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Economic groundhog day

Keynesian policies will keep us in a constant loop of distorted markets and growing imbalances. They guarantee us a Groundhog Day of economic depression.

– Detlev Schlichter, 8th November 2012

…triple-dip recession…

– The Bank of England, 14th November 2012

38 comments to Economic groundhog day

  • Regional

    The Meeja are scum in that they’re the veneer on this ceespool of borrowing to stop the stench of malfeasance escaping exposing politicians who’d sell the futures of their children for power.

  • PersonFromPorlock

    You can’t have a ‘constant loop’ of growing imbalances: eventually, it breaks. What comes after will be somewhat fraught.

  • Paul Marks

    They will not let the market clear – they insist on digging in deeper and deeper. with their credit money distortions of the capital structure.

    Japan has been like this for decades – but what is happening in the United States and Europe (including Britain) makes even Japan look sane.

  • CaptDMO

    But…but…that’s ONLY because ” Keynesian” hasn’t been DONE right…yet.

    “Too big to fail” on an epic scale.

    Eventually the jilted “loan” sharks come in and take whatever formerly “yours” stuff they want. The “Police” just look the other way. They know who’ll
    let them run amok.

  • Perry Metzger

    The beauty of the Keynesian enterprise is how a bad economic theory that has been repeatedly falsified by real world experience has been universally embraced precisely because it provides a wonderful excuse for politicians to engage in the sort of unprincipled behavior they would prefer to engage in anyway.

    The real reason why the dead hand of Keynes still lingers on lies not in the “General Theory” itself, which could contain nothing but repeated copies of “All Work And No Play Make Jack A Dull Boy” for all the politicos care, but rather in the work on Public Choice Theory done by Buchanan, Tullock, et al, which lead us to the inexorable conclusion that any plausible excuse of this sort, once proffered, would be embraced as a new Gospel.

    If Keynes had not been born, a party hack would have had to have invented him.

  • Laird

    Perry Metzger has it exactly right. Keynes dusted off a collection of long-discarded (and internally inconsistent) economic fallacies to provide superficially plausible pseudo-intellectual cover for what politicians want to do anyway. He was to economics what Rachel Carson was to environmental science. We can’t escape the dismal legacy of either.

  • Russ in Texas

    Perry just became my Quote of the Day over on FB.

    Brilliantly stated, Perry.

  • Richard Thomas

    Might be worth remembering what it took to get Thatcher into power. I suspect it wasn’t so much unemployment nor the economy but rubbish piling up in the streets and power cuts at random times of the day. I think we may have a ways to go yet…

  • Wolfie

    @richard To get a real Conservative, let alone a libertarian leader in the UK might take a bit of luck and an awful lot of persistence by the right people in the Tory Party. Personally I don’t understand why the likes of George Osborne keep holding out against the sort of supply side reform, deregulation and targeted tax cuts that would get Britain out of decline. Probably because they weren;t born until the 1970 so won’t try the right policies until they have exhausted all other tired old failed Keynesian possibilities all over again.

  • Richard Thomas

    I think Perry’s Keynsianism comment may about it being convenient for politicians may operate as much, if not more so, on a subconscious level as on a conscious level for many politicians, causing it to affect those who purport to be on the right and for sound fiscal policy as well as those on the left. A form of political “denial”.

    I mean, just look at Bush and McCain in ’08. Admitedly they may havehad ulterior motives but on the face of it, you just have to ask “What were they thinking?”

  • Bruce

    Schlichter looses me with the deflation-is-good argument. The American experience, from 1929-32, should disabuse anyone from seriously making such an argument. When money in a mattress is worth significantly more tomorrow, than today, then the incentive is to neither invest it nor make purchases. The economy grinds to a halt.

    But then the real incentive for current excessive American government spending isn’t Keynes, but rather rewarding cronies and creating a large dependency class that can be reliably counted on to keep the machine politicians in office. Think Chicago, Boston, or Philadelphia on a national scale.

  • RIchard Thomas

    Deflation is a bogeyman used by the powerful to justify stealing from your savings.

