Sleepwalking to Economic Oblivion

...any collectivist system is necessarily self-defeating no matter what its specific policies or leaders. After all, if Johnny is in your group and he can’t read or write very well, you’ll be getting Johnny’s grades.

- Karen De Coster, Groupthink and You.

Someone close to me once confessed that their Economics degree, taken prior to a successful career as a bond trader, had been a complete waste of time. Beyond an awareness of the inviolable laws of supply and demand, and of the somewhat more subjective but no less critical market attributes of greed and fear, the contents of the course had, my source suggested, offered no practical value within the context of a dealing room.

As every year passes, the futility of an Economics degree in the face of a career in finance seems less and less of a surprise. My own choice of degree course (English language and literature, for the record) has not obviously hindered my investment career, nor my original role as a bond salesman. But one can at least make something of a special case for the bond market, in that it does appear to be a more broadly logical and rational arena for investment and speculation, governed in large part by the macro factors of inflation, monetary policy and economic “fundamentals”, compared to the Gothic bazaar that is the stock market, where tips, rumours, stories, the flimsiest of opinions, and all strata of pond life hold uneasy sway.

But what fills me with growing concern is the suspicion that there is a broad consensus – among economists and market observers – that there is no alternative to the gargantuan bail-outs being granted to the western financial system. Indeed, there seems to be a growing clamour for more and yet more of the same, to an even broader constituency of obviously specially unique economic interest groups. Nor, for that matter, does there seem to be overmuch questioning at the wisdom of deploying all sorts of fiscal materiel to suppress the prospect of imminent recession. Nor at the increasingly tokenistic and saver-impoverishing rate cuts, like this week’s from the Bank of England, despite the well-acknowledged fact that what matters is not the price of credit but its availability.

Diapason Commodities Management strategist Sean Corrigan has a nice line in criticising the authorities’ unwillingness (or inability ?) to liquidate bad banks. This would have had the benefit of reducing over-capacity in a systemically and not to say horrifically over-leveraged industry,

But rather than encouraging full and early disclosure of each [banking] entity’s true status and then applying a rigorous practice of triage – thereby making room for the remaining healthy banks to continue to serve sound borrowers at an economic rate of interest – the authorities have so contrived it that almost the entire industry has now come to be dependent upon the public purse and / or the central bank printing press, with regulators also conniving in a relaxation of reporting standards and capital adequacy testing at precisely the moment when the cancer of distrust – of discredit, if you will – is poisoning the system, to the detriment of all. The only purpose this seems to be serving is that of keeping the plague victims alive for just long enough to pass the infection on to the healthy.

Corrigan also cites the notable economist and philosopher Ludwig von Mises, whose ‘Human Action’ of 1949 reads like a road map to the parlous state we seem to be destined for:

The dearth of credit which marks the crisis is caused not by contraction, but by the abstention from further credit expansion. It hurts all enterprises – not only those which are doomed at any rate, but no less those whose business is sound and could flourish if appropriate credit were available. As the outstanding debts are not paid back, the banks lack the means to grant credits even to the most solid firms. The crisis becomes general and forces all branches of business and all firms to restrict the scope of their activities. But there is no means of avoiding these secondary consequences of the preceding boom.

As soon as the depression appears, there is a general lament over deflation and people clamour for a continuation of the expansionist policy.. entrepreneurs enlarge their cash holding because they abstain from buying goods and hiring workers as long as the structure of prices and wages is not adjusted to the real state of the market data. Thus any attempt of the government or the labour unions to prevent or to delay this adjustment merely prolongs the stagnation.

And yet both the financial and political worlds have collectively swarmed, almost as one, to the Keynesian interventionist and pump-priming banner. One wonders whether the spirit of Keynes has already won the battle, but the likelihood is that the spirit of Mises will “win”, albeit in pyrrhic manner, the depression – because the damage, not least in the form of an unnecessarily protracted and grievous economic slowdown, will have been well and truly done by then.

