Friday, January 30, 2009

Economic crisis

I am aware that I haven't actually blogged on the economic crisis. This, some may think is ironic, since I actually used this blog in July 2007 to predict the recession - a year before it happened!" I then followed this up by announcing the beginning of the crisis - the collapse of Northern Rock.

I suppose that the reason I haven't reported is, a) because so many others have, and b) because it has struck close to home. As I type this it is mid afternoon on my last day of work having been made redundant. My company, forced to cut costs in the present crisis, decided the rent of my shop is too high and has laid me off. I will be doing four hours of teaching a week, starting next week, but, that aside, I am unemployed.

On this crisis, my views echo those of Sean Gabb:

For many years, interest rates have been held below the sort of level needed to balance the supply of savings and the demand for loans. The result has been inflation. That many consumer prices have been falling is no argument against this proposition. Inflation is best seen not as price increases but as monetary expansion. There was a time when monetary expansion led fairly soon to price rises. Where at least Britain is concerned, though, most consumer goods are imported. So long as foreigners are willing to finance a growing current account deficit without devaluation, demand for imported consumer goods can expand rapidly and for years without any increase in prices.

The new money will therefore be used partly for investments in new production that may or may not be wise in the long term - and also to bid up the prices of property and of paper assets.

These bubbles never last. There comes a point where people lose faith in a currency, and where the upward spiral of asset prices is checked. The fall in the currency will push up consumer prices. Overvalued assets will fall in at least real terms. Many other investments will be shown to have been unwise. The immediate reasons for their bursting are less important than that they always will burst. This has now happened. There is no definite rule in these matters. But it seems that the length and intensity of the boom is roughly in proportion to the scale of the recession that follows.

The financial collapse we are now witnessing, therefore, should not be seen as some autonomous fall in aggregate demand that can be offset by increasing other variables in the national income income equation. It is instead part of the unavoidable correction to past experiments in demand management...

We should never have got ourselves into this mess. Failing that, the recession should have been allowed to hit last year. Since it was then deferred, it should be allowed to hit now. It will do nothing to moderate the inevitable recession. But there is a good case for cutting taxes and government spending now by at least a third, and then by five per cent a year every year for the next decade. And there is a case for returning to a fully convertible gold standard.

The thing that really annoys me, in light of this account of what has caused the recession, are the ridiculous "solutions" to the recession proposed. I mean, the first thing to notice is the term "solution": Recessions, as the above account shows, should best be called corrections. The creation of cheap credit lead to all sorts of investments that should not have happened, and would not have happened otherwise. Part of the process of recession is the liquidation of these investments that should not have occurred.

On top of this is the claim that banks are not lending to each other enough and that consumers are not spending enough. But as I said in the blog post where I predicted the recession, it was the existing saving and lending ratios that indicated the onset of the recession in the first place. before the recession the saving ratio was 2.1%, or, in other words, we were saving, on average, one pound for every £50 we recieved in take home pay. Meanwhile, the booming loan rates were such that household debt had trippled over 30 years to the equivalent of £55,000 for every household. The idea that banks are now not lending enough and consumers are not spending enough is basically the idea that we should go back to precisely what was occuring before the recessaion and caused it! As the Libertarian Alliance have announced,

Final responsibility for this crisis rests with the authorities. For at least ten years, the Bank of England - and the central banks in most other countries - has kept interest rates below the market equilibrium. The result has been an orgy of credit creation by the commercial banks. This led to an asset price bubble that has now burst.

This should never have been allowed to happen. Interest rates should have been allowed to settle at levels that equalised the supply of savings and the demand for loans.

Instead, of course, the Bank of England has reduced interest rates, and the media and politicians have publicly denounced banks that have not passed on these interest rate cuts. In fact, this has been done whilst we are told that the government should bail out banks to recapitalise them so they can start lending. Errrrr... how about this as a means of recapitalising them and giving them the means to start lending again: Encourage saving. How do we encourage saving? Certainly not by reducing interest rates. In other words, this crisis will be solved quicker if people save more.

Another ridiculous proposal is that the quantity of money in circulation should increase. Confusing falling prices with deflation, there have been calls for actual inflation, or for the government to increase the money supply, part of a process of "quantitive easing." It is ironic that one method of quantitive easing that got the most coverage, that of the central bank buying assets from banks in exchange for currency, was actually proposed by one of the Diretors of Barclays bank! In other words, the director of Barclays bank used "saving us from the recession" as an excuse for the Bank of England to buy huge amounts of "assets" from Barclays bank in exchange for currency! And the reason he proposed this is to reduce interbank loan interest rates... so, in other words, he can get cheap loans!

