Tuesday, November 10, 2009

"Conventional wisdom" vs. reality

So let's talk about "conventional wisdom". What you find, looking at the data, is that "conventional wisdom" typically is nothing of the sort. It's passed-down superstitions and talking points with no basis in fact, no supporting data, no reality.

So let's look at Nathan's "conventional wisdom" from my post on unemployment below:

Instead of lasering in on unemployment as the lone bogeyman, I think we should look at the entire basket of problems.
The problem is that employment is necessary in order for people to consume, and consumption is necessary in order to employ people. Hmm, circular relationship there, right? But in any event, if we're going to wean the economy off of government intervention, clearly focusing on employment is the way to do that, because only increasing employment can increase consumption enough to remove government from the role of "consumer of last resort".
1. we need to deleverage the economy and get back to saner levels of personal and savings,
Indeed, and that is happening. That is the cause of the problems with the banks and deflation, deleveraging by definition decreases the money supply via increasing the effective reserve ratio of the banking system (see: fractional reserve banking). The problem with deflation is that past debts are unpayable with today's lower incomes caused by deflation, causing more defaults, more bank failures, more deflation, wash, rinse, repeat. In short, while deleveraging is necessary, the deflation caused by deleveraging is harmful and must be addressed via monetary expansionary efforts, which are ineffective when we are in liquidity trap territory because any printed money just goes under mattresses because it will be worth more later (as the currency in circulation further deflates). Thus the requirement for fiscal stimulus and deficit spending to draw that money out from under mattresses and put it to use, otherwise the freshly-printed money would just disappear under mattresses where it does nothing to foster employment and investment -- just as what happened in Japan during the 1990's, causing their 'lost decade'.
2. we need to own more of our debt as a nation.
As long as the debt is owed in dollars that is irrelevant. If China was so stupid as to call in their debt, we'd simply print dollars (by issuing new debt that was purchased by the Federal Reserve with freshly printed dollars) and give them to the Chinese and say "okay, here you go!". If we wanted to be *really* mean, we'd deliver it as freshly printed bales of $100 bills, and let the Chinese figure out the logistics of how to get several freighters full of cash from the wharfs in Oakland to Beijing ;).

3. the trend toward higher spending has no end in sight. Is government spending the only hammer in your tool box?
Utter nonsense. We are using government right now as consumer of last resort to provide consumption necessary for full employment. We need full employment in order to prevent the sort of human misery that results in social disorder, violence, and the breakdown of society -- people do *not* voluntarily starve to death. Once employment is on the rebound the amount of government consumption can -- and will -- be reduced because rising prices as economic activity causes a resumption of lending and thus decrease in effective reserve ratio and thus inflation will naturally shift resources away from fixed-price government contracts back into the free market (i.e., $1 of government money will no longer buy as much). We have equations on how this happens that have accurately described this behavior during past recessions. We don't need speculation, talking points, or "common wisdom" here, we have data.
4. everyone knows the phrase "no pain no gain",
Talking point and "common wisdom" borrowed from the sports world that is actually contradicted by facts. What exercise physiologists have discovered is that if you are in actual pain while training for an athletic event (as vs. mild discomfort), you are overtraining. Athletes who train to the point of pain perform more poorly in athletic events than athletes who train to the point of mild discomfort. In short, "no pain no gain" has been utterly discredited and refuted by science -- if you have pain, what that means is that you're causing muscle breakdown, and muscle breakdown is *never* good if you're trying for optimal muscle performance.

As is true for physiology, so is true for economies. Unemployment beyond the amount needed in order to keep human resources mobile is *never* good. Mild discomfort (i.e., unemployment around 5-6%) can be good for an economy because it allows the economy to shift resources around to what's most in demand, but once you pass into actual pain, you are contributing to the sort of deflationary cycle that is not solvable via pure capitalism.