That slowdown is likely to involve much higher tax rates and much higher unemployment. Both straitened workers and the new unemployed will cut outgoings, thus amplifying the negative impact on the economy and on consumer spending (roughly 70% of Anglo-American GDP) – Baugur will not be the last retail business to collapse. And it is not just Iceland that faces a slide into irrelevance. Near namesake Ireland has, according to Bedlam Asset Management, a ratio of banking assets to budgeted government revenue of 26 times. The equivalent figures for the UK and US are 5.3 and 5.9 respectively. Staggeringly, the ratio of Ireland’s banking assets to foreign reserves is 3,117 times.

So how much is that bank guarantee really worth? It is probably premature to regard equity markets as cheap – because it is only those businesses whose franchises are bullet-proof even in a consumer slowdown that are worthy of consideration for an absolute return investor. Having little or no indebtedness will naturally help. And staying with the topic of debt, few could argue with the thesis that whereas the story for government paper is starting to look a little frayed, the backdrop for high quality corporate paper is altogether more constructive. (Corporate spreads are at record highs relative to government paper.)

Perhaps the last word should go to another economist and philosopher we find increasingly worthy of citation – Murray Rothbard, also of the Austrian school (the Austrians are to Economics what Value Investors are to Investment. Discuss).

It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a ‘dismal science’. But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

After a recent commentary criticising the extent and ultimate value of the UK government’s support for the banking system, and the danger that the scale of the economic bailout might actually exacerbate rather than prevent a serious depression, a reader suggested that I email my MP to share those thoughts. I duly dispatched a brief message to one Glenda Jackson. I have yet to hear a response.

Comments

[Moon Kil Woong:]

100% spot on. Until prices and wages correct there can be no real fundamental upswing. And current policy is retarding prices from correcting down and wages from mis-allocated resources from re-aligning.

Thus the only business solution in light of no credit expansion and no new money is to pay down debt themselves, cut inventory due to falling demand from the fact supply and demand can't balance anymore, and layoff workers to make up for falling revenue and narrowing margins.

There can be no traditional recovery without prices being allowed to reset downwards to equilibrium. And jobs will keep dropping as long as we prolong the inevitable de-leveraging from occurring. Thus a sharp abrupt economic collapse led by a recovery is better than what we have now a slow painful government hand holding experiment that takes years of wasted stimulus and saps any economic rebound that should have happened along the way.

The coddling government paternalism we are seeing now, especially towards ill behaved financial companies, will spawn yet another economic monster.

Feb 06 04:32 AM

[Tradememe:]

This is more an asset price bubble than a wage bubble. So, we are seeing the opposite of the wealth effect we had during the housing bubble. The hope is that the coming stimulus package will not try to start another bubble in another sector of the economy.

Feb 06 05:40 AM

[athena:]

Everyone intending to work on wall street should have a degree in Economics. If they had, this disaster would not have happened. The false insurance called swaps that paved the way for extraodinary risk and leverage would have been called false insurance. The money supply would be taken seriously. The debt would be less. Wall street is full of salespeople that look to mathematicians to create products with no overall understanding of the big picture. I was appalled to hear that the mortgage market dwarfed the treasury market 5 years ago. That should have been a huge signal to everyone who understood economics.

Feb 06 07:50 AM

[wdhalgren:]

It's good to hear a few Austrian voices through the Keynesian clamor. Unfortunately the mainstream media have set their course, long ago in fact. Most Americans will suffer through the coming economic disaster without ever knowing that we had choices; that the Federal Reserve is not an essential (or helpful) function of government, that fiat money is not true money, or that government spending does not create wealth. These concepts are rarely given genuine discussion, to the point of being radicalized. Even when the system breaks down, this will be branded as a failure of free markets and capitalism, regardless of the fact that we abandoned both early in the 20th century.

Feb 06 08:10 AM

[kelm:]

You are bang-on. The support the government is planning in the US will prolong the situation. We have heard in the past two weeks that nationalizing the banks temporarily is too expensive. Pity, a quick takeover followed by euthanasia of the weak and a re-privatization of the strong seemed to be the way to provide the controlled destruction that is needed to cleanse the system. Now we are finding that even the aggregator bank is too expensive and so we will go forward with some form of "insurance" guaranteeing that the banks are, kept on life support. This will ensure much worse economic times to come.

