Summary: Please vote, and do so carefully! This could be one of the most important elections in American history, as continued economic crisis might require a massive (and hopefully temporary) expansion of government power — unlike anything we have seen except during wars.
On September 25 I sketched out A solution to our financial crisis, in three parts.
(1) Stabilize the financial system — Being attempted, probably now it’s too late.
(2a) Stabilize the economy with monetary stimulus— Rates are coming down and money printed, but probably with relatively little effect.
(2b Stabilize the economy with fiscal stimulus — Just now being considered; will work but slow to implement and slow to have effect.
(3) Arrange long-term financing for steps #1 and #2 with our foreign creditors — Unacceptable to our leaders at this time.
Parts 1 and 2 are being implemented, much as described. Part 3 was described as necessary at some point in the future. I said that these probably would not work over the medium to long term, but would mitigate the downturn (slow or even reduce the economic decline, and alleviate the resulting suffering). It appears that I was wrong.
The rate of decline — destabilization of the global financial system — has become so great that these measures will prove insufficient. In my opinion (these are, of course, guesses). Since I doubt our leaders have a Plan B, here is a suggestion:
We need extreme mobilization by the government of our economic resources, as we have done during wars.
For deep theoretical reasons our financial system is collapsing. I have discussed some of the reasons in other posts (see below for links), but the causes are irrelevant now. Whatever the cause of a cardiac arrest, the paramedics’ job is not to advise dieting and exercise — but to restart the heart.
The US economy is sliding into deflation. Deflation trashed Japan’s high-savings economy for a decade; two decades after the crash it remains weak. Deflation is potentially lethal to a high-debt economy like America’s.
The evidence of the early stages of a deflationary contraction is all around us. Just to mention a few: collapsing commodity prices, the price of gold falling, the US dollar rising almost 20% since mid-July, and the collapse of yields on one-year Treasury Inflation Protected Securities (TIPS). All are extraordinary. TIPS were priced for inflation a month ago.
Perhaps the global economy as well, in the downturn of the first global (or most global, ever) business cycle. The center is cracking (the US, the EU, and Japan). So are some nations on the fringes (e.g., Eastern Europe, Argentina, Pakistan). And points in between, also (e.g, Iceland, South Korea). This is a tear in the fabric of the global economy, which accelerates as it grows.
So far only the financial markets have felt its full force, but soon we will see the real world impacts on trade, employment, incomes, etc. Some leading indicators suggest the magnitude of the coming storm, such as the Baltic Freight Index down 90% from its peak on 20 May (to learn about it see Wikipedia, or this Slate article).
Markets
Panic is the danger at this point, as more people realize our perilous situation.
Panic drives people to sell risk assets to raise cash. But markets provide liquidity to individuals (a small fraction at one time), not to a large fraction NOW. Panic liquidation would likely force any exchange to close; the closing of a major exchange might spread the panic and force others to close. Already bourses have stopped trading for some period this month in Austria, Brazil, Iceland, Indonesia, Romania, Russia, Thailand, and Ukraine (sources here and here).
Panic means people save more and spend less. Businesses too, cutting both routine spending and investments. Keynes called this the “Paradox of thrift“. A gradual rise in savings rates can help an economy’s long-term performance. A sudden rise in savings rates just reduces everybody’s (i.e., aggregate) income. A rapid rise in the US rate from zero (or less) to 10% (not a large number) would have an unpleasant effect on the economy. (A sign of this: return of “layaway” plans, paying now for future delivery instead of buying on credit now.)
Worse, the very act of the government taking extreme steps — or even rumors that it has plans for such — might incite panic. Preparatory plans to close exchanges, de factor nationalization of industry, large scale stimulus (e.g., in the trillions, not just hundreds of billions) — however prudent, can spark reactions so severe that these measures become necessary.
Main Street
More savings, less debt, less investment, a flight to safety (no risk capital by lenders or investors). If occurring on a large enough scale, as we see today on a small scale, starve businesses of revenue and capital. On the other hand, the government gains the ability to borrow massive sums at low rates as everyone scrambles for the safety of government bonds.
The result: By default the government becomes the primary economic actor. Its spending and investment decisions drive the economy. Not just immediately, but — as a result of the investments it makes — for many years after normal processes are restored. We saw this in Japan during the 1990’s. It borrowed and borrowed, but frittered the money away on largely unnecessary projects (e.g., bridges to nowhere, train stations in the middle of nowhere). This kept their economy rolling, but the debt remains and they have little to show for it.
Now we in a situation like Japan circa 1990. Interest rates must go to near-zero. Government spending programs must be rapidly initiated on a scale not seen since WWII. Government decisions will determine what America looks like for the next two decades (at least). Who gets loans, what kinds of infrastructure to build, what kind of training programs for young people and the older unemployed … it is a long list.
Trillion dollar spending programs for 2009-2010. Plus a trillion or so in capital infusions into the financial system. While other nations do the same. The global savings pool might not suffice for to provide so much capital, and the effects of such massive borrowing might destabilize interest rates and currency values. Hence the need for my recommendation #3: the “Master Settlement of 2009” — a meeting of the major nations to, among other things, reschedule America’s debt and form a new geopolitical and financial global regime.
Alternatives
I doubt any government experiencing these conditions — and there probably will be many — will do otherwise than take extreme actions.
Libertarians and laissez-faire capitalists will advocate elaborate plans for doing little or nothing. What would happen if they took power in Washington January? Who knows? I have little interest in contrafactuals. One might just as well ask what would happen if the Blue Fairy waved her wand and increased the human race’s average IQ by 50 points.
Comparison: now vs. the Great Depression
One advantage we have over the folks of 1930 (and Japan in the 1990’s): we know this song. The response of government leaders since the crisis started in December 2006 (when the mortgage brokers began collapsing) has been slow, reactive, and incremental. In many ways similar to that of President Hoover’s administration between 1929 and 1932. While recognition of our danger has been slow in this cycle (discussed here), action following recognition will be fast.
