Economics of Depression 23 comments
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There will be no interruption of our permanent prosperity.
- Myron Forbes, President, Pierce Arrow Motor Car Co., January 1928.
Stock prices have reached what looks like a permanently high plateau.
- Economist Irving Fisher, October 1929.
[1930 will be] a splendid employment year.
- US Department of Labour, New Year‟s forecast, December 1929.
...the central problem of depression-prevention has been solved, for all practical purposes.
- Robert Lucas, winner of the 1995 Nobel Memorial Prize in Economics, in his presidential address to the American Economic Association in 2003.
Hindsight, of course, is a wonderful thing. Scour Ben Bernanke's 2004 speech, "The Great Moderation‟ as much as you may, the text yields little by way of explicit hubris, although the soon-to-be Fed chairman does tend to suggest, as economist Paul Krugman – another Nobel Laureate – hints:
much as Lucas had, that modern macroeconomic policy had solved the problem of the business cycle – or, more precisely, reduced the problem to the point that it was more of a nuisance than a front-rank issue.
And it is certainly clear from Krugman's The Return of Depression Economics and the crisis of 2008 (Penguin, 2008) that economists love few things more than bitch-slapping their academic rivals. So why are academic politics so vicious? In a quotation that has been variously credited, amongst others, to Woodrow Wilson, Henry Kissinger, Richard Neustadt and Wallace Sayre, the response would seem to be: because the stakes are so low. Perhaps if economists were managing money, say, as opposed to developing models and largely sterile theories in a hugely complex and fecund world, they might be more respectful of each other.
In any event, Krugman's book stands out amongst economic works in that it is highly readable, not to say outright chatty in tone. And for those investors still puzzling over why mature and ostensibly well-managed economies can suddenly be pitched into a savage recession or something worse, The Return of Depression Economics also carries a charming educational vignette, albeit one created by Joan and Richard Sweeney back in 1978, under the title Monetary Theory and the Great Capitol Hill Baby-sitting Co-op Crisis.
The analogy goes like this. The Sweeneys were members of a baby-sitting cooperative. A semi-formal federation of roughly 150 couples would share the responsibilities of baby-sitting each other's children. To ensure that everybody did their fair share, the cooperative issued scrip, which entitled the bearer to one hour of baby-sitting. Having discharged their cooperative duty of an evening, baby-sitters would be paid the appropriate number of coupons by the baby-sittees. Over time each couple would provide exactly as many hours of baby-sitting as they received.
The system broke down, however, when couples with several free evenings in a row, and with no immediate plans to go out, would try to accumulate coupons for future use. This accumulation would be matched by the exhaustion of other couples' reserves. The time came when too few coupons were circulating amongst members of the cooperative.
Couples who felt that their reserves of babysitting coupons were insufficient would become anxious to baby-sit (and reluctant to go out). But one couple‟s evening out was another couple's opportunity to earn coupons they could no longer earn if the first couple stayed in. Opportunities to baby-sit dried up. Couples became even more reluctant to spend their reserves, in turn making baby-sitting opportunities even scarcer.
The baby-sitting cooperative had discovered recession.
As Krugman points out, this little story happens to be “a powerful tool for understanding the not-at-all whimsical problems of real-world economies.” The baby-sitting circle did not enter recession because it was doing a bad job, or because of “crony baby-sittingism”. The problem was simply a lack of “effective demand”. There was too little spending on goods (or baby-sitting time) because people were trying to accumulate cash (baby-sitting coupons) instead. Krugman‟s lesson for the real world?
...your vulnerability to the business cycle may have little or nothing to do with your fundamental economic strengths and weaknesses: bad things can happen to good economies. [Emphasis mine.]
