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- In a mammoth piece for NY Times Magazine, Paul Krugman wonders how economists got it so wrong.
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This news story has 15 comments:
It actually seems pretty simple to me.
Amount Owed > Amount Saved = Deflation Persists
On Sep 05 08:02 PM Bill L. wrote:
> As a group they are still wrong. The problem is there is 52+trillion
> in debt leveraged with derivatives and only 2 trillion in real dollars
> in the economy to pay for it. What they ignored is any time in history
> their has been this much credit in the economy versus wealth and
> savings, the result was a recession/depression. All these "cash for
> X" programs just encourage Americans to continuing adding to the
> indebtedness of the population while also adding to the indebtedness
> of the country. Stimulating the economy by adding to the amount of
> debt outstanding, when it is already at critical mass is not a long
> term solution.
>
> It actually seems pretty simple to me.
> Amount Owed > Amount Saved = Deflation Persists
These "curiosity items" remind me of the kinds of observations that led to chaos theory, which became complexity theory, which today describes how real systems work in the real world. A liquid would flow smoothly then suddenly become turbulent then revert to smooth flow. Telephone lines would be clear then some static would interfere then clearness would return. The turbulence and static had been dismissed as 'noise', but mathematicians and scientists who began to study the noise discovered how these systems cycle into and out of stability. They accepted the noise as 'real', and this led them to a far superior understanding of how complex systems really work.
Remember a couple decades ago when people were accusing each other of linear thinking'? People would extrapolate a current trend into the distant future as if the trend would or could go on forever. But in the real world trends suffer self-limiting conditions that cause the trend to stop and often reverse. Real world systems like economies go turbulent and from turbulence there is no guarantee they will return to the former trend.
'Ice age' alarmists in the mid 1970s extrapolated from the previous 30 years of global cooling to predict we were on the verge of an imminent ice age. Then global warming alarmists around the Rio conference in 1992 extrapolated from a less than 15 year old warming trend to warn of imminent planetary meltdown. There has been no warming for at least 8 years and some global cooling has occurred in the past couple of years. Both of these are examples of linear thinking about real world systems that work in cycles, not lines.
Economists too are guilty of linear thinking. As Bill L. points out above, and as Michael Hudson explains in his, "Why the Miracle of Compound Interest Leads to Financial Crises", debt cannot increase forever. In our monetary system, where new money begins its life as loans of newly created money from banks, economic growth depends on never ending increases in total debt. As Hudson makes clear, any constant percentage increase, such as a 2% annual increase in money/debt, is an exponential function. For years and even decades the increasing rate of growth of total debt seems moderate but in the later stages the growth curve turns vertical and you encounter terminal debt. We are at the terminal debt phase of the curve.
Economists are not talking about terminal debt because, as I wrote in another comment about Krugman's piece, economists treat money as simply a numbers system that faithfully transmits price signals. They treat money as if it is just an inert accounting system. But finance is not an inert accounting system. It has become, as Krugman calls it, the economy's "operating system".
But the operating system has the fatal flaw of requiring constant increases in total debt, which Hudson shows cannot work in the real world. This is why our financial system has to undergo periodic depressions with mass defaults on debt, collapsing asset values and a depressed real economy. The banking system writes down total debt until it falls to manageable proportions then the economy starts rebuilding GDP and debt levels until the next collapse. All because money begins its existence as debt at interest.
I suppose this is essentially the Austrian view, but I don't think it is necessary to revert to metal money in order to solve the monetary flaw. Fiat money and fractional reserve banking work very well in many ways and I think they are worth saving. What we need is a source of non-debt money constantly entering the economy which would at least in principle put enough money in the system for everybody to pay their debts.
Krugman's babysitter coop idea is instructive. People hoarded their babysiting coupons rather than spend them and the babysitting economy collapsed from lack of demand. In the wider economy there are always some people who are really good at accumulating money and some people who are really bad at getting into excessive debt.
The money collectors want to invest their money, not spend it, so eventually there is too little spending money left in the economy and effective demand begins its downtrend as we are seeing now. There is not enough of the existing money being spent for debtors to collect by working and selling stuff so they cannot make their debt payments. Then the banking system that lent them the money is in trouble and new lending slows which slows the supply of new debt-money entering the economy, further reducing effective demand.
