It feels eerily familiar: Stocks are plummeting. The economy is slowing. Politicians are scrambling to find solutions but are mired in disagreement.
Many Americans are wondering whether they are in for a repeat of the financial crisis of 2008.
No, this is not a repeat of 2008. This time will be worse. Why? Because:
1. All of the problems we had in 2008 are still with us in 2011. We have done absolutely nothing to actually address the underlying problems that led to the crash of 2008. All of the same people are still in charge (I'm referring here to all the Goldman Sachs alums running the treasury). All of the same policies are still in place. All we have done is throw a few hundred billion dollars at the economy, which has been enough to stave off complete catastrophe for the past three years.
2. We have used up what little margin we had. Back in 2008 we had money (well, to be more precise, we could borrow money) to throw at the problem. Finding more money to borrow to throw at the problem to stave off catastrophe this time will be much harder, and in the current political climate, probably impossible.
The result, almost certainly, will be at best a double-dip recession. And we might be looking at Great Depression, the sequel depending on how long it takes for the American People to come to their senses and abandon the tea party.
I've said this before, I'll say it again: the fundamental problem with the United States of America is that at all levels of society we have lost sight of the difference between money and wealth. At every stratum, from the very bottom to the very top, you can find overwhelming majorities of people who believe that having a lot of money is the same thing as being rich. And what these people are about to find out the hard way, like they did in the Weimar Republic, is that it isn't true.
The parallels between what is happening today and what happened in the world in the 1920's and 30's is really getting very eerie indeed, including all of the people who are saying that it can't get that bad. It might not. But it can. And if we don't do something about it, it will.
You're right, that the current US situation has a lot in common with the Great Depression.
ReplyDeleteBut you mention the Weimar Republic as well. Yet those were pretty much opposite problems. The Weimar Republic printed too much paper money, and had hyperinflation. In contrast, the US Great Depression (and our current economic crisis) is one of deflation -- which, ironically, could be fixed by printing more money. (The fix to the Great Depression was to get off the gold standard, and thus allow the money supply to greatly expand.)
The Great Depression, the Weimar Republic, and the current US economy are all macroeconomic crises. But they're not all the same kind of crisis.
> Yet those were pretty much opposite problems
ReplyDeleteNo, they were the same problem, just opposite solutions. The underlying problem was a cessation of the creation of wealth. In Germany, that was accompanied by an increase in the production of money, and in the U.S. it was not. But the fundamental problem (I claim) -- conflating wealth and money -- was the same in both cases, and it's the same now.
Whether this turns into GD2 or hyperinflation remains to be seen. But unless something changes radically it will be one or the other.
I couldn't disagree more, but we're probably not going to resolve it here in the comments.
ReplyDeleteYes, there was a "cessation in the creation of wealth". But how is that an underlying problem? You seem to be confusing cause and effect. US unemployment in the 1930's was at 20%. Clearly, those people just stopped working, stopped producing wealth. But why? Because they "conflated wealth and money"? How does that explain why they were idle for years instead of gainfully employed?
I also find it odd that you think the only possible futures are either deflation, or hyperinflation. What prevents the happy medium of stable 2-4% inflation? In fact, what do you think determines the rate of inflation anyway? Surely it's about the balance between the money supply and the wealth created (GDP). And doesn't the Fed control the money supply? Can't they choose what level of inflation we'll have? Why do you think it's not possible to choose 2-4% stable inflation?
I have to admit, I don't understand your theory of macroeconomics. Yes, yes, you think people played games with "money" instead of "wealth": subprime mortgages, bailouts, etc. But why do we have 10% unemployment, which we haven't seen in decades? What about this confusion prevents those people from getting a job, today?
> What prevents the happy medium of stable 2-4% inflation?
ReplyDeleteWell, at the moment, the policy makers at the Fed.
But what you were really asking is: why must it be a choice between depression and hyperinflation. It doesn't in general. But in this case it is because we have abandoned much of our productive and innovative capacity in favor of a military-industrial complex, a prison-industrial complex, a patent-and-copyright-industrial complex, a financial-indsutrial complex, and various ultra-conservative ideologies. Instead of making cars and washing machines and computers and spacecraft and roads and bridges and sewers we are instead fighting wars on terrorism and drugs and arguing over whether to teach creationism in schools.
Inflation is not a magic bullet. It is just a tax on cash that encourages people to spend money instead of hoarding it. But spending money in and of itself doesn't solve anything. At the end of the day your wealth is measured not by what you've spent, but by what you've spent it on.
> Clearly, those people just stopped working, stopped producing wealth. But why? Because they "conflated wealth and money"?