Feb 06 09:53 AM

[Ferdinand E...:]

Both right and wrong Mr Price. I rubbed elbows with traders in Australia and Singapore when I was teaching in those places, and I was amazed at their lack of economic knowledge. I was inclined however to believe that they were intelligent, until I read the book by Nick Leeson. Then I realized that the most important thing was to be a hard worker with a love of money, although a few of those people could have given Einstein a run for his money.

On the other hand, as economists are always saying, if you want to understand the economy, a reasonable knowledge of economics makes a lot of sense. As for Austrian voices, I spent a month in Vienna brushing up my German once, and I really enjoyed those - especially in the vicinity of Graben, around Midnight. By way of contrast, Austrian Economics is for the birds.

Feb 06 10:22 AM

[Jubilee Year:]

Deleveraging can be slow and painful, or we can deleverage all at once: Jubilee. My suggestion is to start with a mortgage Jubilee, if you prefer to do things piecemeal. Until the cancer of debt is excised from our system, we will continue to decline in health.

Feb 06 01:23 PM

[Leftfield:]

Thanks for this article. I'm self-informed, maybe this is obvious, but most mainstream media types chuckle and wear economic ignorance proudly as part of their "common touch" along with math ignorance. Common with the public who has Johnny's failing economics grades but plenty of votes.

So, that ignorance becomes the fate of our society unless we luck out.

Until the Federal Reserve, American businesses were self financing mostly. Now, we have been sucked into ponzi financing and false economic information for about a century provided by the Wall St. and Washington finance capital specialists. They have influenced false decisions, deep debt, internationalism and now, immanent poverty in our formerly prosperous country.

Our ill-educated citizenry and corrupt leaders handed the banksters gifts I never anticipated when the latest chickens came home to roost. Proposed Washington solutions are all worse than the disease ultimately; their utter corruption is unmistakable.

Our options dwindle, Obama, a blind hope to the electorate, seems to continue our downward spiral. Unfortunately, the worst malefactors don't seem ignoran at allt. They are focused on getting and I fear where this is taking the U.S. and the world.

Feb 06 01:24 PM

[henarl:]

The information you learn getting an economics (or many other) degree is of very little value in the real world. The advantage you get is the certificate and, mostly, the connections you establish while going to college.

Feb 06 01:36 PM

[austrian63:]

Spot on. It's a shame that most Americans believe the boom-bust business cycle is a natural part of the free market out of economic ignorance and the overwhelming acceptance of Keynes' theory which does not even include capital theory. We Austrians can at least find peace in that we know what the results of the continued massive government interference will be and we can plan our lives accordingly.


On Feb 06 08:10 AM wdhalgren wrote:

> It's good to hear a few Austrian voices through the Keynesian clamor.
> Unfortunately the mainstream media have set their course, long ago
> in fact. Most Americans will suffer through the coming economic disaster
> without ever knowing that we had choices; that the Federal Reserve
> is not an essential (or helpful) function of government, that fiat
> money is not true money, or that government spending does not create
> wealth. These concepts are rarely given genuine discussion, to the
> point of being radicalized. Even when the system breaks down, this
> will be branded as a failure of free markets and capitalism, regardless
> of the fact that we abandoned both early in the 20th century.

Feb 06 02:16 PM

[Simon Smelt:]

The value of an econ degree depends on the quality and level of the degree. A good degree is worthwhile in helping an understanding of what the key factors are, how they inter-relate and the variety of views on these. Main danger are thinking you know more than you do and getting bogged down in technicalities and losing the big picture.

On the big picture, the presenting problem is deficient demand and the underlying one is excess debt. Current policies are trying to deal with both by shifting debt from private to public hands.

Within the U.S. economy, the price problem is that some assets (equity, property) became overpriced relative to labour, whilst capital was too cheap. But behind that is the international force of easy credit terms for the U.S. which it then misused. Now the U.S. wants more easy credit to put right past mistakes.

