Chandler: Policy makers are repeating the mistakes of the 1930s
Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman has an alarming note out this morning on economic policy. I take notice because Chandler usually writes in more nuanced and non-apocalyptic tones. For example, he begins:
The risks are asymmetrical. Many of the world’s national economies, in various stages of recovery, are still highly dependent on government support. While it is possible that the combination of aggressive fiscal and monetary policy responses have put the economies on a strong growth path, there remains a much greater risk that as the stimulus is removed the economies stagnate or worse.
Aborted recoveries are rare. They are the exception that proves the rule. Despite the gallons of ink spilled on prognostications of a “double dip” or a “W” shaped bottom, there have only been two in the U.S.—the Great Depression and the early-1980s Reagan-Volcker recession. They seem to be products of a policy error, like removing a splint too early from a broken bone.
However, his latest thematic piece changes course abruptly when he writes:
Nearly all policy makers share two key interests: lay the foundations for a sustainable economic recovery and unwind the emergency facilities and spending. There appeared to have been a consensus, giving more weight to the former than the latter this year. The bond vigilantes have instigated a disruption of that consensus much to the chagrin of the popular will. Indeed, those countries that capitulate the most to the vigilantes are likely to experience the most social push back. Stay tuned.
Ironically, the effect of the bond vigilantes and the social resistance may be similar insofar as the economic impact is negative. Ultimately what is at stake is the how the costs (broadly understood) of the bailouts and stimulus are going to be distributed, not just in terms of classes, but also sectors, industries and countries.
This is taking place along another potent but yet somewhat less personal of a force. Like a victim in a trendy vampire show, the life blood of the two largest economic regions, the US and Europe, is being sucked out.
Money supply, measured by the ECB’s M3 has collapsed. In January 2009 it was growing at a 6% year-over-year pace. By the end of the year it was contracting at a 0.2% pace. It was contracting in both November and December. The next report is due January 25th and even if one is not a monetarist, the situation is worrisome.
It has been lost in the light of the preliminary 5.7% Q1 US GDP, but in the Fed’s statement there appeared what seems like the first official recognition of the ongoing contraction in bank credit. The FOMC implies that this is being offset by improved financial market conditions. We thought so too.
But the capital markets are fickle and given the surge in volatility and the general deterioration of market conditions (should it persist), the risk is that it no longer is sufficient to offset the contraction in bank credit. Even if this is just a normal market correction, it could stall the economies at a crucial time.
The real tragedy is not what is happening in Athens, as painful as the adjustment promises to be. Rather the real Greek tragedy is that we are running quickly, even if not irrevocably yet, into precisely that which we wanted to avoid the most. [emphasis added]
The takeaway here is that we are still in a credit crisis. What is happening in the sovereign debt markets is going to force policy makers to unwind stimulus and accommodation sooner than later. However, doing so risks disaster because signs of recovery are still quite incomplete at this juncture. The evidence comes in both the Fed’s assessment of low credit demand and the ECB’s assessment of outright monetary contraction. You don’t get sustainable GDP growth in a world of contracting monetary aggregates and sluggish credit demand.
The explosive undercurrent of Marc’s comments come where he mentions ‘”how bailouts and stimulus are going to be distributed.” What he seems to suggest is that a premature policy exit puts would put most of the risk burden on specific classes, economic sectors and countries (think: high school graduates, homebuilding, industrial commodities and Spain for example).
This does not seem like a logical outcome given comments from people like Ben Bernanke that we have learned from the Great Depression and now know what needs to be done in a severe financial crisis. But, for now, this is where we’re headed.
Read Chandler’s full piece at BBH’s FX website linked below.
Source
Amor Fati: Moving toward Our Maximum Regret (pdf) – Marc Chandler, BBH Thematic Piece, 05 Feb 2010
Very well written article. I think he’s right. What he doesn’t acknowledge is that the bond market perceives that risk is rising. It is. It is rising because nothing (very little) has been done to remove the unprecedented levels of bad debt from the system. New, good money is not being allowed to replace bad, miss-allocated money. Think of debt like you do technology. Technology companies continuously replace slower technology with faster and smarter technology. If they don’t they will go bankrupt. Bad debt (money) is no different. It must be replaced with good money in order to be productive. The banks, investment houses and our Government are not allowing the markets to replace the bad debt (money). It is the replacement process itself that generates growth, which generates jobs. Out with the Old and In with the New! Opportunity for one is often the result of another’s bad decision
I always thought that the M3 contration is bad when I read it. All gov bailouts and extra credit facilities from the ECB.
“By the end of the year it was contracting at a 0.2% pace. It was contracting in both November and December.”
