The Great Experiment
Have we seen this movie before? It certainly sounds familiar.
Once again, the government steps in to bail out a financial institution and Mr. Market takes kindly to the idea. Initially. But then reality sets in and the process starts anew. Perhaps it'll be a true sign of a bottom when the Feds engineer a bailout and the market tanks on the news.
But not yet. The latest installment of rescue centers on the once mighty Citigroup (C). Meanwhile, the stock market is soaring, as is Citi's stock, as of mid-morning, at least.
A giant among giants, this behemoth of financial behemoths surely fits the bill as too big to fail. If such a thing exists as a financial institution that must be saved at any cost, Citigroup looks like the poster boy for this idea.
Total assets for Citigroup were a bit more than $2 trillion in September. For those who like to keep score, that's roughly 14% of the annualized value of U.S. GDP for this year's third quarter.
The days of pulling another Lehman and letting a big bank fail are history. Better to bail out more rather than less and deal with the consequences later. The grand strategy here is that if the government bails out enough banks (and perhaps an auto company or two) while spitting out stimulus in various forms as far as the eye can see, the system will correct itself, or at least stop bleeding. At a time when deflationary risks are rising, this plan is considered prudent and timely by a growing swath of economists and voices from the peanut gallery, including yours truly. The risk of an even deeper implosion of prices and confidence must be avoided lest the vortex of deflation pull everything down the rat hole. Preventing deflation is the last battle in this horror film because once the big "D" takes hold, in sentiment and prices, the challenge becomes much, much tougher.
The problem is that no one's really quite sure if deflation with a big "D" is on our doorstep. Quite possibly it is, or so one could reason after witnessing consumer and wholesale prices fall last month on a scale unmatched since the government began keeping tabs on such things in the late-1940s. Waiting for definitive signs risks letting the monster out of the cage. Decisions, decisions. Nonetheless, there's a strong case for assuming deflation is coming. If we're wrong, we'll have more inflation on our hands than we otherwise would. But the world knows how to fight inflation, even if the political will is sometimes lacking. Attacking deflation, on the other, is another story.
Any way you slice it, there's bound to be more than a little disappointment and finger pointing in the months and years ahead. Indeed, no one should think that the necessary but risky strategy of preventing deflation is destined to end in triumph, or quick results. The stakes are high, in part because the government's moving quickly toward betting the house on a fiscal/monetary solution. On the opposing shore is the unwinding of excess, some of which has been decades in the making. When an unstoppable force meets government printing presses, the outcome isn't entirely clear.
All the more so if the world is looking for signs, one way or the other, by next Wednesday. It's difficult to gauge expectations as we run from one crisis to another. But this much is clear: the financial and economic problems will take time -- years -- to solve, and to the extent that the crowd thinks otherwise, the seeds of disenchantment have been planted.
The U.S. economy is sick, and getting sicker. Europe has the disease and Asia is at risk of contracting the same, albeit in a milder form. Looking back on the past five decades offers no clue for what may be coming. Growth has been a constant, according to GDP numbers from economist Angus Maddison, emeritus professor, University of Groningen (Netherlands). As the chart below shows, outright contraction is unknown in the postwar era.
Fifty years is a long time, virtually an eternity for mere mortals studying the past in search of clues about the future. It's all too easy to look at this track record and conclude that real declines in global GDP aren't possible, or are so unlikely as to be unworthy of considering. The IMF forecast, for one, still imagines more of the same with next year's estimate for real global GDP rising by a respectable if not impressive 2.4%.
Of course, the crowd used to think in persistent-growth terms for housing prices, and how they never fall on a year-over-year basis. Oh, sure, that happened in the Great Depression, but such episodes were dismissed as a thing from the past.
Perhaps it's time to consider the unthinkable. We've all received a crash course in just that over the last few months. But has the education so far been sufficient? Or do we still need to spend more time studying?
There are many dangers stalking the global economy, and at the top of the list is the assumption that the governments of the world can spend their way out of the slump on our collective doorstep. In the U.S. alone, the government now stands at the ready to spend $7 trillion--yes trillion with a "t"--to bring financial salvation to the system, according to Bloomberg News. That's the equivalent of three-and-a-half Citigroups, or half the U.S. economy. Scale no longer looks to be a stumbling block.
By spending enough money, governments are likely to keep inflation-adjusted global GDP floating somewhere above zero, if only slightly. That would still bring a fair amount of pain and repricing, but embedded in the expectation is the notion that a floor can be built under the crisis.
Perhaps, although at some point one might wonder if the cure will be worse than the disease. There are some awkward questions that will accompany the mother of all spending sprees now underway. First up: Is there some point at which additional government spending becomes counterproductive because a) it encourages future inflation on a scale that will be excessively burdensome; and/or b) the prospect of the government owning ever-larger chunks of the economy risks institutionalizing mediocrity or worse in the economy?