Feb 06 02:19 PM

[OldLimey:]

Mr. Price: a truly outstanding piece.

Your alma mater has been snow-bound and virtually immobile today. Regretably, it's just the weather that is Austrian rather than the economic policy.

Feb 06 02:52 PM

[TinyTim:]

WU- Economics tries to encompass greed and unlawfulness as well.

" their Economics degree ... had been a complete waste of time"

"totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance"

Lose if you do, lose if you don't???

Economics is an infant "social" science, hardly able to express theories and concepts quantitatively.
Since it's been around so long, I'm beginning to think changing reality is pulling away faster than the forefront of economic thought.

On the one hand, I certainly wouldn't rely on it for definitive direction on government policy. On the other, what else is there?

Feb 06 05:41 PM

[mr freddo:]

We used to battle forest fires as if they were a demon that must be stopped before all those beautiful trees were burned. Then we realized that forest fires are a part of the natural process and useful in clearing out the dead wood. When we don't allow fires, the dead wood builds to a level whereby when a fire does break out, it is a huge catastrophic fire that takes out hundreds of houses along with the trees.

So the Keynesians are like the forest fire fighters of last generation, trying to prevent the fire that destroys all of the dead wood, the fuel for the catastrophic fire down the road.

Feb 06 07:29 PM

[Erick Tippett:]

Mr. Bird Brain

Have you ever bothered to read the works of Ludwig Von Mises or
Murray Rothbard?

Hit Amazon.com and sample some of their books, you might clear some
of the rocks out!

EDT
Chicago, Illinois

Feb 06 11:13 PM

[Unknown Inv...:]

excellent analogy


On Feb 06 07:29 PM mr freddo wrote:

> We used to battle forest fires as if they were a demon that must
> be stopped before all those beautiful trees were burned. Then we
> realized that forest fires are a part of the natural process and
> useful in clearing out the dead wood. When we don't allow fires,
> the dead wood builds to a level whereby when a fire does break out,
> it is a huge catastrophic fire that takes out hundreds of houses
> along with the trees.
>
> So the Keynesians are like the forest fire fighters of last generation,
> trying to prevent the fire that destroys all of the dead wood, the
> fuel for the catastrophic fire down the road.

Feb 07 11:36 AM

[DiracMan:]

This is not a "normal" business cycle adjustment. I have lived through many. This is a 300 year event. In the END GAME it WILL cause a total re-think of the Federal Reserve System and the Fractional Reserve Banking System itself in the economic structure of society. Maybe even by candle light. In the END GAME it will be completely BEYOND BOTH the Keynesian and Austrian Schools of thought. Both views are extremely helpful for analysis but we are facing something beyond Adam Smith, Karl Marx, Thornstein Veblen, John Maynard Keynes, Ludwig Von Mises, Paul Samuelson, and Milton Friedman just to name a few. We are off the charts. We are in economic No Man's Land. I hope somehow we are up to it. Where is the Credit Default Swap 1931 Viennese Credit-Anstalt out there? Where is the financial nuclear weapon detonation out there that is the equivalent of the engines on the Titanic breaking lose at the moment of maximum pitch and falling through watertight door after watertight door taking it under to the depths?

www.youtube.com/watch?...

Feb 07 03:54 PM

[PauvrePapillon:]

“I call upon all responsible, productive people to work hard and sacrifice so that we can redistribute their incomes to those who will never be able to find a decent job because they refuse to buy into bourgeois middle class values like staying in school or learning a trade or finding a husband before starting a family but are, nevertheless, the Ones We Have Been Waiting For because they will get on a bus and go vote for me whenever and wherever I need to send them.”

His Most Beloved and Exalted Excellency Barack Hussein Obama, JD, the FIBPOTUS

Feb 07 06:15 PM

[mr. burns:]

Von Mises predicted what would happen in the UUSR and his theories predict how our crash occued and will play out. Economics is a type of philiosophy , it is not a science , nor is it it quantitative.

Feb 07 06:34 PM