Also, we understand economics better. Keynes wrote The General Theory of Employment, Interest, and Money in 1936 (although the ideas it presents were in circulation much earlier). Plus we have the work of others during the past 70 years, such as Hyman Minsky and Milton Friedman. This allows a far better response. Perhaps most important, the gross policy errors made during the 1930’s — such as raising taxes and trade barriers — are far less likely today.
Only extreme statists will rejoice at these measures. The need for such result from the accumulated policy errors of the past half-century (or more), a bipartisan orgy of folly. We must do as our ancestors did during adversity: Stay cool, make the necessary decisions as best we can, and move on. These events are just another cycle in the life of a great nation.
Lessons Learned about government for the next cycle
Since 1929 everybody knows that close regulation of banks and brokers is necessary to prevent serious financial crises. We had a bank crisis in the early 1980’s, as they almost went broke due to feckless lending to emerging nations. We had a bank crisis in the early 1990’s, as many folded due to feckless real estate lending. And here we are again. All this despite a large and well-funded state and federal regulatory apparatus, to which we granted draconian powers over the financial sector.
We made a mistake.
“You f**ked up, you trusted us.”
— Otter advising Flounder, from the film Animal House
Update: another voice, similar message
“Roubini Says `Panic’ May Force Market Shutdown“, Bloomberg, 23 October 2008 — Excerpt:
Hundreds of hedge funds will fail and policy makers may need to shut financial markets for a week or more as the crisis forces investors to dump assets, New York University Professor Nouriel Roubini said.
“We’ve reached a situation of sheer panic,” Roubini, who predicted the financial crisis in 2006, said at a conference in London today. “There will be massive dumping of assets,” and “hundreds of hedge funds are going to go bust,” he said. … “Systemic risk has become bigger and bigger,” Roubini said at the Hedge 2008 conference. “We’re seeing the beginning of a run on a big chunk of the hedge funds,” and “don’t be surprised if policy makers need to close down markets for a week or two in coming days,” he said.
Afterword
If you are new to this site, please glance at the archives below. You may find answers to your questions there, as these posts are best considered as chapters in a book. These matters are too complex to cover much ground in 1,000 words.
Please share your comments by posting below. Please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest these days:
- about America – how can we reform it?
- about the Financial crisis – what’s happening? how will this end?.
- about The End of the Post-WWII Geopolitical Regime.
- A solution to our financial crisis
- links to Damage Reports from home and abroad
Posts about solutions to our financial crisis
- Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
- Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
- How should we respond to the crisis?, 24 September 2008
- A solution to our financial crisis, 25 September 2008
- A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
- The Paulson Plan will buy assets cheap, just as all good cons offer easy money to the marks, 30 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008
- Prof Roubini prescribes first aid for America’s economy, 4 October 2008
- Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
- Dr. Bush, stabilize the economy – stat!, 7 October 2008
- The new President will need new solutions for the economic crisis, 9 October 2008
- Results from the IMF meeting – just thin gruel, 12 October 2008
- The G-7 meeting was the last chance for action before the global recession, 12 October 2008
- A brief note about our financial system: Intermediation, disintermediation, and soon re-intermediation, 16 October 2008
FM – technical note: Your website sidebar is blocking out part of the blog post text in a full screen view. Maybe it would help to size down the side bar?
Hi FM, my old IE v6 browser has your right side-bar now covering the right side of your text. Does anybody else suffer from this? (In Print Preview the blue sidebar text is in a transparent box on top of the other text).
Great explanations and charts available at David Hendrick’s Cause for Depression
.
.
Fabius Maximus replies: That site is, from a quick look, all about US housing. While that was the grain of sand that initiated the collapse, the collapse is not about that grain of sand. The dynamics now concern the entire global economy, of which housing is only a small part.
Focusing on housing now is like taking the matches away from Johnny — while the house burns away. To use John Boyd’s OODA loop (observation, orientation, decision, action) this is “orientation lock” — an inability to mentally adjust to a changing situation.
“Fortunately” the US has plenty of meaningful infrastructure projects — highways, bridges, electrical generation and transmission systems, etc. The government will not have to look hard or make up projects to stimulate the economy. These will contribute to the long-term health of the US.
At the same time, research and experimentation can go into providing alternative, renewable sources of energy. Of renovating existing buildings to make them more energy efficient. The “green” agenda.
We could buy up gas-guzzling cars and SUVs and replace them with newly constructed smaller, more efficient models. Reduces energy dependence and creates production jobs.
Lots of good ways readily at hand to stimulate the economy. Similar projects exist in other effected countries.
This is a do-able, and I think you are pointing in the correct direction.
I have had the problem of the right side bar blocking part of text and comment areas for a long time. I dont think anyone else has mentioned it until now.
Despite FM’s cool analysis of the seriousness of the situation, there’s a weird optimism in his view of the future. For example, the phrase “only a stage in the life of a great nation. . .” — sure, just as the fifth and sixth centuries were only a phase in the life of the Roman Empire. And, the reminder of the importance of voting. For whom, or what? Neither of the current Presidential candidates is talking about any of the deep issues that face us — the real economic crisis, the folly of our imperial project, the need to move to a global sustainable economy.
The political institutions we have can’t address these conditions, because those political institutions are controlled by the same financial interests that created them. We need a new politics, a new vision of the social contract, and a new economy.
.
.
Fabius Maximus replies: It is called faith.
I have addressed these things, looking at both sides, in the series “America – how can we reform it?”. I dsicuss the the worst case in the very first post, “Forecast: Death of the American Constitution“. The conclusion:
Our wealth is just things (”hardware”), an inheritance from past generations. What we lose we can work to replace. Our aspirations to global hegemony were revealed as a mirage in Vietnam and Iraqi, lasting less than two generations after WWII.
Our Constitution is just an idea, inherited from the founders. We created it, and its death will give us the experience to do better with the next version.
Our culture is a collection of discordant ideas, mixing lofty and base elements in a manner despised by much of the world – an easily understood disgust to anyone watching many of our TV shows and movies, or listening to some of our popular music.
