Summary: A powerful metaphor, widely used, about this recession — the worst since the 1930’s — providing important insights.
Excerpt from “Financial Heroin”, Don Coxe, Coxe Advisors, 16 December 2009:
… my father was a doctor in the Canadian Army in WWII, and served in the Italian campaign. He became greatly respected for his anaesthesia and pain management under battlefield surgery and rehabilitation conditions. (He was cited after war’s end for perhaps having performed more anaesthetics under such conditions than any other Canadian doctor.)
In discussing his experiences, he told me that he swiftly learned that the best — and frequently the only — reliable drug for the critically wounded was heroin. Soldiers who writhed in agony under other medications almost always responded to heroin. The problem wasn’t deciding whether to administer it: if morphine didn’t work fast, you didn’t waste time, you injected heroin.
The problem for the doctor came when the patient had begun to recover from surgery, and was receiving heroin. How quickly could the dosage be reduced and when would it be terminated? Although few soldiers were freed of heroin without experiencing pain and distress, it was necessary to take the drug away as rapidly as possible. Otherwise they would become addicts and their lives would be ruined — for soldiering and everything else.
… Zero interest rates are Financial Heroin.
This goes to the vital points, mostly misunderstood, about the massive fiscal and monetary stimulus governments have applied in response to this global recession. Government stimulus has several characteristics similar to heroin.
- It mitigates the downturn, minimizing the suffering,
- but it does nothing to fix the underlying problems,
- and creates imbalances which must be removed when the economy recovers.
About government stimulus programs
(1) The miraculous curative properties commonly ascribed to government stimulus results from the brief duration of most recessions. They last a year or so, with government programs enacted in the middle — after the worst, after which signs of recovery soon appear. Sometimes the stimulus programs get enacted as the recession ends — or even during the early stages of the recovery.
(2) When the private sector has underlying problems so severe to prevent normal recovery — as in the Great Depression, Japan since 1989 — then the stimulus programs are seen in their true light — useful palliatives, not magic bullets.
(3) A recession provides a unique opportunity to take important public policy measures, such as tax changes, regulatory reforms, and construction of valuable infrastructure projects. The US has so far wasted this opportunity. Let’s hope the recession does not continue into 2010, and give us another opportunity for such things.
For more information from the FM site
Reference pages about other topics appear on the right side menu bar, including About the FM website page.
- about the Financial crisis – what’s happening? how will this end? – esp section 8, about solutions
- some Good News about America!
Some posts on the FM website about solutions to the financial crisis:
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- How should we respond to the crisis?, 24 September 2008
- A solution to our financial crisis, 25 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008 — How to stabilize the financial system.
- 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
- New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
- A look ahead to the end of this financial crisis, 30 October 2008
- Everything you need to know about government stimulus programs (read this – it’s about your money), 30 January 2009
- Explaining the government’s response to the financial crisis, 3 December 2009
Afterword
Please share your comments by posting below. Per the FM site’s Comment Policy, please make them brief (250 word max), civil and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
An excellent article, FM. Thanks for bringing it to my attention.
I wonder if this is an accurate Metaphor. There is no Doctor here; the addict himself is dispensing the drug. And the drug feels good to all actors in this play.
As we all know, to even begin to reach for sobriety a “bottom” must be reached. VERY few actually reach a bottom and even fewwer survive bottom to seek sobriety. (“BOTTOM” looks like this: WHAT has become of “me”? What type of life have I found myself living? Oh my goodness….STOP! And then possible sobriety can be (only) explored)
What most do not know is that a time comes for the addict wherein he MUST choose and he MUST see “sobriety” as preferrable to addiction—even with only a glimpse of the forgotten life of soberness.
Does anyone really think we will willingly choose sobriety when it is offered? Or even Chmn Ben, et.al.?
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FM reply: You objection is not accurate. The US government, chiefly the Fed, exerts tight regulatory control over the extentsion of credit. The credit boom largely resulted from deliberate removal of post-Depression regulations. The mortgage boom (subprime, interest-only loans, collapse of lending standards) resulted from failure to use their regulatory tools, despite widespread warnings (the Fed responds primarily to its clients, the banks).
“VERY few actually reach a bottom and even fewwer survive bottom to seek sobriety.”
Do you have any links or evidence for this? It’s something I’ve wondered about, but never seen analysis.