Blessing like belt tightening, going back to school, providing venues for humility and charity, focusing on what in important in life, *a smaller carbon foot print!*, slowing the pace of urban sprawl, and restructuring society for future sustainable growth.
Some of these are undoubtedly good things. But people do not willingly starve to death. Real unemployment is now somewhere around 20%, and those people are starting to run out of resources as food pantries and soup kitchens become overwhelmed and run out of food and family and friends become overwhelmed and unable to provide further support to the unemployed. They will do whatever it takes -- WHATEVER it takes -- in order to avoid starving to death. We will need some sort of government intervention here because capitalism has no -- zero -- mechanisms for solving the problem other than "let them eat cake", and that works no better today than it did during the time of Marie Antoinette. The French Revolution was a disaster not only for the French aristocracy (who all lost their heads -- literally), but for the people of France, since it led to the rise of the despot Napoleon and the death of probably 25% of adult Frenchmen in Napoleon's endless wars of conquest. I think we need to avoid that example, thank you very much. If it means that I'm going to be taxed a few percent higher in order to provide food stamps to people currently not eligible for food stamps, well, so it goes. Better that than lose my head (literally).
Come on people, look at this thing holistically. I don't buy that the end of the word is nigh if we don't spend 2 more trillion. Let's start taking our lumps and quit whining.
Who's whining? I'm talking about facts here. The fact is that without serious intervention in the economy, we are going into a deflationary spiral that will result in the collapse of capitalism much as happened multiple times during the 1800's and almost happened in 1932. If capitalism collapses unemployment is likely to peak at around 50% before things start getting better, and the only reason they'll get better is because America and Americans will be so impoverished by then that we'll be living like the Mexico City garbage dump inhabitants who survive by scavenging rotting banana peels and such from the piles of reeking garbage, i.e. they'll get better because it will be impossible to get worse.

We do not live in the agrarian nation of the 1850's, and we cannot survive severe depressions and the collapse of capitalism today by hunkering down on our farms and growing our own food. In the 1850's it didn't matter if capitalism failed for a while and reduced the economy to a barter economy for a few years. But we don't live in that world anymore. For better or for worse we hitched our horse to capitalism, and if capitalism fails today, the suffering -- and outright death toll -- would be horrific. What that means is that we have to do whatever it takes to keep capitalism from collapsing, and the first thing that has to be done is prevent a deflationary spiral, which means we have to figure out some way to get that $2T of disappeared dollars back into the economy -- and circulating, NOT under mattresses, where it's useful for nothing other than mattress stuffing. Since capitalism has no mechanism to do this, we are, by default, stuck with government doing it. If you have some other mechanism in mind, tell us.

-- Badtux the Economics Penguin


  1. I suppose if your forecasts of 50% unemployment are true, I would join your bandwagon. What is another 2 trillion if we're going to be mired in societal collapse? I understand the rinse-repeat nature of positive feed back systems. However, I don't buy the apocalyptic scenarios. And I don't think the time constant of our economic system is so short as to preclude just-in-time stimulus measures if your dire predictions pan out.

    So you seem to agree that the over-leveraged nature of our economy was a bad thing and that we need to deleverage. All we're arguing about how how much to cushion the fall. I am arguing that if we don't allow some type of fall, we'll never wean ourselves of the original problems. You seem to agree, but don't pay much lip service to the fact that after the dust settles, fiscal responsibility must be restored.

    About the "no pain no gain" refrain. I humbly withraw it. You are right, that pain can be damaging if you don't react to it. However, it is a fact that exercise, dieting, quitting smoking, etc. can be very difficult, and painful in terms of psychological effort. So it is really "no effort, no gain". Getting an economy to restructure for sustainability is uncomfortable. We already have welfare programs to prevent the pain.

    I disagree that fiscal policy is the only tool left. It is the tool of big government types. But you can also get people to get the money out from under the mattress by giving them a reason to be optimistic about the future. Threatening folks with burdensome taxes, global warming alarmism, and government takeover of the private sector is a big drag on people.