The Constitution is not America. We are America. We are strong because of our ability to act together, to produce and follow leaders. We are strong due to our openness to other cultures and ability to assimilate their best aspects. We are strong due to our ability to adapt to new circumstances, to roll with defeat and carry on.
We will be what we want to be. The coming years will reveal what that is.
I can confirm some of FM’s numbers.
The Baltic Dry Index has dropped 50% since Oct. 10.
The M3 Money Supply is also dropping rapidly inspite of spiking M1 and M2 numbers.
Jon Markman indicates that although the LIBOR rate is coming down somewhat, the volume of credit transactions has not picked up and the credit market is still essentially frozen and the rest of the economy is beginning to suffer. Here’s the link.
My only concern about Fabius’ suggestions is that they are very Keynesian and that what worked in the 1930’s may well not work now. On the other hand, the old military maxim that doing anything, even the wrong thing is better than doing nothing seems very applicable right now.
FM’s last two paragraphs in his response to Seneca are not currently true. We do not act together, we do not produce leaders, and we do not follow them. We are currently experimenting with closing ourselves off from other cultures and we haven’t demonstrated the ability, as a culture, to adapt to new circumstances and carry on in over 15 years. For example, New Orleans is still nothing more than rubble in large parts, and this is five years after Katrina.
He is right that we have historically done these things and I certainly hope that once we have fallen into the abyss we will relearn these old “outmoded” values. Otherwise, I personally, will not want to be part of the US anymore.
I will do everything in my power to ensure that we return to what we once were, but I’m not sure that there is enough left of the old Republic to make the country worth saving. We need to include this in our planning for the future.
.
.
Fabius Maximus replies: Any examples of us not acting together? The major initiatives of the past decade or so have been bipartisan. From Bush Sr.’s Administation: large tax increases and the American’s with Disabilities Act (both hardly traditional Republican initiatives) to our Middle East Wars (both waged with strong bipartisan support). What more would you like to see, with respect to joint action?
“We are currently experimenting with closing ourselves off from other cultures and we haven’t demonstrated the ability, as a culture, to adapt to new circumstances and carry on in over 15 years.”
Examples, please. Not just of our inability to do so, but of other nations wonderful ability to do so. Such as Japan and France’s assimilation of immigrants. Or Saudi Arabia and Iran’s tolerance for other religions. Or neighborly love between tribes in Central Africa.
Remember, Heaven is wonderful (an absolute perpetual Monarchy) but you must die to get there. So please use historically valid standards.
The rest are much smaller points. For instance, should New Orleans be rebuilt? If so, why? It’s location is pretty much doomed.
As for America, its future will be written by those that have faith in its future. Everyone else is IMO just baggage, along for the ride.
“FM’s last two paragraphs in his response to Seneca are not currently true. We do not act together, we do not produce leaders, and we do not follow them. We are currently experimenting with closing ourselves off from other cultures and we haven’t demonstrated the ability, as a culture, to adapt to new circumstances and carry on in over 15 years. For example, New Orleans is still nothing more than rubble in large parts, and this is five years after Katrina.”
A couple of comments.
1. Americans *can* produce and follow leaders. Have you seen any *real leaders* lately? IMO, “W” is not a “leader.”
2. Truly great leaders are few and far bewteen. I would not expect a “great leader” to pop up every year or once every 5 years.
3. Closing off and New Orleans? Perhaps you’ve been watching too much MSM or are thinking only of the Government. There are grassroots movements to help people in hurricane-affected areas (NOLA, Texas, etc.). Perhaps you should look in that direction for inspiration.
“I will do everything in my power to ensure that we return to what we once were, but I’m not sure that there is enough left of the old Republic to make the country worth saving.”
Your response is unfortunate. We live in a great country with great opportunities. Even in this abysmal outlook, new opportunties, technologies, businesses, etc. will make it out “the other side.”
“We need to include this in our planning for the future”
Good luck. That is the root of the problem and also the “cure.” Unfortunately it is in human nature to focus on the short term.
Dosco,
Mostly I agree with you. Americans most definitely *CAN* produce and follow great leaders, there is a great deal of history proving that point.
“W”, unfortunately, is typical of the current crop of “leaders” which does not breed confidence that we will reach into our collective pockets and pull out a great leader when we need one.
I am aware of the grassroots efforts to help people in the hurricane-affected areas. Unfortunately I am also aware that they spend much of their efforts fighting the government that is trying to help them because five years later there is still massive disagreement about whether large sections of the city should be rebuilt or not. This stunning lack of governmental performance does not inspire a lot of confidence that the government can effectively spend even half of the $2 trillion in additional spending that FM is calling for.
You are right that this has been a great country and has the potential to be so again. But I am also aware that at this moment in history electing another person of minimal competence would probably be catastrophic and that we, as American citizens who are supposed to be self-reliant, also need to plan for that. Thank you for your best wishes, I think that if things get that far we will all need all the luck we can get.
I appreciate that you are searching for meaningful solutions, but all actions at this juncture will be fruitless wastes of resources. We need to let deflation run its course, no matter how painful. The current is just too strong for Keynes to swim against. Depression is inevitable, but hopelessness is not. We must husband our resources and apply them judiciously to research and development, similar to the National Institutes of Health, which has not only funded fabulous basic research, but has also laid the groundwork for the biotechnology revolution. Similar undertakings can be undertaken elsewhere throughout the scientific spectrum through large increases in the National Science Foundation, which currently is funded at ridiculously small levels. We need to offer powerful incentives to promote higher education in science, which has been and can continue to be the source of our economic strength.
.
.
Fabius Maximus replies: Nice to see that Andrew Mellon’s spirit still lives!
Folks with “only one formula: liquidate labor, liquidate stocks, liquidate the farmers, and liquidate real estate. … It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”
Fortunately nobody lets these people near the controls of the State. We listened to them from 1929 – 1932. The experiment was sufficiently painful that no sensible people wish to repeat it.
