I recently had a Facebook discussion, on the global financial/economic crisis, with the blogger of SYNTHESiST. He teaches adjunct at the Asian Institute of Management. I initially pegged him as a neoclassical/Keynesian, which is the impression I got from our little exchange, but he refers to himself as “neo-Schumpeterian, co-evolutionist, institutionalist.”
Debates are largely wastes of time, and the reason is psychological. When people take up positions on a certain issue, what happens is that the issue is transferred to a separate portion of the brain from that involving one’s reasoning faculties. The educational process is hampered at that point, and even the most logical or rational argument will fall on deaf ears. But if you are self-aware enough to let go of your defenses and respond like a student, it can be instructive to see at what points you differ with ‘the enemy’; you just might find areas in your thinking on which to improve, or at the very least you can refashion your arguments to be more convincing.
So my discussion with SYNTHESiST begins with a mutual Facebook contact posting about the idiocy of using GDP as a measurement of an increase in standard of living, to which SYNTHESiST comments:
It actually depends on the type of problem that is being confronted in terms of business cycle. Inventory-change based cycling need only interest-type responses.
A collapse in aggregate demand because of a problem of confidence when banks refuse to lend that also cuts the credit multiplier is a different monster altogether. This is when Keynes suggest the government step-in with results that work from 1935 - 1980 until the first stagflation.
For the 2008 crisis that was global in scale, the bigger rescue like quantitative easing invented by Bernanke was necessary. Unfortunately, because of its success we do not have the luxury of a counterfactual proof - i.e. would the gridlock in financial flows, if no QE was done as libertarians recommend, have resulted into a revolution in the streets of America, for example. Or famine in the Philippines.
I myself do not want to take that risk for a strategy that can moderate the volatility. The demonstrations in England from the austerity program of the Cameron government gives us today a mild peek of the troubles we would have experience if the global financial traffic jam had happened without QE.
SYNTHESiST is recounting two main policy approaches in history, where if the problem is big enough, there is a perceived necessity for the central bank to engage in quantitative easing (QE), that is, massive buying of securities from the private sector, thereby injecting the markets with additional money supply. There is nothing fundamentally different here from what the US Federal Reserve is doing in suppressing the interbank lending or ‘interest’ rate, which has stood at near 0% for a couple of years now.
SYNTHESiST is concerned that without such QE, markets would have gone to shit, that is, even more to shit than they have; not only would the US and other crisis-affected countries have been plagued with high unemployment, but there would have been violent riots and greater political destabilization. As worrisome is the scenario presented, I find it necessary to ask:
Maybe QE doesn’t work after all, but merely postpones the ‘day of reckoning’? Hence the apparent ‘success’ of Keynesian remedies, only for ‘the big one’ to hit such as in the 1970s and the one ‘libertarians’ are expecting to come when QE2 fails to ‘boost aggregate demand’ a year or so down the line.
SYNTHESiST then says:
Hi, that is the counterfactual situation that is difficult to prove, hence your maybe, I guess.
Similarly, it can be argued that Greenspan’s very low rates after the 2001 crises made the 2008 bigger, i.e. if he had kept interest rates higher in the early 2000s, possibly the abuses in sub-prime lending or the commodity speculation from cheap money - and the rise of the shadow banking system - would not have happened.
The problem that is nagging them now is the exit strategy of the Fed. Like our Bangko Sentral - this exit will havve to be drawn out - parang roll-over ng roll-over of the buy and sell of assets so there is no abrupt absence of fixed assets market in June. Kaya siguro nag-trial ballon na they will stop early.
... I think that was always the trick up Bernanke’s sleeve - the exit. But like timing the purchase of stock, he must guess the bottom, i.e when the job and house markets are firmly on the way up para hindi ma-udlot. I think he and the Fed have the technical skills, it is the political environment that is the hard one to crack.
which to me seems to be a continuation of his thesis that the problem is one of confidence, the Keynesian “animal spirits.” Hence the perceived need to avoid shocking the markets with abrupt cuts in credit. But SYNTHESiST cautiously points out that the housing bubble of the 2000s may not have even occurred were it not for former Fed chairman Alan Greenspan’s ‘remedying’ of the previous 1990s internet bubble via what amounts to the same thing as QE. What is to guide policymakers when the situation can be interpreted in an assortment of ways?