I think at least two different aspects of the “stimulus” get mixed. The “bailout” of the banks and AIG enabled them to survive and to stabilize the financial system. However this was a return to “normal” that passed by the opportunity to restructure the system and, for example, get rid of those that are “too-big-to-fail.” The very dangerous part of this comes from the fact that those in the companies that took excessive risk know, once again, that their risk is covered by the American taxpayer. They won rather than lost. We can expect them to “risk” again, and perhaps even more.
I’ve not see a lot of actual “stimulus,” as you suggest. Seems to me that your comment: “A recession provides a unique opportunity to take important public policy measures, such as tax changes, regulatory reforms, and construction of valuable infrastructure projects. The US has so far wasted this opportunity.” has great merit here. We could be preparing the structure of the system for a brighter future, instead, I agree, we seem to be wasting this opportunity for regulatory reform and infrastructure and competency development.
In general, we seem to have wasted a “perfectly good crisis.”
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FM reply: If you don’t see a lot of actual stimulus, then you must not be looking. Or using a different definition than the rest of us. the fiscal stimulus is aprox $100B/month (see this for a summary of its impact). The monetary stimulus takes different forms, most important near-zero interest rates on treasury securities and massive expansion of the monetary base.
Soon, the new world system to go green will emerge. The US is far ahead of developing countries in green technology. The US has been rapidly losing control over the world’s oil and gas resources, and their logistics.Obama hopes to avoid bankruptcy by selling green technology at high prices. When he talks about infrastrcuture, it’s actually about alternative energy and energy efficiency for the US economy. By forcing developing to restrict carbon emissions, Obama is hoping to sustain the US dollar strength despite the huge public debts already accumulated. It’s a game changing solution for which he has already been given the Nobel prize. In 2010 Obama will make everybody sign the legally binding go green agreements, come hell or high weather.
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FM reply: I would like to see one post from you that cites evidence for your often questionable assertions. The US might be “far ahead of developing countries in green technology”, but that does not mean that we will be “selling green technology at high prices”. We have no obvious lead over our fellow developed nations, which is the relevant fact. The leading solar developers are Japanense; the largest solar producer is Chinese. The leading wind power companies are Spanish and Danish. And so forth.
Nor is it clear than any of these technologies can be sold at high margins. So far they have quickly become commodities, as seen in the current crash of solar cell prices.
I think it will be a useful contribution from this blog if the government’s response to the financial crisis can be explained in terms that a common person without an advanced degree in economics can understand easily. This post may not neccessarily adhere to the word limit but it will be an easy read and non specialists can understand their financial system better if they were to go through it.
The simple concept of fractional reserve banking is at the core of the government’s response to the financial crisis. Suppose you deposit $10,000 at your local bank branch. The bank retains $1,000 of that and lends out $9,000 to borrowers for a longer term. Since the bank is liable to discharge your deposit on demand, they offer a lower interest rate to you, and they get a higher interest rate from the borrower because the borrower typically can hold on to the money for longer. This is basically how the bank makes a profit (net interest margin); by lending for longer periods at higher interest rates, and borrowing for shorter periods at lower interest rates. What is interesting is to understand the leverage level that a bank can achieve. {snip}
… Despite the two reasonably good solutions from government policy above, people are continuing to lose jobs, more foreclosures are happening, and the economy is generally not out of the woods yet. What are the reasons for this?
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FM reply: As Indian Investor knows, comments on the FM website should be both relevant to the post and no longer than 250 words. This was an unrelated essay of 830 words. I recommend that I.I. start his own blog to discuss his hobbyhorses.
Comment #2: “What most do not know is that a time comes for the addict wherein he MUST choose and he MUST see “sobriety” as preferrable to addiction—even with only a glimpse of the forgotten life of soberness. Does anyone really think we will willingly choose sobriety when it is offered? Or even Chmn Ben, et.al.?”
A good question, but I think the answer is that the American public WILL choose sobriety when the pain of addiction becomes high enough. We are already seeing this in a fairly large number of individuals who are either getting rid of large debts and not incurring new ones.
In spite of the comments of the doom-n-gloom’ers (I’m a proud member of the group), this is fairly early in what will probably amount to a 20-30 year cycle when America realizes just how collectively broke it is and frantically searches for a way to either deal with the problem or (more likely) ignore it for a little while longer. More and more people will opt to deal with the problem during each mini-crisis until we hit a tipping point.
Like real drug addiction, getting sober and staying that way is going to be an extremely painful process with a high likelihood of occasionally falling off the wagon for a three day bender. Whether we get back on the wagon or stay high will determine whether the country will survive or die.
Like FM, I’m fairly confident that the American public will, in general, make the right choice in the long run (after all other choices have been exhausted).