FM, I think you are exactly right, and it is my ‘hope’ that Obama does or will ‘get it.’ This may not be correct, but it would be much better if it is. Again, I suggest we look to the period right after the election and before the inauguration, as well as to the inauguration itself, for clues. It is my opinion that when the issue of the election is resolved, he will feel much more comfortable confronting the American people with the economic realities and the need for sacrifice, hard work, and a new approach.
I also am of the opinion that his post-ideological, consensus-based approach will serve him and the country well. This is especially so now that there are a large number of people who formerly were in some sense ‘conservative Republicans’ who have surveyed the ridiculousness of the Bush-Palin faith-based delusional approach and been repelled. Were such people… the famous ones and the non-famous ones, to join forces with Obama’s centrist approach, there could be a powerful realignment in this country that would serve us well. I would envision such people holding back such traditional ‘liberal’ impulses as unnecessary social engineering and interest-group politics on the one hand, but supporting a more reality-based foreign policy and an economically pragmatist, bottom-up approach domestically, along with the Obama administration. Idealistic perhaps, oversimplified certainly, but not impossible, and in many ways desirable.
One of Clinton’s gifts was his ability to boil down large issues into well-framed, easily comprehended statements. The New American President will need to do this himself personally, but in reading through this post and the comments it occurred to me that the basis of this being effective is the ability to influence the various elite organs of the society to help everyone recognize that important national business that has to be done now, akin in urgency to a state of war. If the people as a whole from top to bottom can be somewhat on the same page, then there is no challenge that cannot be met as long as it is done with as much honesty as intelligence, or craft.
I do think that one aspect of Obama’s proposed program has been overlooked. In a recent interview with Klein, I think, in Time, he stated that from the beginning his top priority has been an Energy initiative, largely because the foundation for growth the next two decades can no longer be on leveraging debt but has to be on creating a new industry, essentially, similar to how computer technology helped spur growth in the 90’s. Along with this is infrastructure development, but in the context of changing energy technology in a widespread fashion this is far more than just make-work bridge-building. It’s a good point and we’ll see if it can be done. If he’s the One!
Update: another voice, but a similar message
“Roubini Says `Panic’ May Force Market Shutdown“, Bloomberg, 23 October 2008 — Excerpt:
Hundreds of hedge funds will fail and policy makers may need to shut financial markets for a week or more as the crisis forces investors to dump assets, New York University Professor Nouriel Roubini said.
“We’ve reached a situation of sheer panic,” Roubini, who predicted the financial crisis in 2006, said at a conference in London today. “There will be massive dumping of assets,” and “hundreds of hedge funds are going to go bust,” he said. … “Systemic risk has become bigger and bigger,” Roubini said at the Hedge 2008 conference. “We’re seeing the beginning of a run on a big chunk of the hedge funds,” and “don’t be surprised if policy makers need to close down markets for a week or two in coming days,” he said.
Browser problem is 90% fixed, back to often missing the last word on a line — as has been the case for a long time here but is livable (sidebar still has room to move more to the right).
FM, you disappointingly seemed to miss Hendrickson’s “A. Intro thru I. Lessons” sidebar, including this excellent E. Derivatives Jungle
This summarizes Matt Miller’s deconstruction (from a Moody’s cover?)
In his Scale of Losses, after quoting Roubini, he has another:
manic conditions in the credit markets create “fictitious capital,” a term from the Austrian economists (Ludwig von Mises and Friedrich Hayek). A rough definition of the term is capital multiplied by debt and leverage. Return credit conditions to some degree of “normality,” and the fictitious capital disappears.
From my view, the bailout is trying to replace the fictious capital with gov’t supplied cash, to save the Big Banks from their folly. I haven’t yet seen why the Big Banks can’t all fail, and allow smaller banks all the real business of lending to companies and individuals.
.
.
Fabius Maxmius replies: That’s because you do not see what is happening. The financial events, affecting money center banks and brokers, are just the forequakes. The preliminary warm-ups. The main event — taking place on Main Street — has yet to happen. Just wait, it is coming on stage now. Unemployment. Collapse in retail sales and capital investment. Income declines.
Events on this scale move slowly, in phases or waves. Each affecting different sectors of the economy, different players.
Small banks are more highly levered to Main Street than their larger cousins. Their time will come.
100% agree with gloomy. The game has failed and control has (temporarily) been lost. For now it is about salvaging and stewarding (providing stewardship) of what we can, as well as restoring the safety net we have so callously removed. Things will be difficult, that is a given. It is up to us to make the hard decisions that will allow prosperity to return hence and to uplift those elsewhere which are going to be regrettably removed from the US’s aegis.
Much pain coming. There will be weeping and gnashing of teeth.
.
.
Fabius Maximus replies: In what sense have we “callously removed” the sfety net? That has been a leftist trope developed during President Reagan’s time. Whenever Congress does not expand it, that means it has been “removed.”
I am sorry to hear your unfavorable response to my comments above. We can never know the cause of historical events, we can only speculate. This viewpoint is explained in detail in The Black Swan, but let me give you a recent example. A few weeks ago we were told that the TARP legislation must pass or we would face a meltdown in the stock market. We passed TARP, but nevertheless the market crashed. If TARP had not passed, surely the failure to pass it would have been blamed as the cause. Likely it had no effect one way or the other.
In the same way, historians potulate that government inaction caused a downturn to morph into the Depression. However, no one really knows whether prompt large scale action would have been successful. We have had a very proactive interventionalist government this time, but has it done any good? Only time will tell, but neither you nor I can say for sure at this point. In my opinion, depressions are a necessary unstoppable consequence of bursting massive bubbles, and we are now bursting the largest asset bubble in history. In my opinion we are wasting precious resources propping up an insolvent banking system which should be nationalized ala Sweden. Let’s use our resources where it counts in the correct place at the correct time, as I outlined above.
.
.
Fabius Maximus replies: This is not an accurate history of the 1930’s. For one thing, the Scandinavian nations steered a different course, most importantly quickly going off the gold standard, and had a far lighter Depression experience.