  • Richard Thomas

    To elaborate, “hoarding” may be a rational response to economic conditions. To adjust conditions to encourage spending and investment regardless… Ooh look, bubble…

  • Laird

    Agreed, Richard. Bruce, you clearly don’t understand Schlichter’s argument. (Have you actually read his book, or any of his extensive essays on the subject?)

    Massive, rapid deflation is of course destabilizing, but then so is massive, rapid inflation. Schlichter’s fundamental point is that in a growing economy a modest amount of what he calls “secular” deflation is both to be expected and is a good thing. It’s a means by which all of society participates in the growing national wealth. And the fear that no one will invest in a deflationary environment is misplaced. Deflation is a form of “interest” you automatically receive on your savings; for you to invest those savings elsewhere simply means that you need to have a higher expected yield on that investment than the rate of deflation. In other words, investment decisions will be more rational because everyone isn’t constantly scrambling to find something to do with his money to offset the ravages of inflation. You would have a stronger and more stable economy. Which is not to say that there wouldn’t be business cycles, but that the recessionary periods would be shorter and generally less severe that what we see today.

    Anyway, there’s a lot more to the argument, but I encourage you to read his book with an open mind. Schlichter is just about the only economist (although he would probably protest that he is not an economist at all) today who makes any sense at all.

  • Bruce

    I’m not familiar with Schlichter, although I did read a couple of essays on his website. He’s a self-described Austrian School economist and an advocate of the gold standard.

    First let’s put to rest the notion that opposition to deflation is “Keynesian,” a label almost as misused as “Fascist” or “Neocon.” Most economists are not Keynesian, and few economists regard deflation as beneficial or even harmless.

    One of Schlichter’s essays, dated March 9, 2012, is entitled “The deflation delusion.” In it he says, “I am not arguing for deflation per se. Deflation in itself has no benefit…” Rather, due to “massive imbalances that have accumulated as a result of years and decades of cheap credit. A cleansing correction – in balance sheets, state budgets and debt levels – is urgently needed.”

    Current policy is in many ways misguided. And I’m certainly not defending policies such as that advocated by Paul Krugman, who really is a Keynesian, back in 2002:

    To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that … Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

    But it’s one thing to oppose creation of financial bubbles and quite another to advocate deflation. Anything beyond a very modest deflation has the effect of depressing the economy. The downturn feeds on itself and creates political pressure for greater state borrowing, spending, and involvement in the economy.

    Friedrich Hayek, the most influential Austrian School economist of the post WWII period, observed:

    I agree with Milton Friedman that once the [1929] Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation. So, once again, a badly programmed monetary policy prolonged the depression.

    Were it not for “silly deflationary policy,” both the New Deal and Keynes’ The General Theory of Employment, Interest and Money would have been unlikely.

  • Laird

    Bruce, I don’t disagree with much of your latest post. (Although I would argue that most economists today are Keynsians of some stripe; it’s the reigning orthodoxy). Certainly I never said that opposition to it is limited to Keynians; that’s also the reigning orthodoxy (since it strongly favors debtors, which today have all of the political power; econmists know where their bread is buttered). But Schlichter doesn’t advocate deflation; his points are: (1) Massive, destructive deflation is going to be the inevitable result of the unsustainable monetary policies (quasi-Keynsian) currently being followed by all major governments and the systemic imbalances which those policies have created. (2) Once that cleansing deflation has occurred, a hard-money (probably gold) based monetary system will permit a stronger, more sustainable economy, and the fact that such a monetary will likely include modest amounts of “secular” deflation is no argument against it.

    Schlichter doesn’t want that huge crash any more that you or I do, but sees it as inevitable. I agree. And I also agree that a hard-money system is superior to the politically managed one we have today. The small amount of deflation which results does not bother me.

  • Richard Thomas

    Lairs, have you looked at Bitcoin at all? It’s still just a little above an interesting experiment so far but it has properties that I feel means we’ll be hearing a lot more about it in the future.

  • Laird

    I have a little, Richard, but I don’t completely understand it yet and it certainly hasn’t achieved critical mass. I agree that it definitely bears watching, though.