    I tell you what, I would be much more friendly to a second stimulus, if we could all agree that when things get better, we reduce government spending. But from where I'm sitting, it's "spend spend spend". Even you are advocating new *permanent* government spending for your favorite social causes. If I knew stimulus supporters were truly behind the concept of limited-government-when-things-are back-to-normal, I'd be more comfortable with your stimulus efforts. How can I trust that your analysis is honest when in most other aspects of life, you also believe the government is the best answer?

  2. You've pretty much said it all in response to Nathan.

    But I'm not sure we have capitalism - unless crony capitalism qualifies. To a very large extent in our economy we have privatized gains and socialized losses. The finance bailouts only confirm this sad fact.

    JzB the social trombonist

  3. I see Nathan got in a head of me. There is much to respond to, but I have to get to a subdivision meeting.

    JzB the I-am-the-President trombonist

  4. All we're arguing about how how much to cushion the fall. I am arguing that if we don't allow some type of fall, we'll never wean ourselves of the original problems.

    I'm arguing that if any attention was paid to history, we wouldn't be in this situation. In the late 90's, Phil Graham ran through legislative actions that 1) effectively undid Gall-Steagall, which had regulated banking as a result of the 1929 depression, and 2) prohibited the regulation of "sophisticated" mortgage backed securities that nobody knew how to rationally evaluate.

    Near as I can tell, you're arguing that another depression will be good for our collective character. Well, hang in there, chum' cuz, we're fyooqued.

    I disagree that fiscal policy is the only tool left. It is the tool of big government types.

    I'm only banging my head against the wall because I can't reach yours.

    You really have no idea what in the hell you are talking about. Please go do some homework.

    Threatening folks with burdensome taxes, global warming alarmism, and government takeover of the private sector is a big drag on people.

    What I just said, in spades. During the golden years of the 50's, the top marginal tax rate was 90%. It worked. Let's not talk about burdensome taxes, until we actually have some burdensome taxes.





    And for good measure,

    You can cut and paste in your browser. I'm too tired to make active links.

    There - I've done your freaquing homework for you. This at least is a start. Henceforth, unless and until you stop regurgitating right-wing talking points and show some willingness to think and learn, I am simply going to ignore your foolishness.

    Oh - BTW did you know that wars - including Reagan's phony "STAR WARS" have always been the only cause of meaningful budget deficits?

    I didn't think so.

    And if you don't think global warming is real, pay a visit to Glacier National Park.

    JzB the I don't know why I bother trombonist

  5. Shit. That's Glass-Steagall

    JzB the fumble-fingered trombonist

  6. Jazz,
    I'll do your homework. I read your Minsky post and commented on it. I'll work on the others later.

    Meanwhile, I want you know that I have been studying this from a layman's viewpoint for several years. I already know all about Glass Steagall. I think you're doing a bit of cherry picking in your view of history. I'd invite you to read my analysis of the meltdown.

  7. Ah - no.

    First off, I don't recall anyone here saying it is 100% Republicans or 100% Democrats fault, so your basic premiss is irrelevant.

    And someone arguing according to their subjective values and principles does not have standing to make judgement on objective truth. That requires evaluation based on objective principles, and real data.

    Cherry picking is selecting the tiny minority of data points that are consistent with your preconceived notion, while ignoring the vast majority of data that contradicts it. If you think that's what I'm doing, than, once again, you really don't know what you're talking about.

    I'm done.

    JzB that quasi-rational trombonist

  8. Nathan, facts are not a case of belief or not belief. We have the facts for multiple recessions and depressions. We have fit them to predictive models that at each stage of those recessions and depressions predicts what the outcome will be given a certain set of interventions. It could be that these predictive models do not accurately reflect reality, but I'll just point out that they've accurately predicted the progress of this current recession thus far.