There is, however, a more powerful counter-example. One nation anticipated both Keynes recommendations (1936) and the eventual cure (the war mobilization of WWII). A charismatic leader, who defied the established wisdom of his time and all standards of prudence to massively stimulat the economy. The result was prospertity and a nation far stronger than its neighbors.
That is, of course, Germany. Hitler knew what he wanted, and no economists were going to tell him he could not have it (a literal description of the fact). Compare stats on UK and German soldiers in 1943. One small, often bow-legged (childhood rickets) — evidence of childhood poverty. The other tall and healthy.
Now if only the experiment had not ended so badly, due to the madness of the leader. Think if Hitler had been more like Keynes and less a spawn of Hell. But as a lesson in comparative economics, the implications are clear.
Please explain how you can simultaneously believe the following:
– “We will be what we want to be. The coming years will reveal what that is.”
– We will need massive, blatant statist interventions.
– You are not a blatant statist.
I’m not trying to be snarky. It just seems like you’re falling for the same well-intentioned pragmatism that Hayek warned would inevitably turn democratic socialism into full-blown collectivism.
Why is it that we must plunge deeper into the rabbit hole instead of reexamining some of the decisions that made this catastrophe possible in the first place?
.
.
Fabius Maximus replies: I had a revelation after reading your comment, and reviewed the conservative literature in search of condemnations of our mobilization during WWII — the very essence of statist intervention. Couldn’t find any! (BTW — I am sure there are in fact some, buried in the stacks).
As a routine thing I don’t advocate mainlining drugs or cutting people open. But in emergency medicine these things must be done.
So what is your point? Hoover tied a laissez faire strategy. I doubt you can get anyone to repeat the experiment, despite the beauty of your dreams.
No, I bet not. Conservatives are quite fond of statism as long as it’s their brand of statism.
There was nothing laissez faire about America in the 20s and 30s. A laissez faire strategy requires the unwinding of all active interventions, not merely the absence of new ones.
.
.
Fabius Maximus replies: So it’s not a real laissez-faire government (or “capitalist” or “whatever”) unless it is a pure — 100% virgin blend — laissez-faire government. I stand corrected by the ultimo rebuttal of sophomore level debates!
That’s the second time you’ve referred to the American economy as if it’s a living being. It’s not. Our economy will exist for as long as there are people on this continent. It may undergo drastic and painful changes, but it can’t “die”. Therefore, we’re not talking about “life or death”, we’re talking about choosing between various forms of (and their predicted degree of) pain.
.
.
Fabius Maximus replies: Yes, this is a metaphor. On my other website all discussions of these things use 7-dimensional gestalts, backed by equations that perfectly describe not just the equilibrium conditions for all possible economies, but also all possible dynamic transformations. The subscription fee to that site is quite high, and the audience limited to a select few.
Your criteria for defining the existence of the American economy is quite … unique. It was “born” when the first people arrived in North America thousands of years ago, and will only die when the last homo sapiens leaves or dies. That’s pretty broad. On a similar level, perhaps I will not die so long as my descendents walk the earth!
I love these discussions. Oh, to be a sophomore again!
I would have settled for much less. My point was simply that the ink was barely dry on some seriously interventionist legislation — 1913 sticks out like a sore thumb — and yet Hoover never made any serious moves to change or modify any of it. He can only be considered “laissez-faire” in relation to his blatantly socialist successor.
Thanks, luckily I took a class on metaphors this past summer. My point was that your metaphor was invalid. If our current economy “dies”, it will be replaced with some new incarnation because there will still be people that will supply and demand {for} various goods and services.
Apparently, you’re convinced that the current economy must continue to exist in its current form, even if that means we move even closer to outright socialism. I’m sorry; I won’t touch your sacred cow again.
.
.
Fabius Maxmius replies: Your are certainly clear, which makes your theories easy to test.
“you’re convinced that the current economy must continue to exist in its current form’
Is there any basis for this statement? I think not.
* The title of this series is “The End of the Post-WWII geopolitical regime.”
* The first post in my series about America is “Forecast: Death of the American Constitution.”
* This post forecasts that the US government will assume a level of economic control only seen during WWI and WWII, and which we cannot yet see the end of.
Most of the forecasts on this site point toward radical change, with the period ahead like a singularity in astrophysics, a point where the rules breakdown – and beyond which we cannot see.
“If our current economy “dies”, it will be replaced with some new incarnation because there will still be people that will supply and demand {for} various goods and services.”
I agree. Everyone agrees. No human society can exist without an economic system. What is your point?
Was the Hoover Administration a laissez-faire government? Let’s ask President Hoover! He wrote in his Memoirs that Mellon, as Secretary of the Treasury, had
“… only one formula: liquidate labor, liquidate stocks, liquidate the farmers, and liquidate real estate…. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”
What did Hoover’s team do as the Depression deepened? From Wikipedia:
Hoover’s stance on the economy was based largely on volunteerism. From before his entry to the presidency, he was a proponent of the concept that public-private cooperation was the way to achieve high long-term growth. … As the economy quickly deteriorated in the early years of the Great Depression, Hoover declined to pursue legislative relief, believing that it would make people dependent on the federal government. Instead, he organized a number of voluntary measures with businesses, encouraged state and local government responses, and accelerated federal building projects. Only toward the end of his term did he support a series of legislative solutions.
“… President Hoover, in 1931, urged the major banks in the country to form a consortium known as the National Credit Corporation (NCC). The NCC was an excellent example of Hoover’s belief in volunteerism as a mechanism in aiding the economy. Hoover encouraged the member banks of the NCC to provide loans to smaller banks in order to prevent them from collapsing. Unfortunately, the banks within the NCC were often reluctant to provide loans, usually requiring banks to provide their largest assets as collateral.
“… {In 1932} President Hoover and Congress approved the Federal Home Loan Bank Act, to spur new home construction, and reduce foreclosures.
