Things Could Be Worse...

by: Paul Kedrosky October 31, 2008    
Paul Kedrosky

Paul Kedrosky

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Provocative piece up earlier this week over on the (excellent) FT economists’ forum. Authored by Anders Aslund of the Peterson Institute, the piece takes people to task for stubbornly insisting that the current crisis could not end up being worse the the Depression. While it very likely won’t end up being worse than the Depression, taking it as an article of faith is over-rigid thinking that helps no-one.

Here are Aslund’s points with respect to where the “why it could be worse” risks lie. He is not saying it will be worse, just that the following represent some of the possible blind spots.

Then

Now
Defended exchange rates over-aggressively Floating exchange rates could lead to trade panic
Allowed monetary supply to shrink dramatically Monetary expansion and budget deficits lead to currency collapses
States did not go bankrupt States could go bankrupt, leading to hyperinflation
Subprime loans existed, but market were simpler Deeper and more complex markets with connective tissue everywhere
Emanated from two countries: US and Germany Coming from everywhere, i.e., with worst real estate bubbles in Moscow and Middle east
Minimal over-leveraging of major financial institutions Massive over-leverage of major financial institutions
Global trade was frozen in wave of protectionism Global trade freezing in credit contraction
Relatively slow advance and loose coupling Fast advance and tight coupling via trade and global media

More here.

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This article has 33 comments:

  •  
    Oct 31 06:04 PM
    "We must not repeat the mistakes of the Great Depression, but we need to ascertain that new policies are not even worse."

    Well, there is one constant, a dishonest fractional reserve banking cartel. But hey, what does honesty matter anyway? Since the lesson of the Great Depression was not learned, get ready for lesson number two.
    Reply | Link to Comment
  •  
    Oct 31 07:46 PM
    Oh for Pete's sake, what a bunch of total BS!! It's Y2K all over again. I recall how people were stocking up on everything from beans to bullets during the run up to the turn of the century, and it was just as much of a crock as it is now.

    Not only does the list not match up on the points given - it's called reading comprehension, check it out - the list leaves off the most crutial points, which are the differences. Deposit insurance, unemployment insurance, welfare, and Social Security - to name just a few work as counter-cyclical measures to mitigate down-turns such as this. Moreover, the Great Depression was just the worst in an unending series of depressions that occured pre-WWII.

    Some people need a history lesson because, obviously, economics isn't cutting it.
    Reply | Link to Comment
  •  
    Oct 31 08:15 PM
    The point that should be taken from here has nothing to do with how big is the deflationary portion of this crisis (call it recession or depression), it's the aftermath after credit expands again. All this liquidity will end up causing hyperinflation.
    Again, just so everyone can understand. AFTER the recession, the risk for hyperinflation will be enormous. Going into this without a real strategy will curse all of these economies. What brought us here were all those shortsighted policies that could not foresee the consequences down the line. We should not fall for that mistake again.
    Reply | Link to Comment
  •  
    Oct 31 08:42 PM
    I was stuck for a while thinking that inflation would come as the money supply increased. As the banks are keeping their grip on the money (not lending it out to people who can't afford to pay it back), I don't think that there will be too much money in the system. However, start reducing the supply of products in the market (scarce goods), and inflation will come about anyway. This is the worst kind of inflation because prices rise as wages are decreasing.

    We don't make anything here anymore, and the Chinese are done with giving us credit. The ships just aren't bringing many goods from China, and U.S. businesses are going through their existing inventory just hoping to pay the bills. I think what we're going to see is that inventories will drop off, and then businesses won't have the money/ credit to replenish their inventories.

    Going to be some interesting times.
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  •  
    Oct 31 09:22 PM
    Paul article has a very insightful analysis of the weak spots that caused the Depression and the current crisis. On the basis of logic, one must admit that we cannot rule out Depression II. Common sense says Depression II is unlikely but as Paul's aricle says this doesn't mean impossible.
    Reply | Link to Comment
  •  
    Oct 31 09:35 PM
    Here's an insight: An unfettered free market would quickly adapt to changing economic circumstances but we don't have that do we?
    Instead, we have the Fed, the Treasury and innumerable other government agencies responding to innumerable special interest groups causing innumerable problems.