Shows what the average timespan of Wall Street and Main Street is. Plus all the talk about the Recession. There was a psycology article in the NYTs about that we have a recession in our mind too, and no stimulus and Obama Town Hall meeting can change that. Thats now fact. Americans are saving now and paydown its debt.
http://www.nytimes.com/2010/01/31/business/economy/31view.html
Und dann hab ich noch aus meiner delicious liste das hier;
http://www.spiegel.de/panorama/gesellschaft/0,1518,671590,00.html
Unicef-Kinderstudie: Generation der Pessimisten – SPIEGEL ONLINE – Nachrichten – Panorama
And from http://www.ritholtz.com/blog/2009/12/why-arent-banks-lending-they-are-being-rational/ Why Aren’t Banks Lending? They Are Being Rational | The Big Picture
‘The Battle for the World Economy’ is still under way. What would Keynes NOW do?
You would be pessimistic too if you saw the youth unemployment rate. With the education debt burden, the situation is bleak for this generation.
I am 26, I advised my brother and parents to buy (some) real gold and silver and postpone the purchase of a youngtimer they looked for in December.
I am a realist and pragmatist. Politicians are too busy with day-to-day politics and checking poll numbers and surveys, having no sense of urgency and real meaningful policy. And I am acusing all across the political spectrum.
And then I am acusing the media in the US and EU for populistical headlines for pageviews and no real education. They are the checks and balances, and I am not seeing anything of that.
Too soft on near-term problems. Day-to-Day politics and citing statements (2 pro, 2 contra) is the most convenient journalism/reporting.
Why should I pay for that? I better read you blog (and others) and click on the ads to give something back.
*rant off*
michael, there are only two ways out of this where private sector debt is high: 1. inflation 2. default/foregiveness. There is a third i.e. a soft depression (Japan). However, given how many countries are in dire straits I don’t see that as a likely outcome as it may depend to a degree on exports.
Long story/short, you have to lean toward inflation as a real possibility (hence the gold).
I do not see how one would expect a bankrupt banking system to keep lending money to people who will not be able to pay the loans back. What we need is a massive contraction of unproductive economic activity and a transfer of resources from the managers and owners of failed businesses to those that are better able to deploy them.
As I keep pointing out over and over again, the proper approach was not taken by Hoover/FDR but by Harding. It was because Harding shrunk the size of the federal government, cut taxes, and stepped aside as the market liquidated malivestments that nobody has ever heard of the Great Depression of the 1920s. By letting the system cleanse itself Harding and Mellon set the stage for a strong recovery.
Cut the budget deficit, get government out of the way, it all sounds so
easy. So if the political preference is for the government to deficit spend
less, what other sector is ready and willing to reduce its net saving
position? The reduction in fiscal deficits cannot occur without an offsetting
reduction in domestic private or foreign net saving (the latter being the
inverse of the trade deficit). If the answer is no other sector is willing or
able to reduce its net saving, then income growth in the economy will have to
adjust downward. This is the type of coherent analysis that a tautology,
an accounting identity, can reveal.
Minsky had a similar analysis regarding the post-war period. Private
balance sheets were simplified and deleveraged in the course of WWII, and
private net saving was built up. Minsky concluded that is why you got a unusual
period of financial tranquility into the late ’60s, citing in particular the
large share of bank assets made up of default free paper – Treasury debt –
at the end of WWII. The problem was a) economists took this period of
financial tranquility as the new normal, propagating the efficient market
hypothesis and other rationale’s for financial deregulation, and b) the private
sector, including the financial sector releveraged, and liquidity mismatches
became more prevalent in the latter as they came to rely on short term
liabilities for positioning assets. The reality is that from Reagan on, serial
asset bubbles were used (or at least tolerated by policy makers) in order
to prevent the private sector (especially the household sector) multiplier
from decaying as it otherwise would. Alongside this was the tendency of the
nonfinancial sector to either reinvest profits abroad, or engage in
financial engineering, all of which reduced the competitiveness of US productive
capacity and hollowed the goods producing side of the labor market out.
A similar point can be made for the 1921 deflation episode, which Austrian
School adherents often cite as an example of a successful deflation, short
and sharp. WWI changed the debt structure, so the mix of liabilities was
tipped more toward government default free debt than private debt, and the
private sector had cash net savings from rationing plus persistent
government deficit spending. They tend to leave this part of the story out, but it
is a crucial element in financial stability.
In 1921, the US government had no deficit spending so how could savings in government debt be the store of the savings. The reason 1921 was quicker is the debts were liquidated – one of the methods mentioned by Edward.
