Now that we are in the middle of an ongoing depression – and leaving out that the central cause is the shrinking availability of a vital resource and the attendant rise in cost – the variations on Irving Fisher’s debt deflation are stalking the countryside like vampires.
Fisher was an insightful economist who illuminated the quantity theory of money, which relates money supply and the velocity of transactions;
“The stock market crash of 1929 and the subsequent Great Depression cost Fisher much of his personal wealth and academic reputation. He famously predicted, a few days before the Stock Market Crash of 1929, “Stock prices have reached what looks like a permanently high plateau.” Irving Fisher stated on October 21 that the market was “only shaking out of the lunatic fringe” and went on to explain why he felt the prices still had not caught up with their real value and should go much higher. On Wednesday, October 23, he announced in a banker’s meeting “security values in most instances were not inflated.'”
Fisher’s debt deflation narrative runs like this:
Debt liquidation and distress selling. Contraction of the money supply as bank loans are paid off. A fall in the level of asset prices. A still greater fall in the net worth of businesses, precipitating bankruptcies. A fall in profits. A reduction in output, in trade and in employment. Pessimism and loss of confidence. Hoarding of money. A fall in nominal interest rates and a rise in deflation adjusted interest rates.
The outcome leaves the overall economy too poor to pay off the last of its debts. Here’s a version from Richard Koo, who outlines the process in a Nomura Securities paper from earlier this Spring:
– A balance sheet recession emerges after the bursting of a nationwide asset price bubble that leaves a large number of private-sector balance sheets with more liabilities than assets.
– In order to repair their balance sheets, private sector moves away from profit maximization to debt minimization.
– With the private sector de-leveraging, even at zero interest rates, newly generated savings and debt repayments enter the banking system but cannot leave the system due to the lack of borrowers.The sum of savings and debt repayments end up becoming the leakage to the income stream.
– The deflationary gap created by the above leakage will continue to push the economy toward a contractionary equilibrium until the private sector is too impoverished to save any money (=depression).
– In this type of recession, the economy will not enter self-sustaining growth until private sector balance sheets are repaired.
The entire article is worth a look. Koo suggests that fiscal stimulus policy can short circuit the vicious cycle of declining asset prices. It is hard to see where this has been effective either in the past or currently. Any added capital is insufficient to offset increasing liabilities on deteriorating balance sheets. After all, there is no practical limit to the level of fantasy embedded in the quantity of lending and good loans go bad as the means to service them becomes less available. Capital is capital; unlike debt, in the end it is constrained by physics and the 2d law of thermodynamics. A few can rebalance debts to assets/income with new capital, the rest are marooned. Instead of real capital, there is only the replacement of debt with new debt.
Stimulus replaces one kind of fantasy – that of profits – with another – that of avoiding ruin.
The unwillingness to lend – liabilities are greater than assets – ends up with lender failures. There are not enough performing loans added to the lender’s balance sheet at one end to offset the accelerating bad loans that have already been made … that are piling up at the other. Adding capital is throwing good stimulus after bad lending decisions.
Since the aggregation of bad debt exceeds available capital, simply liquidating debt and allowing the resultant failures and bankruptcies would end up with no businesses left. This is the failure of the ‘Austrian’ approach, which is why there are very few Austrian economists in the service of government.
As far as the deflated overall economy, the best approach is Hyman Minsky’s; to aim at the unemployed and put them to work:
Minsky … argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government – or what he liked to call “Big Government” – should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work. Such a program would not only help the poor and unskilled, he believed, but would put a floor beneath everyone else’s wages too, preventing salaries of more skilled workers from falling too precipitously, and sending benefits up the socioeconomic ladder.
Minsky’s non- bailout of big business approach is undoubtedly behind his near- previous obscurity. Big business appreciates economists like Krugman who know who to stimulate first. As this good- money- after- bad is failing to gain any traction on Main Street – we have no shortage of highway overpasses in America – Minsky is getting a review.
Aiming stimulus at the unemployed – not adding to the dole but putting the unemployed to useful work – would add demand to the demand- starved consumer economy. Done properly – in ways that promote efficiency and repair some of the excesses of consumer capitalism – the energy payback would justify the policy.
There are arguments that the government is unable to employ well, that make work jobs cost far more than their return, leaving out the point of stimulus being to halt general deflation by adding capital to a capital deprived circuit. Government is much better at taking from the lowest social rungs and passing the returns to those at the top. This is more a matter of practice; the US employed millions during the 1930’s to no ill effect and millions more during WWII, which compressed wage levels between top and bottom … leading to a long period of post- war prosperity.
With excess domestic energy to exploit, not to forget that!
We are in an energy crisis. Real, long term energy solutions – not just talk or fake solutions such as ‘drill, baby, drill!’ – are absolutely necessary. There are tens of thousands of electrified railroad lines that await building, millions of miles of dangling electric wires that should be buried, abandoned buildings torn down, watersheds repaired, forests replanted.
America needs a million new organic farmers and the communities to support them and their families.
America needs to abandon the auto intermediary- that is, the need to get into an oil- sucking car first in order to do anything. This means a recast of how people live, with more diverse living opportunities, infill development, reduction in ‘exurbs’, removal of highways and redevelopment of water transport. America needs to re- examine its small towns. It also needs to reform its education system, to produce less ‘advertising managers’ and more agronomists and hydrologists.
All of this could have been done at the price of the TARP bailouts of the banking system. A million new farmers would be an investment in the future of the country free of the need for more imported petroleum; replacing black goo with human brains.
Instead, the legacy of bad lending decisions is extended into the distant future.
This foolishness cannot be blamed either on Fisher or his disciples such as Koo. Policy makers tethered to big established businesses are making the (wrong) choices. Difference this time is the ability to endure repeated bad choices is dwindling.