I reply:
Well that’s another thing, can we even say that QE post-2008 has been successful? Employment levels are at Depression levels, if the same measurement method as during the GD is done. Housing is worse than ever. What we do have are ‘stabilized’ stock indexes... along with higher rates of price increases.
It’s always the adjustment or liquidation period that policymakers are trying to address. Perhaps perpetuating that which actually caused these bubbles (the euphemistically called QE) should be rethought? What about a Volcker-like ‘tough love’ remedy that put an end to stagflation? Again, short-term adjustments are going to make the politicians look bad, hence the dilemma. A decades-long Japanese situation where QE is done ‘modestly’ is another possibility.
Mind you, I’m not actually proposing that the Fed do the Paul Volcker solution of raising lending rates to 20%, and the Japanese ‘solution’ of perpetuating low-but-not-TOO-low lending rates is even worse in the longer term. I merely point these out to show that QE isn’t the only thing Bernanke can do. But there are actually other solutions to consider, which do not necessarily involve central banks.
SYNTHESiST:
For the 2008 QEs, the counterfactual argument runs this way: “it could have been worse....” We will never know as crises are typically one-off. Counterfactuals are usually verified using randomized, controlled trials on social questions but not possible with crisis.
On Volcker in 1982, there is a thread of an argument that, for the U.S. having seignorage, the pain he caused was unnecessary because the main cause of high inflation was the oil price shock from the 1979 Iranian revolution and was past the bottom of the business cycle, i.e. the inflation will solve itself maybe after six years of pain. Having seignorage, the U.S. could pass on losses from inflation, for example, via trade as exports would have become more competitive. Again, the counterfactual is hard to test and comes in the manner of an assertion.
The problem with these analyses though is that it is aggregated at the national level so the distribution of pain and misery within the nation is not considered. Therefore, the final policy choices for the Volcker/Reagan and Obama/Bernanke eras were political as well as economic.
On the Japanese experience, the American will not go for two lost decades - the politics will become seesaw chaotic. Thus, the politicians did not have big problems at throwing money at the problem. Unfortunately, its scale and global network was bigger than anybody thought.
It has been just three years from the start of the crisis, the U.S. may be out of it in four in time for the elections if the Democrats will have their way though the Republicans will like to delay the up cycle until after they win the next elections ...
No Republican candidate for President has come forward because it looks like the up-cycle will come before the elections and favor Obama. There is some risk analysis if the Republicans demolition job to delay this up-cycle will not blow up in the Party’s face ...
Me:
Considering that data can be interpreted to suit the interpreter’s hypothesis, I guess there comes a point where we have to resort to logical deductions on variables that are undeniable. As to what these variables are, is our question.
Re: the next ‘recovery,’ time will tell. Time will also tell whose theoretical framework is most suitable in interpreting the events.
My mentioning of logical deduction pertains to the anti-positivist methodology of the Austrian economists, most notably Carl Menger and Ludwig von Mises. This is not to deny the importance of history or the empirical ― after all, all we know of the world can only be gained by experience, even if this be the mere ‘experience’ of logical thinking. But theories are not so much proven, as they are applied to events, with the ‘better’ theory being one where there is logical consistency in one’s interpretation of the facts involved.
For example, there might be a coincidental increase in the viewers of ‘Willing Willie’ at the same time that the stock market goes up, but there is no logical connection as far as we can see, so it would be dumb to theorize about a direct relation between the two events.
SYNTHESiST:
The financial flows is the one to watch at this point.
The banks are the key players because the funds - as expensive reserves - were released by the Fed to them. Unfortunately, in the free-market environment, the Fed could not dictate were the money was going to be invested.