“… The final attempt of the Hoover Administration to rescue the economy was the passage of the Emergency Relief and Construction Act which included funds for public works programs and the creation of the Reconstruction Finance Corporation (RFC) in 1932.”
The two major interventionist acts of his Administration both had disasterous effects: the Smoot-Hawley Tariff Act in 1930, and the Revenue Act of 1932 (raising the top marginal rate from 25% to 63%, and raising corporate taxes as well). Both were, however, popular with advocates of laissez-faire economic policies.
Uh-oh, Hitler has come in! With that caveat, would very much appreciate a recommendation of a book that accurately describes 1930’s Germany especially regarding its economic turnaround. I have often heard it described as the most dramatically positive turnaround in world history – and not by apologists for the regime necessarily.
One idea they had in the late 20’s that I find highly provocative (which they lacked political support to push through I suspect) is the following: each year the workers in a company can purchase up to 5% of the stock meaning that in 20 years the employees can own the company. Furthermore, each company was to have an employee committee that had the right by Reich law to fire the owner and/or manager. I do not know if this latter was instituted. The combination of nationalism and socialism is actually quite intriguing.
But again, if you have recommendations of a good account of this I would appreciate the reference.
.
.
Fabius Maximus replies: Unfortunately this is a delicate subject, so little written about this. Note Wikipedia — whose content displays exquisite political sensitivity — says little. Here is the key excerpt:
“These policies were mostly Keynesian, relying on large public works programs supported by deficit spending — such as the construction of the Autobahn — to stimulate the economy and reduce unemployment (which stood at 30% in early 1933). … The economic policies of the Third Reich were in the beginning the brainchildren of Schacht, who assumed office as president of the central bank under Hitler in 1933, and became finance minister in the following year. Schacht was one of the few finance ministers to take advantage of the freedom provided by the end of the gold standard to keep interest rates low and government budget deficits high, with massive public works funded by large budget deficits. The consequence was an extremely rapid decline in unemployment — the most rapid decline in unemployment in any country during the Great Depression. Eventually this Keynesian economic policy was supplemented by the boost to demand provided by rearmament and swelling military spending.”
The references provided in this entry look like a good place to start. Or pull down “Rise and Fall of the Third Reich”; look in Book 3, Chapter 8, the section titled “The Economy”. {This should be on everyone’s bookshelf. The evils of our time did not die with Hitler; in so many malign things he was just early.
That’s what I thought too, but then you got snippy when I questioned some of your assumptions.
My point was that your emergency room analogy is only valid if you assume that we must save the current economic system.
.
.
Fabius Maximus replies: Have you questioned any of my assumptions? I am not sure you have even stated any of my assumptions.
I suspect most people understood my analogy to mean that America is the patient. Us, the people. That this massive effort is needed to preserve our economic regime seems a bizarre interpretation.
I don’t see how raising tariffs and taxes could be considered laissez-faire in any meaningful sense of the word.
.
.
Fabius Maximus replies: Which is why I called them “interventionist acts”.
Why were such measures popular with the conservatives advocating laissez-faire economics? This is a historically common pattern, often discussed by economists and historians. Perhaps the first and best analysis is “The Myth of Rugged American Individualism”, Charles A. Beard, Harper’s Monthly, December 1931 (see this post for more about this).
I can’t imagine you’re suggesting that we would all die without the massive effort. Please explain what you believe the goal is. I could take a guess, but I don’t want to put words in your mouth.
.
.
Fabius Maximus replies: I suggest reading the rest of the post, which describes what I mean in some detail. For example, this section:
“The US economy is sliding into deflation. Deflation trashed Japan’s high-savings economy for a decade; two decades after the crash it remains weak. Deflation is potentially lethal to a high-debt economy like America’s.”
As the comments to this series shows, this is quite clear to other readers. We are talking about the possibility of a depression. Or even a Great Depression. A long period of great suffering in America. There is no need for highly abstract, even tendentious, interpretation.
I have no idea. As I implied at 11:01, I don’t think very highly of the typical conservative’s fidelity to laissez-faire economics. If you find contradictions in my own views, please feel free to expose them, but don’t burden me with the hypocrisy of others.
.
.
Fabius Maximus replies: There was nothing in my comment that you should take personally. I posted the comment about Hoover as a stand-alone, not an addition to your comment, expressly to avoid that.
Understood. My point was that Hoover’s policies weren’t particularly laissez-faire — and thus bear little reflection on the merits of an actual laissez-faire approach — notwithstanding the opinions of some self-described laissez-faire supporters.
Got it. It seems, then, that you’re operating on at least one of two assumptions:
(1) the massive monetary inflation of the past hundred years was a good thing
(2) retreating from it would be so painful that we must try to avoid it at all costs.
Is that fair to say?
.
.
Fabius Maximus replies: I have no idea how you extract either of those assumptions from what I said. I don’t know any economists who would agree with either one.
Also, my brief extract of the Wikipedia entry suggested that Hoover did govern with a laissez-faire style — there are no absolutes in practical government — until the resulting disaster forced policy changes near the end of his term. I believe that this is also the consensus of historians.
You said the following in your post:
“We saw this in Japan during the 1990’s. It borrowed and borrowed, but frittered the money away on largely unnecessary projects (e.g., bridges to nowhere, train stations in the middle of nowhere). This kept their economy rolling, but the debt remains and they have little to show for it.”
I will repeat part of my comment (the part to which you did not reply) above as to how I think money could be better spent than the Japanese approach:
“We must husband our resources and apply them judiciously to research and development, similar to the National Institutes of Health, which has not only funded fabulous basic research, but has also laid the groundwork for the biotechnology revolution. Similar undertakings can be undertaken elsewhere throughout the scientific spectrum through large increases in the National Science Foundation, which currently is funded at ridiculously small levels. We need to offer powerful incentives to promote higher education in science, which has been and can continue to be the source of our economic strength.”
Don’t you think such investment would be more productive than building bridges to nowhere?
.
.