This is the deflationary spiral that leads to long depressions. Krugman is right to say it took WWII to end the Great Depression. The economy, the financial system, was incapable of getting up on its own and needed the massive borrowing and spending of WWII to begin its recovery. Then the baby boom started a huge population increase which was the main contributor to postwar economic growth. But that growth was accompanied by ever increasing amounts of total debt, and the total debt problem has never been resolved despite a few episodes of large scale bankruptcies and debt writedowns like 1982 and 1991.
Now Hudson believes we have reached terminal debt, so the only way forward is another deflationary depression to write off most of the debt, or a more intelligent approach to operating our monetary system. Warren "Soft Currency Economics" lays out some of the basics of operating a sustainable fiat monetary system that doesn't require periodic crashes and depressions in order to keep functioning.
www.epicoalition.org/d...
Hudson's paper is at
www.michael-hudson.com...
Look again. Milton Friedman was Chicago School - which Krugman addresses early in his article.
On Sep 05 08:28 PM Balderdash wrote:
> There are no such things as real dollars. All dollars represent liabilities.
> Real dollars vanished in 1973.
> "Hmmm..., I didn't read any mention of Austrian economics in the
> entire article. "
>
> Look again. Milton Friedman was Chicago School - which Krugman addresses
> early in his article.
--------
But neither Freidman nor the Chicago School = Austrian economics.
Open Directory
www.dmoz.org/Science/S...//
lists an article by Roger W. Garrison as a discussion of the differences between Keynesianism, Monetarists (Chicago School) & Austrian Economics: www.auburn.edu/~garriro/b4mismac.htm
BTW, someone posted a link on here contending that Bernanke (& Greenspan) were in fact following monetarist policies rather than Keynesians: www.reason.com/news/sh...
"There is always an easy solution to every human problem — neat, plausible and wrong"
On Sep 06 02:35 AM Anthony Alfidi wrote:
> How could HE get it so wrong and still get a Nobel Prize? He still
> favors debt-fueled fiscal stimulus.
It seems to me that the flaw in the perfect market theory is that consumers can't possibly understand all the choices they have in certain areas. Combine that with the fact that people often believe what is conveniant for them to believe and you have a very inefficient market - with the latest example of people buying homes for stupid amounts, both in that the home isn't worth what they paid and that they can't afford what they agreed to pay.
If your buying a mortgage, your basically selecting from a ton of different mortgage products. If your a financial professional perhaps you can understand all the options, but if your a machine operator in a steel mill you have to substitute judgement and trust for understanding the facts behind each product. So while each consumer should know that there is no free lunch, and that if something sounds to good to be true.......they may not understand the differences between ARM's, Variable rates, fixed rates. This doesn't excuse their decisions individually but it impacts the whole system.
We could do with some common sense regulations that narrow the choices of consumers on occasion, that attempts to get rid of those products designed to confuse and basically exploit 97% of the people that enter into them. Something along the lines of morgages under $300,000 have to be fixed mortgages and require a minimum 10% down payment. Consumers can still look at different banks for the best rates, loan lengths, conditions, etc but those loans have to fit within the parameters that exist.
We should again seperate commercial banking from investment banking. We should raise capital requirements for banks. Etc.
The other thing I find interesting about the "perfect markets" is that those that promoted this as a reason for no or limited regulations are the very same people getting our tax dollars in bailout. So we don't really allow the market to be perfect - certain people/parties are "protected" - which means that the markets won't be perfect as those that know they can't fail will take additional risks and thus market prices are distorted.
I guess the market stops being perfect when the "elite" firms/individuals are about to go under. After all Citi, MS, etc were heading to zero - which is where the perfect market says they should be. And I for one had no problem with them all being out of business.
I actually would have like to see the market be allowed to play out with the banks and they go under.....allow the market to play out with homeowners that made bad decisions....prosecute those that falsified mortgage applications and sold these products to the elderly......claw back bonusses from those that obviously hadn't earned them.... And combined that with some keynesian stimulus (think of how much we could spend without all our bailouts of banks and homeowners) for national enegry independance - maybe 10 nuclear power plants, a huge national wind farm, and natural gas filling stations at every post office. And we still would have money left over!! Better all that instead of the nonsense of ensuring a bunch of Wall Street bums get their million dollar bonusses.
Here's a pretty good CNBC video giving the story from the perspective of each of the participants: www.cnbc.com/id/158402...;play=1
For what it's worth, I don't think this is just a matter of some people making poor decisions, and we just need to recover from this mess and then continue on as we have been with a few minor adjustments.
I think there are some serious systemic flaws with the world economy and if they are not addressed, we'll just careen from one fire drill to another trying to avert disaster after disaster.