    Leverage is neither good nor bad in and of itself. Leverage is how capitalism pays for future output using the income produced by that future output. Leverage -- or bank lending, if you will -- is what allows capitalism to be more nimble than non-capitalist economies that must slowly accumulate resources in order to make capital purchases for producing future output. And there is nothing fundamentally wrong with bank lending for homes. A construction loan for a new home creates increased wealth -- we have a home at the end of this loan that did not exist at the beginning of it. Allowing the payback of that loan over the period of use of the home means we have a home in the economy that otherwise would not exist in the economy -- i.e., society is wealthier.

    Housing prices had to reset to a lower level because the payments could not be made with the levels of income that were available or that will be available for the foreseeable future. De-leveraging is inevitable in that case. The core problem with de-leveraging is preventing deflation, because deflation destroys capitalism by preventing payback of loans and loans are the fundamental means via which capitalism creates future production. No capitalism means a much poorer society. Capitalism itself has no mechanism for preventing deflation -- indeed, has a positive feedback mechanism built into it that creates deflation automatically upon economic downturns, which destroyed capitalism periodically during the 1800's but that wasn't a big deal for an agrarian society that didn't use a lot of cash anyhow because they grew most of their own food and made most of their own goods, they just went back to barter for a while until capitalism re-started itself. But we don't live in that society anymore.

    Regarding "no effort, no gain" exactly my point. Because capitalism has no built-in floor for deflation other than zero (i.e., zero flow of money in the economy), preventing the positive feedback loop from taking out capitalism requires effort. Because capitalism itself has no mechanism for this, we use other methods, such as taxes and selling bonds and so forth, to coax that money out from under mattresses and put it to use. Note the "we", as in We The People. Government is not a foreign imposition upon the American people. This is a democracy. Government is *US*.

    "Burdensome taxes" -- uhm, the U.S. is the least-taxed major economy on the planet. "Welfare programs" -- Clinton and Newtie Newt Gingrich gutted those. For example, food stamps are no longer available if you're a single person without kids (so what are you going to do if you get hungry? What the **** do you think? People do *not* voluntarily starve to death!). Same deal with Medicaid. Not available if you're a single male. And so forth.

    I've asked you to give me an alternative to fiscal policy when monetary policy fails because we've hit the 0% interest boundary and entered deflation (which inherently drives money under mattresses, which means that any money printed by monetary policy just goes under mattresses rather than creating inflation or economic activity). So what's your alternative?

  9. Tux,
    I agree with most of what you are saying. I couldn't have explained leverage any better. And I appreciate your study of the 1800's. It strengthened your argument to admit that models can be imperfect.

    I think the only debate here is one of degrees and of values. I'm pretty confident that we have different values. And since intangibles such as values actually matter to people (notwithstanding your ideology of not believing in ideology) they must be included in the cost/benefit analysis. I simply can tolerate a higher level of short term unemployment than you.

    I'll agree that fiscal stimulus is a good tool. I won't mention tax policy because I think we've gone there before and I'd prefer to just leave it as "let's agree to disagree".

    I think my post about the stimulus earlier this year still sums up my overall feelings.

  10. I'll tell you what, I'll wager you $100 payable via PalPal.

    Assuming we don't pass any more stimulus packages:
    If unemployment hits 20% within the next two years (using the standard number, not the underemployment number), I'll send you $100 bucks via paypal. (And I'll probably be spending my unemployment check on you)

    If unemployment comes back down to 7.5% without any extra stimulus within two years and stays there for 6 months, I win.

    Notice that if unemployment stays in the teens, then it is a draw because your deflation spiral didn't pan out and my hands-off approach failed as well.

    If cap-and trade passes, we add 2 percentage points to the unemployment in both scenarios, as I think it will hurt consumption and job growth. If obamacare passes, we subtract 2 points, because it is kind of a stimulus.

    If we do pass another major stimulus, we see what the details of it are, and tweak the wager.

    You game? Feel free to propose different terms.


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