And Krugman takes us on a breathless, whistle-stop tour through some of the world's most celebrated or at least infamous financial crises. Mexico's Tequila Crisis of 1995 has a cameo role, as does Argentina's hyperinflation of 1989, and Japan's lost decade of the 1990s gets a "best actor‟ nomination. But perhaps the pan-Asian crisis of the late 1990s gives the most urgent early warning signs for our present rolling panic: first, because it spread from economically "guilty‟ countries to economic "angel‟ sovereign nations at a blistering speed; second, because it reached its zenith with the inglorious failure of hedge fund Long Term Capital Management (and its handful of Nobel Laureates): an eerie forewarning of the deflationary, deleveraging and panic-spraying role to be played by the rise of the shadow banking system – and the outright failure of regulation – this time round.
To return to the babysitters... How was their recession resolved? Intriguingly, the first response (in reaction to a perceived “structural” problem) required each couple to go out at least twice a month. (In a more directly economic context that sounds like brute intervention and the opposite of a free market dynamic.) Eventually, following advice from economists, the cooperative changed tack, and simply increased the supply of coupons. “The results were magical: with larger reserves of coupons, couples became more willing to go out, making opportunities to baby-sit more plentiful, making couples even more willing to go out, and so on.” Krugman takes pains to point out that the couples hadn't become better baby-sitters; rather, “it was simply because the monetary screwup had been rectified. Recessions, in other words, can be fought simply by printing money – and can sometimes (usually) be cured with surprising ease.”
But our current malaise is evidently more profound than just an absence of circulating money. In Krugman's words,
...for the first time in two generations, failures on the demand side of the economy – insufficient private spending to make use of the available productive capacity – have become the clear and present limitation on prosperity for a large part of the world.
Yes, credit needs to flow again (perhaps with a keener eye on the quality of borrowers, this time around), and consumer-driven economies require a boost to spending, at least for as long as GDP is driven by consumption. Economics has a rather heartless way of describing the problem: as a fallacy of composition, and particularly as the paradox of thrift. Increasing saving makes sense for the individual, groaning under a burden of debt, but if everybody starts saving at an increased rate, the economy tips further into recession. To which one might fairly respond: whoever said that it was the individual's duty to put the economy before himself?
Happily for them, economists are not primarily concerned with the management of wealth, so they can indulge in homo economicus theorizing to their hearts' content. For those of us that are, Krugman's book serves as a handy reminder that economics doesn't have all the answers. The critical questions now have no sure answers either: do we get deflation, or inflation, or some combination of the two? Do we get a sequence of competitive currency devaluations and / or a continued flight from fiat currency that ultimately hits the US dollar? Is it too early to get back into the stock market? (Probably it is, unless on a highly selective basis, given the likely duration and severity of the recession / depression. Friday's dire US GDP figures cannot be spun into anything more positive.) My best guess is that notwithstanding the enormity of the banking system's spree of serial capital destruction, the monetary authorities globally are indeed stepping up to the plate. Which is indeed easy for them to do, since it's not their money: they are redirecting much of the wealth of current and future taxpayers to shore up the banks. Investors globally meanwhile are succumbing to crisis fatigue. Perhaps the low point in the fragility of the financial system really is already behind us. The "nationalisation‟ word may spook our American friends, but de facto that is where the banks largely are. To pretend otherwise is self-denial. Their 2006 era market capitalisations aren't coming back. If you want real growth for your equity investments, back another horse.
The deflation horror story is probably somewhat overblown. That is not to say that an extraordinary (and shockingly globally synchronised) recession cannot last far longer than the current myopic consensus. It may be true that in Roosevelt's words all we have to fear is fear itself. But isn't that enough to be worried about?
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Charles Eisenstein
...and that's a serious and certainly well-known problem with Krugman's analogy. (much as I appreciate and generally endorse his economic views)
I think the main problem with the baby sitting scrip is what if one of the couples doesn't want all of their hard work to be valued less through the 'printing press' effect? To further this analogy to reality, you'd have to add in 'dishwashing scrips', 'laundry scrips' and etc. What you'd find out is if one was devalued in such a sense, the savers of that one scrip would either object, or advocate that they all get devalued, and at the same level as well.