    And we have the hubris to think we can retain a dishonest banking system due to our cleverness. I suggest prayer.
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  •  
    Oct 31 10:42 PM
    I have been working in engineering for about 15 years here in silicon valley.My observation is that executives have squeezed every last ounce of profit from companies by doing stuff over seas. The idea being we can juice profits now and the heel with the future. Kinda like the angelo mozillo model or the high profit hummer model by detroit. I think the short sightedness has finally come homw to roost. first manafacturing, then call centers, then engineering have gone overseas. I have racked my brain for years trying to figure out how we could sustain this. I think with the advent of the internet, education of people around the world we have come to a major turning point. We need to refocus and retrench for a while the global economy gets balanced. when our wages come down a bit we can start doing a little more here to compete.
    Reply | Link to Comment
  •  
    Oct 31 11:14 PM
    the reason we can even logically discuss whether is could be a depression or not is because of the opacity. we cannot quantify or qualify many negative factors - identical to the concerns of Y2K. this is the fault of the regulators and our capitalistic system which does not force complete disclosure of transactions which cross interstate lines.

    but just because Y2K was a flash in the pan, does not make this a flash in the pan. i doubt whether it could be worse then the pessimists view, but it is obvious it is having an impact - and the economic indicators still point negatively. we are in the middle of a major economic event. defensive tactics are in order.
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  •  
    Nov 01 12:44 AM
    Global trade is very temporarily frozen because of the credit contraction. Once the credit starts flowing, businesses in all countries will march forth in true capitalist form to buy and sell based on their own best interest.

    During the Great Depression, protectionism was mandated from the highest levels of government by tariffs to protect local producers. We have nothing like that now. In fact, major economies are coordinating efforts to avoid just that scenario. Give us credit for learning from some of the mistakes of the past.

    This is a global contraction, nothing more. Just today the US produced it's first negative GDP figure of this cycle, yet the media have been screaming "recession" for over a year now. China is still growing at almost 10%, Brazil at 6%. The world ecomomies are slowing, but not dissappearing. Bubbles burst, but life goes on. The world still needs goods and services, and the US is still best prepared to provide them.

    Dan
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  •  
    Nov 01 01:58 AM
    the media sells us only fear and sex, nothing else of value.
    There are huge differences between 1930s and current crisis.
    There are many safety nets which did not exist in the 30s.
    Global trade is well and alive.
    These crisis are a necessity. They flush out the excesses and we will come out of it a much better nation.
    People still need to eat, to have a roof on their head, to be entertained and life will go on.
    US has huge amount of waste, from our gas guzzlers to amount of junk mail we produce to packaging our products and buying stuff we do not need.
    New industries are being created (alt fuel tech, bio tech, etc. ) which will be the industries of the future. The US leads in all these industries.
    Empires do not fall this fast. It takes couple of centuries and the 21st century is still the US century.
    Reply | Link to Comment
  •  
    Nov 01 04:35 AM
    ...
    yeah I feel a ton better. I'm going to sleep now. thanx for the help.
    Reply | Link to Comment
  •  
    Nov 01 06:35 AM
    Good points but I don't think that's what's happening. Rather, no one is going broke and no bad bank has to pay the poper so basically there still remains no regulation, no hazard to reclessness, and no solution to the massive hidden losses bad financial institutions have created. And now you have a government that's overleveraged, leveraging even more to prevent a much needed economic deleveraging to purge bad risky business practices. This is not economics or capitalism. This is crony socialism.
    Reply | Link to Comment
  •  
    Nov 01 08:20 AM
    Gee guys, can you just pull up a chart for the last 10 years and look at the trends. I did that for my portfolio. Wow, you either have those stocks that were depressed in 1999 and are trending up or those that have fallen off the edge and have not recovered (look at GE). I think we may be in the 14 year bear market cycle that started in the lae 90s and will continue into the early teens. If we are not and we do go off the edge.....buy guns, ammo, canned goods and learn to farm cause life the way we know it isn't going to be anymore. BTW gold isn't worth much if you can't find a buyer.
    Reply | Link to Comment
  •  
    Nov 01 09:29 AM
    The downturn will not end until we begin to do something to fix it. It will not fix itself. MarketLost has commented on things that we have now that will safeguard us. I'm thinking he forgot to mention the huge debt and trade deficit we have now. Also, as Markmc2000 has mentioned and MarketLost left out, we no longer have our manufacturing to pull us up by the bootstraps. The ruling elite (central bankers) have sucked the working class dry. Now someone please tell me how the feds/treasury throwing fiat money (losing value fast) is going to solve our problem. Has everyone forgotten that our economy has become 70% dependent on what we spend? I, personally, will not live to see the United States humming again.
    Reply | Link to Comment
  •  
    Nov 01 10:27 AM
    tony Palermo: "Global trade is well and alive. " Have you checked out the Baltic Dry Index lately?......

