Bush proposes a Keynsian-style stimulus package of tax cuts, refunds, coerced loan renegotiations, and other gimmicks to boost us out of the recent economic slump. But why are we here? Isn’t understanding that somewhat important to getting out of this jam? We are here, it seems, for a variety of inflationary pressures on the economy mostly caused by the government: artificially low interest rates from an undisciplined federal reserve strategy; a glut of bad loans and improvident consumer spending from refinances (also caused by loose money); a slump in the housing market (from earlier waves of overspending and overbidding); too many “house poor” Americans now paying on upside down or poorly capitalized loans; and a very weak dollar from the combination of a loose federal reserve policy and high government deficits and spending. Finally, we should not forget, our trade policy with China that has caused a massive increase in demand for various raw materials (and a simultaneous drop in the prices of certain manufactured goods) has also been caused in a sense by a government policy, the no-restrictions trade regime we have with Communist China.
We are in the midst of what the Austrian Economists would call a crash or correction caused by an artificial and inflationary monetary policy. The chickens are coming home to roost. Assets need to be redistributed to more productive uses, even if that is to lie dormant in some cases, i.e., half-finished “downtown revitalization” projects and the like. Homes must be foreclosed and resold. But so long as the government continues to inflate, and try to spend its way out of the problem, the dollar will remain weak, the economy will remain unstable, and we will risk the kind of hyperinflation that has plagued other high-debt, loose money economies, i.e., Asia in the late 90s, Argentina in the 2002 time frame, Weimar Germany in the 30s. Needless to say, holders of hard, high-value assets like gold, copper, oil, and the like will benefit tremendously.
Every recession since WWII and Breton Woods has been inflationary. Under the classic macroeconomic model, that means instead of having a mere shortage of demand, we instead had a supply shock. (Of course, very few have connected the dots on this fact-of-life other than the redoubtable Austrians.) In a “shock,” the supply curve is moving left, as represented in the graph below. This is bad, but it can self-correct much more quickly without artificial and misguided Keynsian interventions. Purposeful and artifical inflation won’t stop the inevitable redistributon of assets and investments necessitated by the shock, particularly as the overextension of supply and investment was a consequence of overspending and central-bank-created loose money in the first place.
The rules of personal and public finance are not that different: do not spend more than you make; save for a rainy day; be prudent and deliberate about non-investment spending; be especially prudent about debt; and you cannot get something for nothing. Keynesianism has apparently displaced the Chicago School’s monetarist revolution at the Federla Reserve in the late 1970s. While not perfect, this regime at least attempted to recreate what would result from a sound money system, such as the earlier gold standard.
Today the eternal, inflationary temptation of Keynes has returned because his philosophy amounts to a kind of flattery of both politicians and consumers: do as you will, spend as you like, encourage others to do the same, and everything will be OK. For Keynes, such profligacy is a public duty and, as he said, “in the long run, we are all dead.”
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Absolutely and for certain. The Fed begat 0% rates, which begat the housing bubble, which begat the subprime mortgage market, which begat the current financial turmoil.
Why no one blames the Fed for this mess is beyond me. The Fed does not smooth out the business cycle, it causes the business cycle.
The business cycle was here before the Fed; the business cycle will continue long after memories of the Fed have fallen into the dust.
The business cycle and the length of any recessions or depressions was much shorter before centralized banking. The “panics” of the 19th Century typically lasted a year at most, i.e., the Panic of 1819, the Panic of 1895.
The supply and demand curve that is most important is this particular crisis is the relationship between lenders and borrowers.
Faith in the U.S. economy and increasing world-wide savings (resulting from world-wide economic growth) led to a glut of investment available to American borrowers. This surplus investment resulted in low interest rates (the P in your supply-demand curve).
The exceedingly low interest rates then resulted in asset appreciation rather than real growth(i.e. homes overvalued and corporations over-leveraged). Basically, the U.S. was over-valued.
The American economy, for all its problems, is still a fundamentally sound one. If we allow the correction to work itself out, we will once again attract capital, which will help fuel real growth rather than asset appreciation. On the other hand, if we try to protect the over leveraged borrowers, by freezing adjustable rates for example, we are just going to scare off future investment.
http://money.cnn.com/2008/01/18/news/economy/cure.fortune/index.htm?cnn=yes
What he said.
Chris, I think that is fairly inaccurate. Usual caveats about Wikipedian reliability, but this list accords with what I recall from my economic history classes:
http://en.wikipedia.org/wiki/List_of_recessions
To the extent that your implicit argument regarding centralized banks exacerbating economic downturns holds water, I think it is a symptom, not a cause — central banks make it easier for the government to screw things up because it has access to a centralizing tool that, as Friedman and other monetarists have shown and Keynes inadvertently admitted, can leverage government miscues into massive screw-ups. To paraphrase Archimedes, Give FDR a place to stand, and he’ll prolong the depression by four years or so. The costs of these Keynes-inspired blunders have to be balanced against the benefit of Volcker/Greenspan “tight money” policies that simulate tying U.S. currency values to commodities.
And, because no one asked: I agree with David.
I think that is a very sensible position.
[...] US credit, and an eventual meltdown of the currency, whether in hyperinflation, deflation, or some kind of supply shock combination of both remains to be [...]
[...] I lean towards inflation, but the data seems now to point more the other way. I am a crappy prognosticator in any case, but I do think prices will go up and output down in the usual “stagflationary” supply shock, as I said way back when. Whether one or the other factor–i.e., the deflationary or inflationary trend–is dominant, I don’t know. This is another way of saying, even if prices go up, I don’t think it will be signs of or helpful to a recovery, and we’re in for bad times one way or the other. I made this “stagflationary” point about the Bush stimulus way back in early 2008. [...]