On Mar 01 09:51 AM Lilguy wrote:
> Liked the story from Krugman about the baby-sitting scrip. Unfortunately,
> he failed to note that, unlike the scrip, increasing money supply
> creates inflation so that it takes more money/scrip to buy the same
> level of services.
>
> ...and that's a serious and certainly well-known problem with Krugman's
> analogy. (much as I appreciate and generally endorse his economic
> views)
they did it as art lovers, and likely had a long term relationship with the designer/owner. they bought because of that, not because they had the money, not because they were trying to look like something they already weren't, like art-world-newbies might.
if they are offered $35 million next week, they will turn it down.
the lession here is simple: we need to build a society that values things beyond the money, beyond making a quick buck. that was the underlying problem with dot-com, the housing bubble, etc., and the bankers and the government went along with it, either through greed or ignorance of potential outcomes.
when i was a kid, i'd collect baseball cards, and felt really good when i'd get a Mickey Mantle. i also felt good getting a Willie Mays, but i'd use that card to trade for another 'high-value' Yankee, because my heart was with that team, not with manipulating the neighboirhood market for trading cards. i certainly wouldn't have emptied my piggy bank to buy up the local market in hopes of making a profit.
lesson: if we simply have solid, lasting reasons for what we do (in addition to the desire to make money on a transaction) our lives will automatically remain in balance.
who are writting tickets like mad now to save their jobs but its okay for them to speed off to lunch without using their turn signals. A double standard and tell me why we accept it. Because we have been manipulated to be lazy. Fattened up for the kill. Remember when you have had enough LOOK DEEP INSIDE FOR PEACE AND ANSWERS.
Then make a difference.
On Mar 01 09:33 AM Charles Eisenstein wrote:
> Irving Fisher, whose ignominious prediction you quote at the beginning
> of this article, advocated another kind of solution to the babysitter
> problem: a stamp scrip currency that bears demurrage charges or,
> in essence, declines in value over time. The equivalent in the babysitter
> scenario would be to subject the coupons to an expiration date. Rather
> than increasing money supply, this solution increases money velocity
> instead. It also discourages the accumulation and polarization of
> wealth. Originally expounded by Silvo Gesell, demurrage currency
> was used in Austria during the Great Depression with remarkable results
> (until it was banned by a threatened central bank). See www.realitysandwich.co...
> for a more detailed analysis.
> Charles Eisenstein
I thought we did that and it worked out to be something called Long-Term Capital :)
> Generally speaking, depression is a period of severe downward adjustment
> that follows a period of Irrational Exuberance, as Mr Greenspan put
> it. Why he could not therefore see this thing coming leaves me cold!
I think that a lot of people knew this was coming but who wants to stand in front of a crowd and tell them to stop enjoying good times? Jim Cramer and the other financial geniuses would shout and scream like monkey's at the mere thought of slowing down the economy intentionally.
We are getting what we deserve and while we can place some of the blame on our leaders it is unlikely that any of them would have been kept around if they had been completely honest with us about how greedy we were acting.
Today many consumers have more debt than they can handle and quite a few savers have a lot of money that they don't want to spend on consumption, which creates the scenario 'lack of effective demand'. Savers, by natural inclination, want to invest to increase their personal money supply rather than spend to increase their standard of living. Human nature causes money systems to eventually seize up like this.
In other words, those who have money want more money, and those with no money cannot spend what they don't have, so money flows cease and the economy is dead in the water.
The Industrial Revolution and subsequent technological improvements vastly increased the productivity of labor. A modern economy does not need full employment to produce all the goods that everybody wants to consume. In mercantilist days countries tried to 'beggar thy neighbor' by exporting more than they imported and thus increasing their national gold supply, but clearly 'everybody' can't export more than they import so this is a declining sum game where eventually somebody ends up with all the money and the trading economy stops. You can pretend to keep it going by 'lending' your money to people so they can keep buying your exports, but they can never pay you back.
We still haven't implemented any of the solutions that have been advanced to solve this monetary problem (by CH Douglas, Warren Mosler and others), so let's have a depression instead of understanding how money works and acting accordingly. Depression builds character in the herd. Not.