    rsinvestor: "Global trade is very temporarily frozen because of the credit contraction. Once the credit starts flowing, businesses in all countries will march forth in true capitalist form to buy and sell based on their own best interest." Probably right, but when money does start circulating properly again you'd better prey hard that the central banks can rein in the monetary base they've been busy exploding. If they can't (or won't), monetary inflation is inevitable.
    Reply | Link to Comment
  •  
    Nov 01 10:39 AM
    It is another economic cycle. The prepared will come out better, the ill-prepared will come out worse. If you have a job, at least six months of income in savings, and no credit card debt - I'd put you the prepared category.
    Reply | Link to Comment
  •  
    Nov 01 12:21 PM
    The jobs are the key. The outsourcing has emasculated the US. Young people who should be engineers building the future got caught up in the MBA trap and engineered CDO's etc.

    The next president may well be the LAST PRESIDENT of the US. People don't really know what they are buying. And buyers remorse will be a terible thing.

    If banks are only going to loan money to people who can pay it back we are in for a bad time. A house mortgage should be no more than 2 times an person's annual salary. So figure out that means in your neighborhood.

    Incomes are not going up and have not for years. Many are underemployed or havae given up looking for work. The day traders and speculators have ruined the markets.
    Reply | Link to Comment
  •  
    Nov 01 12:38 PM
    So if China stops sending us stuff, cuts off our credit, what happens next? Their economy ceases to grow and they go back to sustenance farming, maybe have a revolution, etc.

    Not bloody likely.
    Reply | Link to Comment
  •  
    Nov 01 02:11 PM
    who cares anymore? not me.
    Reply | Link to Comment
  •  
    Nov 01 02:14 PM
    who cares not me. china is an independent nation they can do as they like. if they stop sending us stuff we'll adapt and innovate.
    Reply | Link to Comment
  •  
    Nov 01 03:23 PM
    bricki,

    cant' they dump that stuff in a volcano?
    Reply | Link to Comment
  •  
    Nov 01 04:23 PM
    dump what stuff?
    Reply | Link to Comment
  •  
    Nov 01 04:28 PM
    it depends on if your dumping the products... or the manufactoring facilities of the products.
    ...
    if your retooling the whole manufactoring facilitiy then you can control the amount of the products produced. no need to dump extra products if no waste is made.
    Reply | Link to Comment
  •  
    Nov 01 04:30 PM
    it is sorta like choosing a response, and then choosing a strength of a response. - or just resetting the scale back to: -1, 0, 1.
    Reply | Link to Comment
  •  
    Nov 01 06:09 PM
    late dinner that makes mor sense now.
    Reply | Link to Comment
  •  
    Nov 01 08:08 PM
    We have stepped into the unknown, into a new paradigm and there is no going back!
    There are those who say, if it’s not broken, why fix it!
    Well, the current system is irreparably broken and if the status quo remains, then the global society will collapse.
    In looking for some foresight into possible futures, we first need to get some background on how we got here and where here is?
    This event had its origins in the population explosion (commonly referred to as the Baby boomer generation), which started as the Great Depression was ending.
    With a few relatively minor interruptions, the period 1945 to 2005 was the greatest Global economic BOOM in history.
    In particular, the period 1995-2005 experienced massive growth, driven by the Peak earning and spending capacity of US & other Baby Boomer consumers.
    In addition, around the same time, technology drove massive gains in productivity, leverage multiplied and interest rates in the US remained artificially low, for far too long, following the events of 9/11.
    This was a perfect storm, for making money.