  • Perry Metzger

    I have serious doubts about bitcoin itself (most of which are technical issues — Ben Laurie does a better job discussing them than I can here. Unfortunately, most of the arguments about why Bitcoin is a bad idea are not entirely easy to explain to non-specialists.

    Suffice it to say, however, the system is not merely non-anonymous but actually makes all transaction logs available to everyone on earth forever, and in such a way that one probably has far too easy a time trying to ascertain who is who within the network. It also burns lots of energy entirely needlessly but then relies on a fairly inherently touchy byzantine agreement protocol to provide its real security, thus making it both inefficient and probably insecure. (Ben published a followup in which he suggested a system that was at least efficient.)

    What Bitcoin really tells us, in my opinion, is that there is a great hunger out there for non-State controlled monetary systems. If someone can build a really good one, they’ve got a winner in the marketplace.

  • Laird

    Just don’t try to use it in the US.

  • Bruce

    Laird, you state Schlichter’s view is that:

    (1) Massive, destructive deflation is going to be the inevitable result of the unsustainable monetary policies (quasi-Keynsian) currently being followed by all major governments and the systemic imbalances which those policies have created. (2) Once that cleansing deflation has occurred, a hard-money (probably gold) based monetary system will permit a stronger, more sustainable economy, and the fact that such a monetary will likely include modest amounts of “secular” deflation is no argument against it.

    But that makes no sense. If the problem is excess debt, a deflationary policy has the effect of increasing the real amount of the debt and the burden on the debtor. It represents a further transfer of wealth away from debtors. Has any economy ever deflated it’s way out of debt? Usually the problem is runaway inflation. By what mechanism does this deflationary correction occur?

    Regarding the assertion that, “the reigning orthodoxy” is Keynesian, in 2009 The Economist put forward the proposition that “We are all Keynesians now” to its readers. The motion failed decisively by 63% to 37%.

  • Alisa

    If the problem is excess debt, a deflationary policy has the effect of increasing the real amount of the debt and the burden on the debtor.

    The real amount of debt stays the same no matter in what currency it is denominated (for the purpose of this point a dollar inflated is a different currency from a dollar deflated or kept the same as it was). Real debt/capital can only be measured in terms of goods/services.

  • Richard Thomas

    Perry, Bitcoin is pseudonymous which, for many purposes is good enough. Though that is not my interest in any case. It should be noted that most of your second paragraph applies equally, if not more-so to all fiat currencies.

    The interesting things about bitcoin for me are that it is out of government control (or indeed, any single entity), that it cannot be inflated (counterfeited) and that it is protected by some seriously hardcore cryptography. That it is an electronic currency with near-immediate transactions (it can take a few minutes for the network to verify a transaction) and is effectively international are just gravy.

    When I say I expect to hear more about it in future, I surely mean the fiascos that will erupt as governments try to control it. It’s currently trading at mid-$11 per bitcoin as of last time I checked fwiw.

  • Richard Thomas

    Bruce: and many socialists would claim that they are “moderates” also. Cognitive dissonance is the permanent environment of the statist.

  • Richard Thomas

    Laird, the liberty dollar guy was trying to pass off his coins as the legal tender of the US (or at least was sailing as close to the wind as to make no difference). He was a buffoon.

  • Bruce

    I’ll use the United States as an example, but the same argument applies to other economies.

    One function of money is as a store of wealth, and inflation and deflation can significantly alter the value of money.

    That’s the distinction between real (i.e. constant purchasing power) and nominal dollars. Debt is typically denominated in nominal dollars and some economists advocate inflation as an easy why out of repaying burdensome government debt. It’s also why deflation increases the burden of repaying debt.

    If I lend the government $1000 and a burst of inflation reduces the purchasing power of that nominal amount to the equivalent of 100 pre-inflation dollars then there has been a net wealth transfer to the government equivalent to $900 in pre-inflation dollars. The government’s debt burden has been significantly eased in terms of real (i.e. inflation-adjusted) dollars.

    Likewise, if I lend the government $1000 and a deflationary event increases the purchasing power of that amount to the equivalent of 10,000 pre-deflationary dollars, then there has been a net wealth transfer to me. The government’s debt burden has increased in real dollars.