Does the money supply need increasing? Well, this is what the money supply looked like before the crisis:

So, like encouraging borrowing and lending rather than saving, qantative easing is, basically, doing what the government and BofE was already doing! Is there history of "quantative easing" working? It was tried in Japan during the recession of the 1990s and >didn't work there.

The new President of the United States of America, Barrack Obama, has joined calls for a "New New Deal," a "stimulation package," whereby the US government attempts to "stimulate" the economy by engaging in huge public spending sprees, funded either out of present taxes, or out of borrowing (later taxes), or by printing more money (funding it out of present taxes is impossible because the revenue is not there, funding it out of future taxes means reducing economic activity later, and funding it through increasing the money supply means stagflation and destroyed savings, so, no real stimulation). The belief is that this sort of "stimulation" worked after the last economic crisis as great as this one, the Great Depression. That stimulus, instituted under Roosevelt, package was called "The New Deal," hence the "New New Deal"!

Did it really work? No, not really. Public works schemes were introduced to try to end the massive unemployment that the 1929 crash had caused. This, of course, meant that jobs were created on these public works schemes, but jobs would be created if the government spent money hiring people to dig holes and then fill them in again all day. The question is whether this lead to increase economic activity in the actual real economy, in the private sector. What are the figures for unemployment during the years that Roosevelt "saved" America from the Great Depression? Well, here they are:

1931 15.9
1932 23.6
1933 24.9
1934 21.7
1935 20.1
1936 16.9
1937 14.3
1938 19.0
1939 17.2

Unemployment, as you can see, did clearly did not come down as a result of this stimulus package. Likewise, Real output (once one has taken account of inflation) was about as low in 1938 as if had been in 1932. UCLA economists Harold L. Cole and Lee E. Ohanian wrote, in the August 2004 Journal of Political Economy, arguably the top academic economics journal in the world, in an article entitled "New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis," that "Real gross domestic product per adult, which was 39 percent below trend at the trough of the Depression in 1933, remained 27 percent below trend in 1939" and "Similarly, private hours worked were 27 percent below trend in 1933 and remained 21 percent below trend in 1939." Thomas DiLorenzo writes,

This should be no surprise to anyone who has studied the reality of the Great Depression, for U.S. Census Bureau statistics show that the official unemployment rate was still 17.2 percent in 1939 despite seven years of "economic salvation" at the hands of the Roosevelt administration (the normal, pre-Depression unemployment rate was about 3 percent). Per capita GDP was lower in 1939 than in 1929 ($847 vs. $857), as were personal consumption expenditures ($67.6 billion vs. $78.9 billion), according to Census Bureau data. Net private investment was minus $3.1 billion from 1930–40.

This is what Obama wants to emulate!!!

The greatest, most quotable assessment of the various proposed "solutions" to the economic crisis comes from Perry de Havilland:

A large number of people, certainly the majority of the political looter class, think the best way to deal with the rapidly deepening economic crisis is via 'stimulus packages' with money plucked off the magic money tree... which is to say, by trying to re-inflate the credit bubble that actually caused the crisis. This is a bit like treating alcoholics by urging them to buy more whiskey.

So what is the solution to the economic crisis? Here, again, I echo the Libertarian Alliance:

The British Government is proposing to use £50 billion of the taxpayers' money to buy shares in illiquid banks and other institutions...

However, it is obvious that £50 billion will not be enough to restore stability. There are trillions of pounds of imaginary money on the markets. The fundamental problem is that no one really believes in this money today, and it just disappears whenever people stop looking at it. No government on earth can painlessly clean up the mess left by the bursting of the credit bubble.

Governments can stand back and let weak institutions fail. This will bring on the worst financial collapse since 1931, and be followed by a nasty recession. Or they can spray vast amounts of our tax money into the financial markets, which might briefly delay the worst financial collapse since 1931 and a nasty recession to follow.

Do nothing. People are aghast at the suggestion that the government should do nothing - or less (cut spending and taxes). Something, they say, has to be done. Industries cannot be allowed to collapse and fail, the people working in them cast out on the street. However, this ignores the fundamental position of the do-nothing advocates: The stimulus will fail, bailouts cannot be enough, slashing interest rates and increasing the money supply will simply restore the scenario that lead to the crisis in the first place. At best, they will postpone a massive economic crash and a recession to follow, but they will not prevent it. The industries will still crash, their workers thrown out on the street, but, on top of this, taxpayers will be burdened with billions, trillions of pounds or dollars in debt. At worse, the economic collapse will bre greater, the recession harsher (Historical parallels: There was a crash in the US in 1921. After that, fallimng prices were held up by strengthened tariffs, falling wages by tightened immigration controls, and the Fed held interest artificially low, leading to the creation of cheap credit and excessive lending, falling saving. The result? At the end of the 1920s the stock markets crashed worse than they ever have since, and the Great Depression was ushered in).


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