I’m more concerned about the politicians who are considerably more hooked on self-destructive financial habits and who cannot imagine a life without them. We so like to be lied to by our leaders and the wrong leader at the wrong time could easily destroy us in the next 15-20 years.
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FM reply: While I agree with most of this, one aspect is misleading. Private debt is decreasing, but more than offset by increased government debt — so total debt increases. This is the same policy followed by Japan.
Wow… so taking on more debt doesn’t solve the problem of having too much debt? That’s a shocking revelation.
“When the people find they can vote themselves money, that will herald the end of the republic.”
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FM reply: That’s not the point of the post. I suggest you re-read it. Also, the quotation you give is bogus. Usually attributed to Alexander Fraser Tytler (Scottish attorney, 1747-1813), it’s first appearance is in the mid-20th century. Of course, that does not mean that it’s incorrect — just that it is not a quotation.
#4. I think green technology may prove to be another bubble.
Nuclear energy would do it better ; Socially , people need jobs ;
Natives of areas blessed with Unknownium etc are going to get more possessive of it .
Two reasons for unrest and terrorism.
A 140 acre photovoltaic farm in Nevada is cutting edge technology , but not green .
A windmill made from old car panels supported on a wooden post , is green technology . (Developed by a kid in Africa.)
Perhaps a better analogy would be sugar fixes. They add good taste but no nutritional value. Unfortunately, they also cause diabetes.
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FM reply: The primary point of this post is that heroin is a powerful, useful, and dangerous medicine — the opposite of sugar. And so are large-scale economic stimulus programs. Why is this so difficult to understand? Perhaps it will take another great depression for American’s to re-learn basic economics.
Most of the Fed’s special liquidity facilties are scheduled to expire on February 1st of next year. I expect that at least some, and perhaps all of these programs, will in fact become permanent.
Was it Heinlein who said that there is nothing as permanent as a temporary emergency? We will not off the heroin easily.
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FM reply: It depends on the economy. If we get the robust recovery most economists expect (consensus GDP growth for the 4th quarter is roughly 4%, with 2010 expected strong), then I am confident that the Fed will quickly act to wind down its extraordinary support programs — shifting from fighting deflation to inflation. If the economy slumps in 2010 as the government stimulus programs wind down (unless renewed) — the Japan-like deflation scenario, predicted by Richard Koo — then the Fed programs will continue.
I realized my previous comment (#7) might have come of as snide towards this post. That was not my intention at all, even if I apparently misunderstood the post’s point. My derision was aimed at the government’s fiscal policies. My apologies if that wasn’t clear.
As to why the “powerful, useful, and dangerous” point is being missed, I offer some possible reasons:
1) Heroin is generally considered a bad thing, so there is a negative connotation to the comparison from the start.
2) Some readers have negative preconceptions about the merit of stimulus programs, generally.
3) The current stimulus has had no noticeable benefit, except to the government itself, to the average Joe.
4) Only the first of the three bullet points of similarities between stimulus and heroin is positive.
5) Finally, and perhaps most importantly, the second similarity about doing nothing to fix the underlying problem basically makes everything else in the post fade into the background. That is the most key point to those who don’t like/approve of stimulus programs.
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FM reply: Changes in economic aggregates are by their nature almost invisible to the average person. A typical recression of GDP down 2%, unemployment rate from 4% to 8%, is invisible — just a change in barometric pressure or termperature of 2% cannot be detected without instruments. Second derivatives, change in rate of change (rate of improvement or deterioration) are totally invisible. Which is why the media can run stories about the economy almost irrelevant to actual conditions. There are always some prices going up or down. Some companies closing. Some people going bankrupt. Put them on camera and people generalize by the process of confirmation bias.
“Heroin is generally considered a bad thing”
Not to anyone familar with pain management. This of course goes to the heart of the current American delusion that economic policy management is a sport anyone can play, no matter how ignorant of economic theory and history.
“negative preconceptions about the merit of stimulus programs, generally.”
Yes, as a result of a large-scale and pernicious propaganda campaign by right-wing elements. This was not so ten or more years ago.
“The current stimulus has had no noticeable benefit, except to the government itself, to the average Joe.”
False on many levels. To mention just two… First, the “average joe” has had tax cuts. Second, the economy’s stabilization has had massive benefits to everyone. It’s just invisible to those blinded by ideology.
My previous comment wasn’t meant to judge the merit of those points, simply to give possible realities about your readership. There’s certainly no point in debating what others’ opinions are or how they came to those opinions.