    Either way, the real amount of the debt has been significantly altered by changes in the value of nominal money due to inflation or deflation. What I don’t see is how deflation, which increases the burden of the government’s debt, is supposed to ease the burden.

  • Alisa

    Richard:

    the liberty dollar guy was trying to pass off his coins as the legal tender of the US (or at least was sailing as close to the wind as to make no difference). He was a buffoon.

    Evidence?

  • Alisa

    What I don’t see is how deflation, which increases the burden of the government’s debt, is supposed to ease the burden.

    Bruce, I haven’t noticed anyone claiming that deflation is supposed to ease the burden of debt, but if anyone did, he or she is wrong. When an entity (a person or a government or a company) incurs debt, the nominal value of that debt is denominated in the currency of choice/compulsion by the debtor and the creditor. But the real value of that debt has nothing to do with currency, and has everything to do with the value of the underlying goods/services at the time of transaction (i.e. incurment of debt).

    If I, instead of buying myself a new pair of shoes, I lend you my $100, the value of your debt to me is a pair of new shoes. If you in turn use the $100 to buy a new pair of jeans (I’ll let you be the fancy one here), that pair of jeans is the value of your debt to me (value being subjective). If meanwhile the government inflates the $, the price of shoes and clothing doubles, and if you repay me the $100, I can now only buy one shoe with it, so in effect you repaid only half of your original debt to me. If the government deflated the $, the price of everything is halved you pay me back $100, and I now can buy two pairs of shoes – while you may have forgone the purchase of two pairs of new jeans to repay the debt. All of this does put both of us in a situation different from the one we would have been had the value of $ been left constant, but that in no way changes the real value of the original debt.

    Just thinking aloud here, as you may be saying the same thing I am.

  • Bruce

    All of this does put both of us in a situation different from the one we would have been had the value of $ been left constant, but that in no way changes the real value of the original debt.

    The problem is that debt is typically denominated in nominal money and changes in the real value of nominal money do result in wealth transfer. That’s why governments burdened by debt typically attempt to inflate their way out of the problem.

    What I don’t understand is Schlichter’s Nov. 8, 2012, argument that deflation will stimulate the economy. The mechanism would have to work something along the lines of a massive wealth transfer from the government to debt holders causing debt holders to increase their spending and stimulate the economy. Schlichter argues that:

    To assume that nobody will spend money in a deflationary environment is nonsense. It ignores ‘time preference’, which is essential to human action and which also explains why interest is a universal concept. To want something means, all else being equal, wanting it sooner rather than later. Current example: Prices of computers and smartphones are falling constantly yet people spend heavily on these items.

    It’s an interesting argument, but Schlichter offers no historical examples supporting it on a macro scale and experience tends to point in the opposite direction — that deflation discourages overall economic activity.

  • Alisa

    Bruce, I can’t presume to speak for Schlichter, but in that quote he is not saying that deflation will stimulate economy – merely that economic activity will not need to cease or even subside.

    There may also be the issue of misunderstanding/misuse of the term ‘deflation’ that is at play here. If we go by strict semantics (which I always find a useful thought exercise), in order for there to be a deflation, something has to be first inflated. If my above shoe/jeans scenario took place in an environment where the currency was not being manipulated by fiat but rather represented real value in the eyes of all players in the economy – then, if after the transaction the money was suddenly manipulated, it would indeed cause a real transfer of wealth upon the repayment of the debt. However, if that same transaction (the debt incurment) took place in an environment with an already inflated currency, then it may stand to reason that at least one of the parties to the transaction was already either the beneficiary of such arbitrary transfer of wealth or the victim of such a transfer – both prior to said transaction (by virtue of previous transactions). IOW, the natural balance of the market was already distorted, and so the deflation that followed returned the market to its original balance.

    Hope that makes sense.