A vibrant economy has a very broad basket of goods and services, and the market allocates resources by setting the relative prices of these myriad goods and services.
Misguided government policy distorts the market by creating artificially high demand in certain sectors, until their supply becomes untenable. The obsession with housing as a favored economic sector led first to tax subsidies (mortgage interest deduction), then to more direct subsidies at the expense of the taxpayers (through the GSE's) and at the expense of savers (through artificially low interest rates).
This sort of policy-introduced distortion creates an unstable positive feedback loop, just as an amplifier with its microphone and speakers in the same room turns a minor whisper into a terrific screech. When various players in the economy realise that there is a favored sector, housing in this case, they jump on the bandwagon. With more people profiting from the bandwagon, the lobbying to even heap greater favor upon an already favored sector increases. This makes the favored sector even more profitable, and more players pile in, and so on until the screech splits everyone's eardrums.
The way to end such crises is for government to avoid selecting sectors for special favor, as it did with housing for several decades, and just let the market allocate resources based on natural demand, rather than policy dictat.
On the other had there is a player who is happy to go out every day. That is the US because it has the ability to make more scrips heedless of the consequence. The ultimate outcome is that eventually the US will find themselves at home babysitting forever after Asia finds out it's scrips it has been collecting are worthless.
It is an economic imbalance, not bad things happening to fundamentally sound economies. For one thing, Asia and the emerging world need to find out how to build a middle class that can consume and keep an economy running. And the US needs to control their credit levels starting with the banks and tell their government to lay off the printing press.
The US consumer is not the central cause of overspending or the resulting recession. Banks and financial institutions are. If the extra credit didn't go to consumers it would go to speculators (derivatives and mortgage market ones in this case). Telling people to spend within their means while they watch their cash devalue every day is like telling you to play monopoly with a guy who takes $200 pass go money every turn and not buy as much as you can before you can't buy any property. The problem is a macro economic problem and can't be solved on the micro economic scale.
Crewmember on the RMS Titantic
Having watched "from the inside" market evolution for about 20 some odd years, it strikes me as kind of strange that people aren't looking at changes in the demand sources -- redefinitions of value add in terms of what people want -- and the changes in the rate of capital spending depreciation. Many global enterprises, especially in financial services, have billions in sunk costs -- and they're not getting them back. Global banks have immense investments in technology infrastructures (poorly managed and chronically the "poor step-child", it's true) that they can't live without, but which can be replaced at fractions of the carrying cost. Markets won't allow that kind of crap for too long -- you can pretty much write off the banking industry as it currently exists.
As to the redefinition of value add -- we have entire industries devoted to selling things that people are rapidly losing interest in. Haven't done any actuall counting, so this is only anecdotal, but I find it interesting to note that I've seen more and more "We're hiring!" ads from open source software companies of late. Thought that was a "non-starter" as a business model? And just spoke with someone who lost his star programmer because the guy made $500k in 6 months writing apps for the iPhone. Consumers and consumption are changing -- and the entire fabric of our economy is going through some pretty profound changes that are basically reflections of changing global demographics.
Looking at the current situation strictly as an economic or financial event misses some key points. We're all going to have to look at things differently. Maybe even come to a place where we can have workable shared definitions of "facts" - what they are and what they mean.
My local newspaper, "The Oregonian", caries Paul Krugman as a regular and frequent contributor in its Op-Ed pages. There is usually no offsetting article of interest.
Without question, I find his articles contrary to rational thought, bereft of foresight, and offensive. I know this article really isn't about him, but the mention of him makes me sick and sad for the legions who subscribe to his philosophies.
The example is misleading, because the couples that earn cupons cannot do anything else with them than consume. In reality - we also have investment market, where the savings are invested.
The more people save and invest, the better. If everybody was just consuming, we would go back to caves, as nobody would be investing in houses, infrastructure, research, etc.
Krugman is a pure Keynsian, who was proven time and again to be wrong about how economy works...