Monday, June 28, 2010

The Third Depression


Recessions are common; depressions are rare. As far as I can tell, there were only two eras in economic history that were widely described as “depressions” at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929-31.

Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses.

We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.

In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.

But future historians will tell us that this wasn’t the end of the third depression, just as the business upturn that began in 1933 wasn’t the end of the Great Depression. After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.

In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.

As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels.

Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.

It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.

So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.

And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.

Kartik Athreya of the Richmond Federal Reserve Bank argues that bloggers are stupid, and that only PhD economists have a right to say anything about economics policy.

This distinction is a little ridiculous, given that many of the world’s top PhD economics professors are bloggers.

And it must be noted that the Fed ignores any PhD economist who exercises any scintilla of independence.

For example, all of the PhD economists who say the economy won't recover unless we break up the giant banks are ignored (even if they happen to be former Federal Reserve chairmen or Fed Bank presidents).

And well-known PhD economist James Galbraith is ignored when he argues that - because fraud caused the economic crisis - economists should move into the background, and "criminologists to the forefront".

And of course, the PhD economists calling for a complete audit of the Fed or - heaven forbid - a challenge to Fed powers, are ignored.

In fact, as I pointed out in December, most economists don't exercise any independent thinking because economists are trained to ignore reality:

As I have repeatedly noted, mainstream economists and financial advisors have been using faulty and unrealistic models for years. See this, this, this, this, this and this.

And I have pointed out numerous times that economists and advisors have a financial incentive to use faulty models. For example, I pointed out last month:

The decision to use faulty models was an economic and political choice, because it benefited the economists and those who hired them.

For example, the elites get wealthy during booms and they get wealthy during busts. Therefore, the boom-and-bust cycle benefits them enormously, as they can trade both ways.

Specifically, as Simon Johnson, William K. Black and others point out, the big boys make bucketloads of money during the booms using fraudulent schemes and knowing that many borrowers will default. Then, during the bust, they know the government will bail them out, and they will be able to buy up competitors for cheap and consolidate power. They may also bet against the same products they are selling during the boom (more here), knowing that they'll make a killing when it busts.

But economists have pretended there is no such thing as a bubble. Indeed, BIS slammed the Fed and other central banks for blowing bubbles and then using "gimmicks and palliatives" afterwards.

It is not like economists weren't warning about booms and busts. Nobel prize winner Hayek and others were, but were ignored because it was "inconvenient" to discuss this "impolite" issue.

Likewise, the entire Federal Reserve model is faulty, benefiting the banks themselves but not the public.

However, as Huffington Post notes:

The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession, an investigation by the Huffington Post has found.

This dominance helps explain how, even after the Fed failed to foresee the greatest economic collapse since the Great Depression, the central bank has largely escaped criticism from academic economists. In the Fed's thrall, the economists missed it, too.

"The Fed has a lock on the economics world," says Joshua Rosner, a Wall Street analyst who correctly called the meltdown. "There is no room for other views, which I guess is why economists got it so wrong."

The problems of a massive debt overhang were also thoroughly documented by Minsky, but mainstream economists pretended that debt doesn't matter.

And - even now - mainstream economists are STILL willfully ignoring things like massive leverage, hoping that the economy can be pumped back up to super-leveraged house-of-cards levels.

As the Wall Street Journal article notes:
As they did in the two revolutions in economic thought of the past century, economists are rediscovering relevant work.
It is only "rediscovered" because it was out of favor, and it was only out of favor because it was seen as unnecessarily crimping profits by, for example, arguing for more moderation during boom times.

The powers-that-be do not like economists who say "Boys, if you don't slow down, that bubble is going to get too big and pop right in your face". They don't want to hear that they can't make endless money using crazy levels of leverage and 30-to-1 levels of fractional reserve banking, and credit derivatives. And of course, they don't want to hear that the Federal Reserve is a big part of the problem.

Indeed, the Journal and the economists it quotes seem to be in no hurry whatsoever to change things:
The quest is bringing financial economists -- long viewed by some as a curiosity mostly relevant to Wall Street -- together with macroeconomists. Some believe a viable solution will emerge within a couple of years; others say it could take decades.

Saturday, PhD economist Michael Hudson made the same point:

I think that the question that needs to be asked is how the discipline was untracked and trivialized from its classical flowering? How did it become marginalized and trivialized, taking for granted the social structures and dynamics that should be the substance and focal point of its analysis?...

