Tuesday, February 17, 2009

Decade at Bernie's

Paul Krugman sort of backs in to what I've mentioned earlier: the current crisis is a solvency crisis. I.e., banks can't lend money because they're insolvent. People can't borrow money because they're insolvent and don't meet the basic criteria to borrow money. People can't buy stuff because they're insolvent. And the insolvency, by deflating incomes because other people aren't buying stuff due to their own deflationary expectations, inflates the debt load of Americans, causing further insolvency as further people become unable to service their debt load.

I've previously hypothesized that nothing less than a national declaration of insolvency -- i.e., much easier access to bankruptcy protection, and the complete re-structuring and re-capitalization of the banking industry -- will get spending back up and going again. The desired end game, remember, is to achieve a level of supply and demand that results in near-full employment, which is necessary in order to prevent social unrest and maximize output of goods and services in the economy in order to provide a better life for the majority. If nobody is buying, there are no jobs. If there are no jobs, then people aren't buying. This solvency trap is hell to get out of, and anybody who thinks the economy can get out of it without massive government intervention has to be smoking crack or hillbilly heroin or both.

-- Badtux the Economics Penguin


  1. You probably need your beauty rest after roughing it, but I ma curious as to how Frontline will explain the Meltdown tonight. It should be online late tonight or tomorrow.

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  4. Reminder: The penguin is the only one allowed to be an ass here. Read the ground rules.

    - Badtux the Asshole Penguin

  5. Krugman is right. We were borrowing too much. He talks about the stimulus not being enough. Enough for what? Returning us to our spendthrift ways once again?

    I do hope we can bring the economy to a soft landing, but it must come down.

    I disagree that the government is the only possible solution. I started to read Panics, Manias, and Crashes once (didn't finish it unfortunately) but there is one rule of thumb: human nature doesn't change. Whether the government pulls the strings, or private individuals...there will always be bubbles. The government has the power to make much bigger bubbles. The Federal Reserve was created around 1913. Within 10 years we had the biggest recession in American history. How come all the prior recessions were smaller and shorter? How do we know that Krugman's medicine doesn't just create another bubble (like in the value of the dollar).

    It's true that wars seem to end recessions, but getting people to make those kinds of economic sacrifices (a major war is a hardship no matter what your GDP!) takes a war. During peace, isn't the recession itself the vehicle for causing economic hardship? Krugman believes that we can replicate economic benefits of a war without the hardship. You get the cake and eat it too.

  6. Howdy, Nathan. Here's the deal:

    1. Regarding stimulus not being enough: The stimulus needs to be enough to re-inflate the money supply so that we avoid a deflationary spiral. See my past articles on why a deflationary spiral is *bad* -- monetary deflation shuts down bank lending, which shuts down business modernization and expansion, which makes the economy less productive and less competitive, plus creates debt inflation which makes even more debts unpayable which causes even more monetary deflation.

    2. Please see my previous articles on inflation-deflation cycles, including the one where Thomas Jefferson complains that inflation-deflation cycles were a massive conspiracy to transfer wealth from working people to the wealthy. Inflation-deflation cycles are inherent in any monetary system that includes fractional reserve lending (see my articles on inflationary-deflationary expectations and the effects upon bank reserves). The only way we have thus far found to smooth out inflation-deflation cycles is to print money during deflationary parts of the cycle and un-print money during inflationary parts of the cycle, and that requires a central bank that has control of the money supply. I.e. government.

    Unfortunately, as I point out, simply printing money is useless if it just disappears under a mattress as "mattress money". It might as well be toilet paper at that point. Only circulating money is part of the actual money supply, not "mattress money". Which is where fiscal policy comes in -- when monetary policy fails because any newly-printed dollars get stuffed under mattresses, government has to step in and attach strings to that newly-printed money, e.g., you *will* spend it on infrastructure. You *will* spend it on food (via food stamps). Etc. Otherwise it just disappears under mattresses and you just wasted good paper for nothing.

    3. Your history is false. In 1873, we had the biggest depression in U.S. history, even bigger than the Great Depression, and it lasted for over fifteen years, i.e. longer than the Great Depression. Inflationary-deflationary cycles were common prior to the Great Depression, and some of them were very deep indeed. The Long Depression was ended by two things -- gold strikes in Nevada and California that re-inflated the money supply, and massive government spending to modernize the U.S. Navy in the 1890's (prior to the 1890's, the U.S. Navy was obsolete Civil War era ironclad gunboats, hardly suited for winning encounters with modern dreadnaughts). So much for the thought that an economy can re-inflate itself without outside help from either money being printed or massive government spending... it did not happen during the Long Depression, only government spending and the coining of new money (thanks to the gold strikes) got the economy moving again.

    4. There is no such thing as a "recession" as an entity separate from the reduction in economic activity. The reason why WWII got us out of the Great Depression was because it re-inflated the money supply and thus caused debt deflation (see his statistics about debt load prior to the war and debt load after the war). This solved the "solvency trap" where insolvency caused deflation which caused even further insolvency (since monetary deflation causes debt inflation). Monetary inflation-deflation cycles are inherent in fractional reserve lending (see my previous posts on the subject) and short of outlawing fractional reserve lending (which would destroy the economy as a competitive entity), you need some outside organization to deal with it. In the post-WWII timeframe we've done a damn good job of it using the government mechanisms that you are pooh-poohing -- this is the first deflationary cycle we've had in sixty years, and it occurred because the Bush Administration dismantled the Depression-era safeguards against deflationary cycles, not because of government.