  • Laird

    Bruce, nowhere does Schlichter argue that massive inflation or deflation (i.e., your hypothetical $1,000 turning into either $100 or $10,000 of value) would be beneficial. Both are enormously destructive. What he’s saying is that in a hard-money system, where the amount of currency in circulation is essentially fixed (with perhaps some mild growth due to mining operations), a growing economy would result in mild and continual secular deflation (a growing amount of goods and services chasing after that static pool of currency), and that this would be benign. And historically that is indeed the case: before governments got really good at debasing their currencies (through issuing paper or electronic money) most currencies were minted in precious metals and the economies were relatively stable over long periods of time. You can certainly find instances of massive inflation (such as when the Spanish discovered so much gold in the Americas), as well as instances of governmental currency debasement (notably in the late Roman Empire), and both were destructive. A relatively fixed, stable amount of currency outside of governmental control and backed by something tangible of universally-recognized value is the ideal.

    You ask “What I don’t see is how deflation, which increases the burden of the government’s debt, is supposed to ease the burden.” Which misses the point entirely. The burden isn’t supposed to be “eased” for anyone; the playing field should be level. You are correct that inflation eases the government’s burden, which simply means that the government has rigged the game by first requiring that we use only its own currency and then by systematically debasing it; it is stealing from all of us. With a fixed amount of currency it couldn’t do that. The small amount of deflation resulting from economic growth would simply be equivalent to additional interest on the debt, which could be adjusted for simply by reducing the nominal interest rate on the debt. And indeed, once it got used to the idea the market would so adjust. But the government couldn’t resort to theft by stealth to reduce its burden, and in my view that is a very good thing.

  • Schlichter is talking about two kinds of deflation as far as I can see.

    One kind is what you get when you have a fixed quantity of currency and economic growth. Things get proportionally cheaper because we get richer. This happens anyway, regardless of what the currency does. I still buy computers, even knowing that a better one will be available for the same price in 6 months’ time. I doubt this should properly be called deflation, actually. Or at least we should not use the word deflation without specifying its cause.

    I’ll probably do a longer post about deflation soon with some quotes from this discussion.

  • Alisa

    Indeed, Rob – this is the same semantic point I was making.

  • Laird

    And Rob, that is what Schlichter calls secular deflation (a term which I haven’t seen elsewhere but find extremely useful).

  • Plamus

    Bruce: “The American experience, from 1929-32, should disabuse anyone from seriously making such an argument. When money in a mattress is worth significantly more tomorrow, than today, then the incentive is to neither invest it nor make purchases. The economy grinds to a halt. ”

    And the US experience from 1860-1900 of prolonged solid growth in a deflationary environment nicely counters your anecdata. Furthermore, money in the mattress being worth more tomorrow than today may decrease the economic incentive to spend – or at least creates an incentive to delay purchases, but please, honor me with an explanation how it kills the incentive to invest? If money in the mattress brings me (with deflation), say, a 2% a year increase in purchasing power, and any investment project that brings a positive nominal return, the incentive to invest is still there – I’ll have more money, and it’s only gravy that it’s also worth more. With 2% inflation, I have an incentive to invest only in projects that offer a return of more than 2% (nominal). How exactly does this not imply MORE investment under deflation?

    Inflation favors borrowers, and deflation favors saving and investment. You’d have to work hard to convince me that a switch to more investment-based growth from spending/borrowing-fueled growth is a bad thing.

  • Paul Marks

    Bruce the READERS of the Economist magazine (it calls itself a “newspaper” as a tax and postal dodge – the sort of dodge it denounces when other people do it) may have voted against Keynesianism – but the Economist magazine itself supports Keynesianism.

    It supports it every week – both in its specific policy advice and in its background assumptions.

    This raises an important question.

    I can understand why someone might read the Economist magazine – partly to know “what the enemy are thinking” partly to laugh at their absurdity (for example this week’s issue was dominated by a long attack on how big government is in France – without any suggestions on how to more France away from the “Social Justice”, “public services” position and actually reduce government spending, and the Economist magazine would promptly denouce anyone who tried to do that).

    But why would anyone (of any point of view) actually BUY the Economist magazine?

  • Paul Marks

    “Inflation or deflation”.

    How about a third alternative.

    The money becomes meaningless – it is fiat (whim) rubbish, and people just do not use it any more.

  • Laird

    Paul, I think that’s deflation taken to an extreme!