No, not *them* (the workers), the people who were running the show, the bankers and the politicians. Just like today.
> I don't understand your theory of macroeconomics.
Good to know. I'll spell it out for you in a future post.
Can't wait for your econ theory post :-)
ReplyDeleteYou said: "Inflation is not a magic bullet. It is just a tax on cash".
Now, now. Inflation may be a tax, but it's not just a tax. It appears that you don't understand how (low stable inflation) could do any magic. So let me try to explain.
Surely you understand about the magic of free market capitalism and the invisible hand. Without any central planning, somehow my local supermarket always has fresh bananas available for me to purchase. Now, the price may go up and down, but the quantity is there. In fact, pricing changes are the tool that free markets use, in order to balance supply and demand. In other economic systems (e.g. communism) you typically find the wrong quantities, and supply and demand being out of balance. So you get products out of stock, and long lines of people waiting to buy something. In capitalist economies, the store shelves are always full (at some price).
So what about labor? The labor market is a market, just like any other. Why is there ever unemployment? Why doesn't the "market price" of labor go up and down, in order to balance the quantity of supply and demand, like it does for bananas?
One reason is structural: there needs to be a pool of available workers, so that when a company needs to hire more, it can find some. And people change cities, take some time to settle in, and choose new employment, etc. This "natural rate" appears to be 3-5%.
Why sustained 10% unemployment? This is what you must explain. You don't have sustained (multiyear) over or under quantities of bananas.
The difference is that wages are sticky. People sign long-term contracts at given rates, and are loath to take pay cuts. As a result, when economic conditions lower the value of labor, instead of the price of labor dropping (in order to maintain full employment), what happens instead is that some people get fired, and others keep lucky too-high-paying jobs. And you have sustained unemployment.
And finally we return to inflation. Mild, stable inflation takes some economic pressure off of sticky wages. It allows them to continue to receive their contracted nominal wages, while their real compensation declines.
The past few years of 0% inflation is what has directly caused the 10% unemployment, and the resulting lack of wealth creation. People are idle, because the current price of labor is too high, and the labor market is too sticky to allow it to drop quickly by itself.
That's why inflation is a magic bullet. It has nothing to do with having people spend cash instead of saving it. It has to do with putting the 5% unnecessarily unemployed back to work, creating wealth.
The tendency of inflation to ratchet down real wages and hence increase spending on labor (and hence employment) is just a special case of the tendency of inflation to encourage short-term spending in general. Nothing guarantees that inflationary pressure to spend will result in increased spending on labor. It could just result in, say, a runup in commodity prices. That is what we saw in the 1970s. Yes, the situation there was complicated by the oil embargo, but it's still a data point that proves that high inflation and high unemployment can co-exist. The situation now is complicated by the various debt crises around the world, but regardless, nothing guarantees that inflation will reduce unemployment. I predict it won't in this situation, for reasons that I will elaborate on in a later post. Nonetheless, I would be happy to be proven wrong about that, and it's certainly an experiment worth trying.
ReplyDeleteAre you serious about that "Depression 2011" claim?
ReplyDeleteFrom what I see it's a minor correction and the last time when you see DOW/S&P500 at such low points ever.
The economy is clearly recovering, unemployment started to go down.
Government gridlock helps.
Real estate bubble almost fully deflated.
Technologies are on the rise (as usual).
> Are you serious about that "Depression 2011" claim?
ReplyDeleteYes. (Though with the caveat that I could be wrong, and I hope I am.)
>The economy is clearly recovering, unemployment started to go down.
Yes. It was recovering in 1937 too. Then the government tightened up on money and everything crashed again. Just like it's starting to do this time around.
> Government gridlock helps.
Not in this case. The steady-state trajectory is towards unsustainable debt and ultimately national bankruptcy. We're not there yet, but that's the direction we're currently headed.
>> Are you serious about that "Depression 2011" claim?
ReplyDelete> Yes.
>> The economy is clearly recovering, unemployment started to go down.
> Yes. It was recovering in 1937 too. Then the government tightened up on money and everything crashed again. Just like it's starting to do this time around.
Wow. I can't believe that I agree completely with Ron's responses. Who are you, and what have you done with Ron? :-)
Ron wrote (some time ago): "Inflation is not a magic bullet. It is just a tax on cash that encourages people to spend money instead of hoarding it. But spending money in and of itself doesn't solve anything."
ReplyDeleteWay back in 1998, Paul Krugman wrote a very accessible article about D.C. baby sitting, and Japan. (It's a shame that Krugman didn't give this same argument as strongly in 2008, when the US economy started experiencing the same thing.)
I'm curious if the baby-sitting example changes your opinion at all, about the merits of (mild) inflation.