    - Badtux the Economics Penguin

  7. I don't dispute your points 1-3. Thanks for informing me of 1873. Like I said, I didn't finish the book. I agree in part with your assessment of WWII, but I do not agree that it is a lesson that directly applies to current conditions.

    My point was simply that bubbles will not go away just because a central entity takes over. Nor do I want bubbles to go away. The control it would take to make life 100% predictable would reduce freedom to zero. We've all heard the phrase "At least Mussolini ensured the trains left on time".

    The Federal Reserve has learned a lot over the years. But Alan Greenspan kept the money too easy for too long. So if a bunch of smart guys like those at the Fed can screw up, why are Krugman and the Keynesians going to do any better? Krugman isn't the only economist with a PhD out there. There are plenty that agree with me that massive spending is not always the answer. They might hit a few home runs, but eventually a bubble somewhere will burst. Humans will learn to game the system no matter what that system is.

    What I'm saying is that now is the time to take our medicine. Let the deflationary cycle take place. Even if some social dislocation takes place. I'm not worried about 1789...this is a socialized country with many safety nets. The medicine will be good for us.

    Even if stimulus money sent to Americans goes under a mattress, so be it. I'm not willing to throw freedom out the window and tell people *they must spend* their money. Plus, very few Americans put money under the mattress. Most put it in banks which then increases the money supply every bit as much as when the FED loans to banks.

    It's against the ideal of American freedom to dictate how people should spend their money. Roosevelt used to berate Americans for eating asparagus out of season. It it breathtaking to me that we would let government tell us what groceries we are allowed to buy. (And I guarantee that the privileged class to which FDR belonged did not care if they ate food out of season)

    My points are simply
    1. Recessions are good. Just like forest fires are. A little fire mitigation is okay, but too much just leaves a future disaster.

    2. Let us assume we agree that a recession is okay but we want to prevent a deep depression. I disagree that fiscal policy is the *only* lever left.

    3. Assuming that fiscal policy is the only lever left. I disagree that spending for spending sake is helpful. Unless the spending has a some kind of pay-off like certain kinds of infrastructure, it is nothing more than generational wealth transfer. I remain unconvinced that much of the proposed stimulus creates long term efficiencies. I'd feel better if 50% of it was actually targeted at major infrastructure like building nuclear power plants or cross country bullet trains or something. At this point were only talking about 15% of it going to repair bridges, roads, and weatherizing buildings. Sounds nice, but it isn't anything like Eisenhower's Interstate system.

    4. Assume that the money creates little long term efficiencies. If I understand you and Krugman, you still advocate massive consumption spending because of the reinflationary solvency related benefits. I will agree that this can be so. But at what cost? There are political costs ( at least for people with my values). There are costs to future generations. There are opportunity costs that arise from the government picking winners and losers less optimally than the free market. Corn ethanol is a great example of the government picking the wrong winner. Again, the government sometimes hits a home run, but I'm not ready to socialize our entire economy because the Manhattan project was a success.

  8. Hi Nathan. I'll address your points in a separate post, or, rather, give you links to past posts where I've already addressed your points. Regardless, we definitely are going to have a reduced standard of living at the end of this because we will have to reduce the productivity of the economy in order to provide full employment (in the economist's sense of full employment, not in the "every single person has a job" sense). But my fundamental point that I want you to think about right now is that capitalism works only when money has a consistent value, which is what allows money to serve as an effective token of exchange for goods and services. If money does not have a consistent value due to runaway inflation or deflation, then capitalism fails because money ceases being used as a token of exchange to "train" the free market, and instead starts distorting the free market. Inflation or deflation disrupts the system of promises that are used, the contracts and bonds and loans that lubricate capitalism, and basically turns those promises into lies. Lies are toxic to capitalism, whether the lies are deliberate lies such as Bernie Madoff's lies, or are inadvertent lies as are caused by inflation or deflation.

    Regarding your Hooverite economics, they didn't work for Herbert Hoover, and they won't work today. I notice you do not mention alternatives to fiscal policy for re-inflating the money supply. I've already noted why monetary policy has failed. But you simply state as a matter of faith that there is some way other than fiscal policy to re-inflate the money supply, without stating what that mechanism would be. Simply stomping your feet and saying "It isn't so!" will not make it so. If you believe there is an alternative to fiscal policy right now for preventing deflation, please state what that alternative is, instead of putting your hands over your ears and shouting "It can't be! I can't hear you! I can't hear you!".

    - Badtux the Economics Penguin

  9. Penguin,
    I think we have a lot more in common than you can imagine. We need to spend more time acknowledging that. Thanks for the discussion. I learned a few things and I agree with most of what you say to one degree or another. I've been around the block, lived abroad, and I've had a small business. So I hope you can consider my insights of value as well. I am not a dogmatic conservative that can see no value in others insights and opinions. It is a breath of fresh air when liberals can concede the value of conservative thought. Yin and yang.

    P.S. I find it odd you'd call me a Hooverite given my willingness to allow deficit spending, my disdain for the both the Smoot Hawley tariff and Hoover's massive income tax hike.


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