    Inevitably, GREED followed, sub-prime (NINJA) mortgages flowed, on the assumption that property values would continue to escalate, the party would go on forever and leverage went into orbit.
    However, around 2005, the Baby Boomer BOOM broke and the Supply & Demand basics went into reverse, as did US & Global housing prices.
    Also, around 2005, Murphy’s Law also came to play, with Oil production Peaking and with demand exploding internationally, Oil prices burnt thru the roof.
    So, we now see Supply & Demand constraints, the de-leveraging of markets, a Global population set to age, at first, then decrease over time and looming problems relevant to Climate Change and Food production.
    And, with Debt levels already at historical highs and past fixes, either not able to be used or possibly set to cause more harm, than help, we really are between a Rock & a Hard place!
    Now, expectations build of a slowing economic future, as reflected in stock markets and oil prices, next comes the reality.
    Now, the perfect storm is reappearing, this time it is a Cat 5 in financial demolition!
    Where do we go from here?

    The truth is, I do not have any magic wand solutions and nor does anyone else.
    The truth is, there is no pot of gold at the end of the Kansas rainbow.
    The truth is, things are going to be tough, for quite some time.
    Had corrective decisions been made earlier, then it may have been possible to reduce some of the worst side effects, regrettably, that did not happen.
    Regrettably, if we opt for a better now, then future generations will pay for our mistakes and indulgence.
    That reasoning is not acceptable and can not succeed!
    As we look to the future, the effects of the Baby Boomer Bust increase in severity. Health and Social Security costs increase dramatically and Demand continues to fall, first as Boomer retirement numbers increase and then as Boomers leave us in increasing numbers.
    As we look to the future, we need to look thru different eyes, thru different thought processes.
    The days of Smoke & Mirrors, of Shock & Awe, of the Desire to Acquire & Retain Power, of Self interest, at the expense of Societal interest, must end.
    There is an overriding need for a change in human psychology, in order for humanity to have a future.
    Can we make those changes, the answer is YES!
    Will the required changes be made?
    The answers will come on these boards and others, in other forums, in politics, in business and the answers will need to come quickly.
    Good luck & watch the Debt!

    Reply | Link to Comment
  •  
    Nov 01 08:27 PM
    perceptionsnow,

    The folks at lewrockwell.com, mises.org, and Ron Paul have been predicting this mess. Who caused it is simple: the government backed fractional reserve banking cartel headed by the Fed. What caused it was keeping interest rates below what the market would have set.

    It turns out that one should not trifle with Mother Nature's interest rates.
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  •  
    Nov 01 09:10 PM
    "Things Could Be Worse..."

    Perhaps.

    That's why it might be good idea get matters settled peacefully?


    www.prosefights.org/th...
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  •  
    Nov 01 09:35 PM
    Is that perceptions now - or perception snow?
    Reply | Link to Comment
  •  
    Nov 02 12:38 AM
    Neither private banks nor countries "have to" fail. Insolvency is a technical term that means a bank's balance sheet is in violation of some rule that was made by people. The people who make the rules are not omniscient and the rules are not necessarily perfect. The rules are certainly not written in stone and they are not works of nature but works of people.

    The G10, G20 central banking system is a banking system for countries just like private banks work within countries. Rules can be relaxed or changed as circumstances warrant, both nationally and internationally. Neither a private bank nor your central bank "has to" be declared insolvent, especially if insolvency is not in the interest of your country.

    Mark-to-market was one such rule for investment banks. Relaxation was deemed to be warranted and has been done. This restored the asset side of these banks' balance sheet which had been decimated by plummeting asset values for which there was no actual market, no buyers, so how do you "mark to market" when there isn't one?