There are two great episodes of deflation in modern history, and each continues to raise questions about the associated lessons. Yes, spending is the only hope of sidestepping the beast, and if that means artificially engineered demand from the government, so be it. But it's not clear that the strategy leads to happy results all around. Meantime, there's more than one way to fight deflation.
That's not to say we shouldn't try to spend our way out of a deflationary trap. We should. We must. And we will. The risk is real this time, unlike the previous worries over deflation in 2001-2003. But the details of how we engage our anti-deflationary war may matter as much, if not more, as the decision to wage the war in the first place.
The dismal science has precious little experience with fighting deflation and so we must recognize that we may soon be caught up in an economic experiment on a scale that has little or no precedent. By all means, let's fight this war ferociously. But it also needs to be fought intelligently. What exactly do we mean by "intelligently"? We can't say for sure. No one can, and therein lies the greatest risk.
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This article has 14 comments:
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eddy shore
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6 Comments
Nov 24 02:26 PM-
opti
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1 Comment
Nov 24 02:32 PMwe all know that true inflation is so much higher than the government reports.
just go to the supermarket and buy some milk, or drive on a road and check what the toll costs now compared to 10 years ago. or look at the increase cost of your real estate taxes.
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DaveW
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230 Comments
Nov 24 02:34 PM-
DaveW
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230 Comments
Nov 24 02:38 PM-
Smarty_Pants
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1124 Comments
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Nov 24 02:59 PMNo. There's this process called liquidation. It doesn't sidestep the problem, it ends the problem. "Sidestepping&quo... implies that the problem is still around and you're only trying to avoid dealing with it.
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vanyali
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12 Comments
Nov 24 03:45 PMNow, the popping of the bubble has lead to a perceived risk of deflation which the government should respond to by drastically increasing the money supply . . . . . . and then spending all the new money?
Was the problem in 2001 really that the government didn't spend all the new money it created itself? Something about that doesn't really click with me.
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moonbat1775
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707 Comments
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Nov 24 03:46 PMSince this is a "balance sheet" depression, why not takes steps to clear it? How about a general amnesty on consumer debt? The consumers were discouraged from saving by artificially low interest rates for the sake of business. The interest rates were suppressed by fractional reserve banking and the Fed. Along with the general amnesty, both should be abolished to prevent a recurrence of this problem. It turns out that investment capital must come savers or else who will buy the products of the investments? Mises figured this out long ago, I reckon.
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Robert Nabloid
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Nov 24 08:16 PMSo to save the economy, you reckon they better do the bailouts, though there are risks involved. (I must give you credit, at least you realize there are risks involved!) Now, the bailouts will come in the from of USD's... What if the USD slumped or crashed as a result? How can you print your way out of this if the dollar crashes due to all the bailouts and money creation?
Everything in the US economy is built upon debt. As soon as anything bad happens, everyone rushes to manipulate the currency and and encourage others to take on more debt dollars and spend what they have not yet earned. This manipulation and way of thinking helped create our present reality.
Inflation is ultimately part of the problem that got us here, not the solution - though it may temporarily solve this crisis and reduces the negatives involved with taking on more debt, isn't a very foreword thinking "solution".
When we consider printing more money a "solution" I'd tend to think that we are headed for worse problems. This won't solve the underlying economic problem and doesn't even begin to address them: The economy is unsustainable and completely reliant, in it's present form, on debt and the USD maintaining status of the world's reserve currency. It doesn't solve the problem with our actual economic output or the trade balance, nor the problems with free trade and globalization.
Globalization is a noble goal when done properly, but we can't just issue free trade agreements to nations that don't reciprocate by allowing us free access to their markets - and even if they do allow us free access - if we must follow a completely different set of rules, the trade agreement will not work out fairly. We can't give companies in China/others free access to our markets and expect American companies to compete when the American companies must pay minimum wages that are much higher, benefits, follow strict environmental regulations, etc, etc, etc. Why can their companies sell items here without following OUR government rules that we must follow to sell here?
While I'd love Free Trade, it first must be Fair. We have initiated a race to the bottom by improperly structuring this. Fair Trade must come first, which will eventually help lead toward Free Trade with all.
The economy is unsustainable, even if they ward this present crisis off for the time being with rampant inflation. After the present system continues to show signs of problems, they will come to us with a solution... world government. One set of laws. One set of regulations. One currency. Unfortunately, I don't see that as a solution, but of an even bigger problem.
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Smarty_Pants
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1124 Comments
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Nov 24 08:51 PMI respectively disagree. The differences you note are what make progress possible. The division of labor allows the parties with competitive advantages in one area supply others who then apply the advantages they have in another area to supply still others. Whoever can meet a market need most efficiently should 'win' so that a minimum of resources are utilized in the effort.
