money for Treasury by buying bonds, but the Fed charges interest so Treasury must ultimately pay back more money to the Fed than it injected into the economy. Commercial banks create money for firms and individuals, at interest, so we must ultimately pay back more money than we put into the economy. The ONLY way new money can enter this system is as new debt. So to pay off all our old debts + interest we have to take on ever higher levels of new debt.
Savings in bank accounts are not recirculated in our system. Savings just enable more lending, which is more debt for the borrowers. Savings are actually money that is taken out of circulation which further exacerbates the money/debt imbalance.
Eventually there is so much more debt in the system than there is money to pay it, or the people who have the money are not the same people who owe the debts, that people start defaulting and we get a recession/depression with debt destruction as banks write off unrepayable loans. Once enough debt is destroyed by bankrupting borrowers the system becomes balanced enough to start a new runup of lending and debt. This is "the business cycle" which is merely varying degrees of debt runup and bankruptcies. It's a piss poor way to run an economy's financial system.
Otherwise perfectly viable businesses are bankrupted not because they don't efficiently provide what consumers want but because there isn't enough new debt flowing into the system for people to buy their outputs. Andrew Mellon says LIQUIDATE THEM ALL! to preserve this perverse arithmetic of finance, at the expense of the real economy.
In a fiat money economy this is obsolete economic thinking. Unlike a commodity money system like gold there is no limit to money in a fiat system. The total amount of money in a hard currency system limits the speed of economic growth because there are real limits to the velocity of a fixed amount of physical money.
This may not be a bad thing in an ideal world where everybody honored 100% reserve gold money. But in the real world any country who cheats and expands their money supply to speed their economic growth will gain massive industrial advantages over their competitors and we're back to the Great Power musical chairs of 1500 to Bretton Woods.
In a gold system whoever hoards the gold shuts down the economy. In a bank-debt money system credit contractions and/or unrepayable levels of debt periodically shut down the economy. We don't have to prostrate our economy before almighty numbers, because in a modern fiat system money is really nothing other than numbers in computers. If the number system is harming our real physical economic system which one should be blamed?
It doesn't have to be llike this. Fiat money does not have to be some mysterious evil that tyrannizes us. Go to epicoalition.org and read Warren Mosler's "Soft Currency Economics". Mosler understands fiat money and how to use the financial tools it offers us. I don't agree with all of specific measures Mosler suggests, but these at least give an idea of the kinds of measures that will work to fix the problems.
On Nov 17 12:12 PM Alex Filonov wrote:
> As matematicians know, one false assumption negates the proof. Or,
> as Gilbert used to say, if I assume that 2x2=5, I can prove that
> Moon is made of blue cheese. Great Depression happened in times of
> gold based money. Which tells me that credit boom (and bust) can
> (and did) happen in times of "real", i.e. precious metal based money
> as well. Has nothing to do with fiat money. Has everything to do
> with human psychology.