    A bank's balance sheet is simple:

    A = K + L

    Assets = capital + liabilities

    The assets are the loans the bank has made, money that people owe the bank. The capital is common and preferred shares and long term debentures held by the bank. Liabilities are mainly customers' deposits, the balances in your savings and checking accounts.

    When a new loan is made a new deposit is credited to the borrower's account, so you add $1000 to the asset side and $1000 to the liability side and the sheet stays balanced.

    Asset to capital ratios can be set by legislation, but the practice of central bankers is that these are set by volatility measurements. In a low volatility environment you can take more risk and up the ratio to 20:1, for e.g. With high volatility you consolidate your position at 10:1; you get rid of risky loans and keep the good ones. Right now for commercial banks I think the ratio is either 12:1 or 10:1.

    If you're fully extended in a 12:1 environment, and your capital suddenly loses 1/3 of its market valuation, you would need to either add capital or dump assets to rebalance your balance sheet. Banks are doing both, selling bad mortgages to Treasury and Treasury is buying bank stock.

    When bank stocks dropped along with the rest of the stock market their asset to capital ratios climbed above the "concensus line". To get back under the line banks created new preferred shares and sold them to Treasury to increase their capital, to "restore their balance sheets". That money is locked up in those shares and will not circulate.

    Transferring ownership of bad mortgages from banks to Treasury also doesn't affect the money supply. Banks reduce their asset side by the amount of the transferred mortgages, and this also helps restore their balance sheet after their capital declined.

    The mortgage money entered the economy when the real estate deal went through. It doesn't matter who the mortgage payments will be made to, banks or Treasury, or not made to. Whatever effect that mortgage money will have has already been done when it first entered the economy. You can't just reach in and get it back out because the person who borrowed the money doesn't have it anymore and the person who has the money now "owns" it by selling the borrower a house.

    Now that their asset to capital ratios are back in line the banks are in a position to acquire new assets, which means make new loans. But Americans are not lining up to take out new loans and increase their personal debt. Everyone is paying down debt, which reduces assets on one side and deposits on the other side of bank balance sheets. So the money supply is contracting as debt is paid down. This is deflationary.

    The G10, G20 banking system for countries also has rules and lines drawn by people. Even if a country falls into technical default of one or more of these rules, that doesn't mean the world's central bankers "have to" declare that country bankrupt and liquidate its assets, which means selling off your country at firesale prices to restore your central bank's balance sheet.

    Banking and money are essentially an accounting system. No country, and the world as a whole, needs to be held hostage by its accountants, by a sheet of paper with numbers on it.

    As a country you make rules that work for you, for your people, for your real physical economy. If the central bankers say you are in violation of "their" rules you, who has legislative power over your central bank, arrange to relax the rules rather than give up your country.

    Central bankers' rules are designed to enable smooth global trade among many countries who use different currencies. International trade and investment decisions require a transparent national and international financial system, and the G10 system attempts to provide this. But in extraordinary circumstances it can be in the interest of G10 countries to meet and decide rule relaxations. This is better than national and international bankruptcy.

    We wouldn't really need G10 financial coordination so badly if our economy did not depend on imports of economic essentials like oil and manufactures. Import dependence is a very risky business. Yes, everyone can become much richer by specializing and trading, but at the expense of this extreme vulnerability of economic collapse if you can't get enough oil to fuel your transportation fleet, or you can't buy critical commodities like steel.

    I think there is going to be some large scale restructuring of economies over the next few years. Now might be a good time to rethink the wisdom of allowing yourself to be import dependent. Steel may cost more if union labor produces it in the USA rather than cheap Asian labor, and higher costs for essential commodities reduces the amount of money you have to spend on everything else, but the money stays in America and is spent into the economy so the net result is probably a shift in the kinds of things you produce (stuff that wealthy steelworkers want to buy)but not an overall drop in economic activity.
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  •  
    Nov 02 12:56 AM
    About time to haul those errant leaders and CEOs to court and put them behind bars.
    Have laws to confiscate all their ill-g