Edward mentions a slow depression as the third option for debt deflationary environments. This is another way of saying repaying the current debt is the third option. This is where much of the net savings went in Japan, which is why the consumer debt to GDP (or income) in Japan has dropped drastically since 1990. This could happen in the US as well. So we don’t necessarily need government debt to absorb savings. The reason we are in this mess is too much debt, which leads to malinvestment. Japan’s borrowing binge hasn’t helped their situation at all. In fact, they face severe problems as their aging population goes from net savers to spenders. Without the government spending, they may have faced more debt deflation and write-downs, but they would have a healthier balance sheet today.
Marshall:
Cut the budget deficit, get government out of the way, it all sounds so easy.
I did not say that it is ‘easy.’ I merely point out that it is necessary if a true recovery is to be allowed to happen with the least amount of damage. I can’t see how it is better to tax productive individuals so that we can subsidize inefficient businesses to prevent them from going under. Why do we use tax revenues to pay off the losses of reckless bankers who refused to evaluate risk properly? How do they ever learn if we keep bailing them out time after time?
Marshall:
So if the political preference is for the government to deficit spend less, what other sector is ready and willing to reduce its net saving position?
Who are you to decide that someone should reduce his/her net savings position? And why exactly is borrowing and printing money preferable to the market solution?
Marshall:
The reduction in fiscal deficits cannot occur without an offsetting reduction in domestic private or foreign net saving (the latter being the inverse of the trade deficit). If the answer is no other sector is willing or able to reduce its net saving, then income growth in the economy will have to adjust downward. This is the type of coherent analysis that a tautology, an accounting identity, can reveal.
Deficits can be eliminated by defaulting. If there is no money to pay back the debts the solution is to stop spending, not to pretend that there is no problem and to keep doing what created the problem in the first place.
Marshall:
Minsky had a similar analysis regarding the post-war period. Private balance sheets were simplified and deleveraged in the course of WWII, and private net saving was built up. Minsky concluded that is why you got a unusual period of financial tranquility into the late ’60s, citing in particular the large share of bank assets made up of default free paper – Treasury debt – at the end of WWII. The problem was a) economists took this period of financial tranquility as the new normal, propagating the efficient market hypothesis and other rationale’s for financial deregulation, and b) the private sector, including the financial sector releveraged, and liquidity mismatches became more prevalent in the latter as they came to rely on short term liabilities for positioning assets. The reality is that from Reagan on, serial asset bubbles were used (or at least tolerated by policy makers) in order to prevent the private sector (especially the household sector) multiplier from decaying as it otherwise would. Alongside this was the tendency of the nonfinancial sector to either reinvest profits abroad, or engage in financial engineering, all of which reduced the competitiveness of US productive capacity and hollowed the goods producing side of the labor market out.
I have never been much of a fan of Minsky. His, Financial Instability Hypothesis, is somewhat of a joke because he blames capitalism for underestimating risk during periods of prosperity without looking at the role of the central bank interventions that mispresented the time preference of savers.
The way I see it people like Minsky miss the obvious; as a group, the bankers did not make very many errors even though they engaged in activities that had to end badly for the institutions for which they worked. They simply responded to the incentive structure and did what they must to get as big of a piece of the pie for themselves as they could. While they may have ruined the institutions that they worked for most of them earned much more than they would have had they seen reality as it was and acted prudently. As long as the incentives are put in place by the manipulators the smart people who work in Wall Street will take full advantage of them, even if they take the entire system down. There is no such problem in a market system because without the interventions the incentives are very different and create negative feedbacks before things can get out of hand.
I am actually glad that brought up the post WWII period. Most of the Keynesians were predicting another depression as government spending collapsed and demand for war supplies dried up. But they were wrong. The reduction of spending and the regime change that made it attractive to invest once again caused an investment boom that brought prosperity. Once again, a reduction of government spending and debt was good for the general economy.
Marshall: A similar point can be made for the 1921 deflation episode, which Austrian School adherents often cite as an example of a successful deflation, short and sharp. WWI changed the debt structure, so the mix of liabilities was tipped more toward government default free debt than private debt, and the private sector had cash net savings from rationing plus persistent government deficit spending. They tend to leave this part of the story out, but it is a crucial element in financial stability.
This is a very nice narrative but it does not change the argument. There was a severe contraction during the 1920s as bad investments were liquidated and debt was cleansed from the system. There is absolutely no reason why we cannot go through the same process sooner rather than later. If debt cannot be repaid then stop accumulating more of it and face reality as Harding did.
From what I see, if the Minsky narrative is the best you could do, you do not have much of an argument. Yours is a logically bankrupt argument that fails the smell test and is contradicted by history. Unless you have something better you need to go back to the drawing board and rethink your bias.