Paul McCulley of PIMCO made a few comments back in March which caught my attention. Given how well banks are doing this earnings season, I thought it relevant to quote him here. The essence of his remarks was this:
- Deleveraging is a self-reinforcing vicious cycle brought upon by the Paradox of Thrift. In order to stop this downward deflationary spiral, we need the political will to socialize losses from which privatized gains have already been made. While this socialization of losses is unseemly and maddening, it is wholly necessary.
Personally, I don’t buy it. McCulley is talking his own book. It is a self-serving statement. Nationalization or stuffing bondholders are equally good ways of stopping this spiral. Nevertheless, here is what he had to say:
The present crisis, in textbook terms, is a case of the dual, mutually reinforcing maladies of the Paradox of Thrift and the Paradox of Leverage. In many respects, they are the same disease: what is rational at the individual citizen or firm level, notably to increase savings out of income or to delever balance sheets, becomes irrational at the community level.
If everybody seeks to increase their savings by consuming less of their incomes, they will collectively fail, because consumption drives production which drives income, the fountain from which savings flow. Likewise, if everybody seeks to delever by selling assets and paying down debt, or by selling equity in themselves, they can’t, as the market for both assets and equity will go offer-only, no bid.
Both of these maladies require that the sovereign go the other way, (1) dis-saving with even more passion than the private sector is attempting to increase savings, thereby maintaining nominal aggregate demand and thus, nominal national income; and (2) becoming the bid side for the levered private sector’s offer-only markets for assets and equity. It really is that simple, at least on paper, as Keynes and Minsky wisely taught.
The problem with the desirable textbook solution is that it suffers from constrained political feasibility. Actually, dealing with the Paradox of Thrift is practically much easier, even if less critically important, than dealing with the Paradox of Deleveraging. While Congress may belly-ache and wrangle incessantly about the precise size and composition of fiscal stimulus packages, it is safe to say that but for a few wing nuts, we are all Keynesians now in the matter of cracking the Paradox of Thrift.
In contrast there is limited political consensus for using the sovereign’s balance sheet and good credit to break the Paradox of Deleveraging. Put differently, while we may all now be Keynesians, we are not all Minskyians. What is ineluctably needed involves socializing the losses of a banking system – both conventional banking and shadow banking – after the spectacular winnings of the Forward Minsky Journey were privatized. It simply doesn’t sit well politically. In fact, it stinks to high heaven.
Thus, to quote my partner Mohamed El-Erian, we must contemplate a scenario in which the economically desirable solution is not politically feasible, while that which is politically feasible may not necessarily be economically desirable. Last Sunday, on 60 Minutes, Ben Bernanke addressed this nasty reality directly when he said that perhaps the most severe risk we face is the lack of political will.
In my view, the Geithner-Summers-Bernanke bailouts are very much a case of socializing the losses, as bank earnings this quarter attest. So McCulley is getting his wish. Let’s see whether this method of dealing with the crisis has longer-term benefits.
The Thinking Behind the Stimulus and Bailout Programs – Paul McCulley