To answer this question, my book describes the "intellectual engineering" that has turned the economics discipline into a public relations exercise for the rentier classes criticized by the classical economists: landlords, bankers and monopolists. It was largely to counter criticisms of their unearned income and wealth, after all, that the post-classical reaction aimed to limit the conceptual "toolbox" of economists to become so unrealistic, narrow-minded and self-serving to the status quo. It has ended up as an intellectual ploy to distract attention away from the financial and property dynamics that are polarizing our world between debtors and creditors, property owners and renters, while steering politics from democracy to oligarchy...

[As one Nobel prize winning economist stated,] "In pointing out the consequences of a set of abstract assumptions, one need not be committed unduly as to the relation between reality and these assumptions."

This attitude did not deter him from drawing policy conclusions affecting the material world in which real people live. These conclusions are diametrically opposed to the empirically successful protectionism by which Britain, the United States and Germany rose to industrial supremacy.

Typical of this now widespread attitude is the textbook Microeconomics by William Vickery, winner of the 1997 Nobel Economics Prize:
"Economic theory proper, indeed, is nothing more than a system of logical relations between certain sets of assumptions and the conclusions derived from them... The validity of a theory proper does not depend on the correspondence or lack of it between the assumptions of the theory or its conclusions and observations in the real world. A theory as an internally consistent system is valid if the conclusions follow logically from its premises, and the fact that neither the premises nor theconclusions correspond to reality may show that the theory is not very useful, but does not invalidate it. In any pure theory, all propositions are essentially tautological, in the sense that the results are implicit in the assumptions made."
Such disdain for empirical verification is not found in the physical sciences. Its popularity in the social sciences is sponsored by vested interests. There is always self-interest behind methodological madness. That is because success requires heavy subsidies from special interests, who benefit from an erroneous, misleading or deceptive economic logic. Why promote unrealistic abstractions, after all, if not to distract attention from reforms aimed at creating rules that oblige people actually to earn their income rather than simply extracting it from the rest of the economy?

As I have previously written, mainstream economists and financial advisors who promote flawed models are not necessarily bad people:

I am not necessarily saying that mainstream economists were intentionally wrong, or that they lied because it led to promotions or pleased their Wall Street, Fed or academic bosses.

But it is harder to fight the current and swim upstream then to go with the flow, and with so many rewards for doing so, there is a strong unconscious bias towards believing the prevailing myths. Just like regulators who are too close to their wards often come to adopt their views, many economists suffered "intellectual capture" by being too closely allied with Wall Street and the Fed.

As Upton Sinclair said:

It is difficult to get a man to understand something, when his salary depends upon his not understanding it.
See this, this, this, this and this.

Michael Rivero may have the hardest-hitting critique of all:
This seems to be a return to the mindset of the middle ages where only the clergy were allowed to read and interpret the bible and the laity were presumed incapable of comprehending the intricacies and subtle nuances of the faith.

And indeed there is a great deal of similarity between economics and [fundamentalist version of] religion in that both depend on the unquestioning faith of the masses that those pretty printed pieces of paper represent something real, albeit invisible.

But the advent of the printing press led people to take a closer look at the actual content of [fundamentalist version of] religion and it has been revealed not as a complex and sophisticated system but as a mish-mash of half-baked myths and legends often in contradiction with itself and used to enrich the church ....

The same is true of eocnomics. the advent of the blog has led people to take a closer look at the actual content of economics and it has been revealed not as a complex and sophisticated system but as a mish-mash of half-baked theories and math often in contradiction with itself and used to enrich the bankers and conceal their fraud against the public. Athreya is reacting to the blogs the way [fundamentalist] priests reacted to Gutenberg's Printing Press.

The fraud and danger of the Federal Reserve system of banking stands exposed to the public eye, sans the "benefit" of correct interpretation by the self-appointed priests of Mammon. The public now understands that when a private bank issues the public currency at interest, debt will always exceed the available money supply. The public now understands that the Federal Reserve is no more Federal than Federal Express. The public now understands that the Federal Reserve is a legalized counterfeiting operation, that creates the money they loan out out of thin air! The public now understands that the Federal Reserve system of banking, since its creation in 1913, has reduced the value of a dollar down to about four cents! The public now understands that the Federal Reserve system is a pyramid scam that only works when ever larger populations of borrowers can be found, and that once an entire nation or planet has borrowed to the max, the system must crash (which is what is happening now).

Just as the [fundamentalist] priests, stripped of the arcane scriptures and rituals, stand exposed ... so too the economists, stripped of their arcane equations and theories, stand exposed ....

Karthik Athreya doesn't like that fact that the public sees the Federal Reserve for what it really is.

No comments:

Post a Comment