Fabius Maximus replies: I only say something when I have something interesting to say.
The reply was IMO obvious.
I think everyone agrees with you, in a general sense. Probably the Japanese people were unhappy that their wealth was in effect burned off by the government. Can we avoid a similar outcome? Determing how to wisely spend is the easy part; getting this to be the political outcome is the difficult part.
USA found its way out from the Great Depression in WWII (as you know, economically speaking the New Deal did not really make the job). By fighting and winning WWII, USA “went imperial”, and the economical side of American hegemony was formally stated in Bretton Woods.
In the present crisis, maybe USA faces the possibility of losing its status of world hegemon (end of the dollar as a reserve currency, overextension of its armed forces, credibility gap of its ruling class). Do you think it probable that in the next, say, five years, the American elite will look for a way out of this predicament in a major war? (E.g., Iran)
.
.
Fabius Maximus replies: WWII found us; it was not a solution sought by America. Nor were any of our wars since the Spanish-American War. Nor do I believe America’s elites will seek war as a solution to our problems.
Ok, it’s senseless to continue arguing over a label. The bottom line is this: Hoover unwound few, if any, of the existing and ongoing interventions. Therefore, his example yields no information on whether or not such an unwinding would prove beneficial.
You’re trying to avoid deflation and you’re willing to use inflation — amongst other interventionist policies — in order to do so. You clearly don’t want deflation; I get that much. It sure sounds like you’re ok with inflation, at least in some circumstances, but now you’re saying you’re. I find it hard to believe that all of the economists you know can oppose the monetary inflation of the past century while simultaneously embracing the system that yielded it.
So what do you want with respect to the money supply?
.
.
Fabius Maximus replies: That is quite clear. The standard treatment for deflation is expansion of the monetary supply (this is not inflation). This monetary stimulus must be withdrawn when the economy resumes normal operation (i.e., full employment and high capacity utilization), or we will have inflation — or hyper-inflation. That is a risk of the treatment; all powerful medicine involves risks.
The reason for this strategy is simple. Deflation was a major driver of the Great Depression. It trashed Japan’s economy for over a decade, from which it never really recovered — and has now again slumped into recession. It is potentially disasterous for a high-debt economy like ours.
Inflation is a known enemy, and — unlike deflation — has been successfully treated by many nations.
Deflation is caused by a contraction of the money supply, right?
.
.
Fabius Maximus replies: Deflation is a decrease in the general price level. Under some (not all) circumstances, a decrease in the money supply can cause deflation.
This is easier to see with inflation. An increase in the money supply causes inflation only at full utilization of resources (capital and labor). Hence monetary policy can be used to stimulate the economy, as described in both Keynesian and Monetarist schools of economics.
Are there other possible causes of deflation?
.
.
Fabius Maximus replies: An increase in “goods”. Money increasing faster than available goods creates inflation, and vice versa. This was one cause of the depressions in late 19th century America. Rapid economic growth with a too-slowly money supply (i.e., gold). Remember “Bimetallism“, “Free Silver” — and William Jennings Bryan!
Molby, comment #18: “you {FM} are convinced that the current economy must continue to exist in its current form”
It is IMO vital to understand that this is not so, as I have explained in so many posts. Perhaps this says it best:
Excerpt from: “The post-WWII geopolitical regime is dying” (21 November 2007)
Economic regimes come, and they leave. As do Empires. The post-WWII regime has brought incredible prosperity to most of the world, but that does not make it eternal. As Queen Gertrude says to Hamlet (Act I, scene 2):
Good Hamlet, cast thy nighted colour off,
And let thine eye look like a friend on Denmark.
Do not for ever with thy vailed lids
Seek for thy noble father in the dust:
Thou know’st ’tis common;
all that lives must die,
Passing through nature to eternity.
** The movie “The Matrix” prominently featured a version of this, “All that lives must die.”
That seems as though it would be a self-limiting form of deflation. Deflation causes a decrease in production, so a new equilibrium would be reached, right?
That was my first impression, but you seem very willing to give more power to the powers that be. History shows us that few individuals are willing to give up power voluntarily and our leaders have gotten very good at convincing us that the alternatives to their decisions are always worse. That seems to be a recipe for more of the same.
.
.
Fabius Maximus replies: OK, here is another cause of deflation. The revese of the previous one.
“The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand — a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers”
— Ben Bernanke, “Deflation: Making Sure ‘It’ Doesn’t Happen Here“, 21 November 2002
I don’t understand your second paragraph.
Ok, but if the cause of the collapse of demand is non-monetary, wouldn’t it it be self-limiting?
When I first happened upon your blog a few weeks ago, I was attracted to your awareness of the big picture and your willingness to consider fundamental changes to the status quo. But as I’ve read more of your short and medium term suggestions, it seems that the net effect of your advice — regardless of your intentions — would be a strengthening of the current regime.
.
.
Fabius Maximus replies: No, deflation in a high-debt economy has a tendency to postiive feedback — re-enforcing itself. I explain this at some length in this post.
What do you mean by “regime”? If you mean our Constitutional regime, of course the answer is yes. If you mean our financial regime, I believe the goal should be to get through this difficult period with as little suffering and economic damage as possible. As I have said, reforms come after first aid.
That is the type of deflation I was attempting to exclude when I said “non-monetary”. What I’m trying to determine/demonstrate is if a hypothetical currency is significantly less elastic than the current dollar, deflation ceases to be such a big scary thing.
Yes, that’s what I was referring to. Again, it seems misguided to think that you can use “first aid” that strengthens the regime and then expect to make meaningful reform after the fact. If the first aid is even the least bit successful, the Powers That Be will use that success to reinforce their control.
.
.
Fabius Maximus replies: What is non-monetary deflation? Deflation is a monetary phenomenon. Often expressed in some version of the quantity theory of money: MV = PQ, relating the factors discussed in these comments. Money in circulation, velocity of money, price level, quantity of expenditures (related to quantity of goods and aggregate expenditures). Deflation can result from changing any of the 3 other factors (again, as described above).