It is possible to compete with 'cheap' labor. America did so for some time by becoming more productive than foreigners. One American worker at $30 could produce more than 3 foreign workers at $10 via automation advances. If we can't do that any more then we should be looking for other areas where we have an advantage over foreigners. This is the natural progression of economics.
We must find the areas where we surpass the rest of the world in productivity and compete there. Any gub'mint attempt to "level the playing field" only serves to hurt the American consumer by forcing them to pay more than they would otherwise. The gub'mint could be a great help by minimizing the taxation and regulation they impose on our businesses to no effect other than piling on costs.
Our forefathers turned a backwater nation of farmers in 1800 into an economic powerhouse by 1900, not by complaining about whether other countries were 'fair', but by figuring out how to do things better and/or cheaper. We can do the same if we really decide to apply ourselves.
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Robert Nabloid
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Nov 24 09:21 PM"The division of labor allows the parties with competitive advantages in one area supply others who then apply the advantages they have in another area to supply still others. Whoever can meet a market need most efficiently should 'win' so that a minimum of resources are utilized in the effort."
I agree, 100%. The problem is that the "competitive advantage" is NOT having to follow government regulation that others must follow. It has nothing to do with CORE competitiveness at individual companies. Even if Company A is more competitive than Company B, it must be DRAMATICALLY more competitive just to come out even after factoring EXTERNAL factors legislated by the government, for which Company B gets a FREE pass and Company A must follow to a "T".
I'm a free market advocate!!! You're preaching to the choir, I agree with it all, every word of what you said. The government is getting in the way of the free markets. I don't think you really understand what I meant to point out by writing my comment above. The competitive advantage others have against us has nothing to do with their companies actually being more productive (they may or may not be) - it has everything to do with our government giving them an EXTERNAL advantage.
I'd love the free markets to be operating here... I'd love free and open borders, but how can they be free and open if we tie our hands with regulations we must follow and others must not? You are preaching to the choir. If you check, I even have your website in my favourites on my blog links...
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Third Party Guy
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9 Comments
Nov 24 09:36 PM"Our forefathers turned a backwater nation of farmers in 1800 into an economic powerhouse by 1900, not by complaining about whether other countries were 'fair', but by figuring out how to do things better and/or cheaper. We can do the same if we really decide to apply ourselves."
Our forefathers also only supported the federal gub'ment through tariffs and without an income tax. This could still apply if and only if WE were willing to reduce gub'ment programs. Free Trade will never be Fair Trade for American taxpayers.
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Robert Nabloid
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252 Comments
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Nov 24 09:42 PM"Our forefathers turned a backwater nation of farmers in 1800 into an economic powerhouse by 1900, not by complaining about whether other countries were 'fair', but by figuring out how to do things better and/or cheaper. We can do the same if we really decide to apply ourselves."
Even they had some tariffs to enable them to become the powerhouse by 1900. Trust me, I don't want protectionism. But they didn't give other countries an advantage over domestic ones either! I'm 100% free market kind of guy. I just don't understand how we can get efficient enough to compete with others if we tie our hands behind our backs at the same time by actually GIVING them an advantage over us. I don't want to "give" anything to anyone. I think it should all be done based on pure free markets and things would work out much better. That is why I brought up free trade. I want free trade - not government regulation - but governments do regulate and they do so UNEVENLY in which they can inadvertently pick winners and losers.
Yeah, we can we've encouraged ourselves to get rid of those manufacturing jobs and we've moved on to industries we can compete and dominate where we are much more efficient... if that's the case, so be it. I'm just not sure we aren't good enough to compete in some of these industries and I wonder if it is an external advantage granted by our own government to foreign companies. Maybe the advantage is so minimal it is actually negligible? If that is the case, then let me know and please explain it to me. I know, it's convoluted and might not make sense. I'm a bit of a scatter-brain. I am 100% free market advocate. My previous railings on the "Free trade" was to outline the negatives associated with some of our government interventionist practises. I brought it up in an ironic way by pointing out how this isn't working out so well for us.
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zanardm
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42 Comments
Nov 25 12:49 AM-
Asbytec
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230 Comments
Nov 26 07:45 AM"What exactly do we mean by "intelligently&qu... We can't say for sure. No one can, and therein lies the greatest risk." Some one can speculate, though. Eat a little inflation, then kill it with reckless abandon.
"...by fractional reserve banking and the Fed. Along with the general amnesty, both should be abolished to prevent a recurrence of this problem." I concur. This debt is money "experiment" must be shown a failure, every hundred years or so.
"Our forefathers turned a backwater nation of farmers in 1800 into an economic powerhouse by 1900, not by complaining about whether other countries were 'fair', but by figuring out how to do things better and/or cheaper. We can do the same if we really decide to apply ourselves."
Another truth, smarty. Obama seems to plan just such a push.