All this is basic Economics, perhaps even Econ 101. I don’t know where you are going with these questions.
Forgive me for not getting all of the jargon right. It seems that runaway deflation can only occur when it’s reinforced by a contraction of the money supply. So why don’t we strive for a currency that’s less susceptible to drastic contractions?
.
.
Fabius Maximus replies: It is unfortunately not that simple. “Currency” is a deceptive term, which is why economists refer to “money” — a far more abstract thing in a modern economic system. A collapse of velocity, widespread loan defaults — many things can create deflation.
We want a monetary system that allows growth (unlike the late 19th century gold-based system), that allows contra-cyclical fiscal and monetary policy, that supports globalization (e.g., currency flows, convertibility), that maintains price stability, maintains confidence, and is operationally reliable. Many of these are in practice contradictory. As usual in these things, it is a matter of trade-offs and how to evolve what we want from what we have (there are no “clean slates” to start with).
I get that. I can’t help but focus on one glaring fact:
We are susceptible to runaway deflation because of our policies that allow M2 to become orders of magnitude larger than M0. Maybe I’m just a spineless wuss, but I find a stable, low-growth economy more attractive than a high-growth economy that’s liable to explode every three generations.
You’re referring to economic growth, right? Clearly that statement’s an exaggeration. If pre-modern economic systems didn’t allow for economic growth, we’d still live in caves.
I get that. What I’m having an extraordinarily hard time doing is figuring which aspects of our system you are willing to change. You constantly talk about the fundamental changes, yet you seem to embrace all of the basic tenets of the status quo. Do you believe that we can make it work if only the planners had the “right” data and the “right” tools?
.
.
Fabius Maximus replies: I don’t discuss changes to our monetary system for the same reason I don’t discuss alternative methods of neurosurgery or car repair. It’s out of my league. I have a nominal understanding of these things, but know my limits.
Also, I don’t think reference to paleolithic times is relevant to my specfiic comment about late 19th century America. We had growth at the cost of frequent depressions, an unnecessarily high price. If the gold supply had not expanded, due to strikes in the West and Alaska, the economic stress might have been even worse.
I respect that. Your namesake, however, played an active role in addressing his generation’s crisis. Do you expect to play an active role or simply foster discussion? If you do intend to play an active role, how do you intend to do that without exceeding your limits?
Likewise, a couple decades of economic data that came right on the heels of a vastly inflationary fiat currency aren’t particularly representative of the merits of a hard currency.
Erasmus: “would very much appreciate a recommendation of a book that accurately describes 1930’s Germany especially regarding its economic turnaround.”
Some measures are described in the article Nazism and the German Economic Miracle by Henry C. K. Liu.
My article Sovereign Credit is State Usury discusses that article and other attempts at economic revival.
.
.
Fabus Maximus replies: Henry Liu writes for Asia Times (see the archive here). His views are original and provocative, but IMO way out there. Bio:
“Henry C K Liu was born in Hong Kong and educated at Harvard University, US, in architecture and urban design. His interest in economics and international relations started when he participated in interdisciplinary work on urban and regional development as a professor at the University of California Los Angeles, Harvard and Columbia. He is currently chairman of a New York-based private investment group.”
This Financial Crisis began a long time before America was “discovered”, long before the British Isles were settled, in fact so long ago that we’ve forgotten. It was when humanity first made the decision that Land could be considered personal property and belonged in the marketplace as a commodity when in fact Land is a necessary component of Life and therefore a Birthright. Food and materials for clothing and shelter all originate from Land. In fact Land is where the majority of wealth producing goods originate. Along with Oxygen and Water, Land is a necessary component of Life and therefore a Birthright of every human being. All “great” societies have met their demise due to the neglect of this simple fact. We can point our fingers at peripheral problems and solutions all we want but until we learn to honor the contract of Life and build our social structure upon that Sacred Foundation we will always reap dire consequences in the long run. Land is a Universal Birthright!
There is a principle called Ockham’s razor which is attributed to the 14th-century English logician and Franciscan friar, William of Ockham. It basically states that – “All other things being equal, the simplest solution is the best.”
The following are two simple ideas that effectively create the ideal social construct.
Simple Idea #1
1. Socialize ALL Land (socialism defined as the vesting of ownership of Land back in the community as a whole)
2. Charge leases on ALL Land based on current market prices.
3. Return 100% of the resulting revenue equally to every man, woman and child (no matter their financial status) in the form of a yearly dividend check.
4. Make the Universal Birthright of Land an Everlasting Standard in the education/understanding of every human being.
This effectively makes the average piece of Land Free for every Living Soul and restores our Natural Birthright as well as coupling our social construct to the Principles of Life.
Simple Idea #2
1. Remove ALL FORMS of taxation
2. Implement a Tax on ALL NEW goods based on the resources they contain and the resources they use in production and delivery (this can easily be implemented with the current barcode system used at the checkout)
3. Use this system to encourage/discourage various resource usages (High tax on non-renewable/ecosystem damaging products and low/no tax on renewable/ecosystem enhancing products) and to encourage purchasing of local products.
4. Use the resulting revenue to fund infrastructure expenses and the restoration of ecosystems.
This effectively encourages the creation/use of longer lasting, high quality products as well as encouraging recycling and reuse of existing products while also establishing a compatible relationship with the ecosystem. Idea #2 effectively constrains the ravaging appetite of the capitalistic consumer society within the Boundaries of Sustainability while Idea #1 effectively encloses both Sustainability and capitalism within the Principles of Life.
That’s it! The path to True Democracy (rule by the people) – True Liberty (freedom from control) – True Socialism (Universal Birthright of Life). Simple and Effective.
.
.
Fabius Maximus replies: Please note that the comment policy (stated above) asks that comments be relevent to the specific post and max of 250 words. This is not a relevant comment (these are not open thread discussion forums). At 500 words this is 2x the max. Thank your for your cooperation on this is the future.
Pingback: Econ Job Rumors Wiki | job hunters