Blaming the ‘uncertainty’ of the policy environment though I suspect they were chasing yield. the banks did not lend to Main Street - the housing market or industry - that the bankers saw as still risky. Instead, they continued to invest in the shadow banking system, in commodities and in emerging markets that did not create jobs in the U.S. The previous excesses had to be wrung out of unproductive U.S. companies before they will invest.
The power of the free-market ideology is so strong in America that even knowledgeable people do not raise the issue of where investments were. Industrial policy is anathema and money is fungible - profits earned any where in the world will flow back to America (that is if the tax regime is right) ...
Without the banks re-investing their funds in credit-multiplying enterprise activities, the FED’s funds as really expensive reserves resulted results in jobless growth - the firms themselves are still shedding unproductive capacity and assets. Indications are this process has ended already though it is still a fragile situation.
Actually, we had the same situation in the Philippines from 1997 - 2003 when the banks used the cheap funds from the BSP to invest in T-bills and re-build their capital from the crisis of 1997.
I wouldn’t call ‘free market ideology’ strong, whether in the US or elsewhere in the world. After all, the entities that guaranteed all these bad housing loans were government-sponsored enterprises. And the central bank is not a free-market institution; it in fact perpetuates cronyism (politically connected banks, credit rating agencies, and other firms). It is free market rhetoric that is commonplace, particularly among Republicans, but now also with Democrats like Barack Obama, who is trying to get back the ‘redneck’ vote before 2012.
Me:
Yeah, what you said about the bond markets sounds right. Let’s see how it affects industries when the dollar depreciates and yields rise. The positive effect of depreciation on imports would have to offset the loss in purchasing power that comes with it.
When the funds are finally lent out, it should be noted what sectors or markets benefit, as well as how well commodities hold up.
Unemployment rate can be expected to drop, for however long as can be managed, and fingers crossed that this won’t be a temporary improvement of data like the last several times that got progressively worse.
Commodities are to be watched because they indicate what stage of the business cycle the economy is in. But given that credit expansion is done so profusely and at odd points in time, it happens that both stock and commodity indexes can rise at the same time (such as what is happening now), rather than in opposite directions.
I’m not inclined to believe that the infusion of funds into ‘Main Street’ will be less destructive than as occurred when the funds were used to hold lousy securities. In fact, as these funds work their way into ‘real’ industries, this is where the business cycle really picks up steam, as manifest in rising prices, not uniformly across the board, but at different rates of increase with each sector.
The process may initially favor the companies that borrow from the banks, manifesting in increased profitability of investments; but consumption (“aggregate demand”) will later get out of control, and you can’t have an increase in both consumption and investment at the same time; the ‘structure of production’ becomes unstable, and will eventually lead to the bust ― unemployment and unusable supply of goods. It is when prices are allowed to drop that a recovery is possible. This is the Austrian theory of the business cycle.
FINAL POINTS
So while SYNTHESiST and I do not look at the situation in the same way, even when it comes to methodology, I can appreciate where he’s coming from with regards to handling the short term, no matter ‘whose fault’ it is. But the reason I could not go with remedies such as QE is that it only delays and aggravates the inevitable. The solution is not just a matter of monetary policy; there are other things to consider in dealing with the mess that is the short term.
Instead of increasing spending, the US government can lower its budget while cutting taxes. It can abolish the monopoly of central banking and allow for competing currencies. As it is, the US government is going the opposite direction, by keeping Liberty Dollar creator Bernard von Nothaus in jail for providing a private currency whose purchasing power does not diminish as the fiat dollar does.
Roger Garrison, who restates the Austrian theory in Keynesian and monetarist terms in his ‘Time and money,’ stressed political leanings or trust in the market’s ability to self-adjust/self-regenerate as being tied to one’s adoption of economic theories.
As a “free market ideologist,” my quote-unquote bias is towards less government, tax-wise, regulation-wise, money-wise. By no means is such thinking the norm, and its radical nature in fact makes it unwise for politicians to take it up as a philosophy. But as competing-currencies advocate Friedrich Hayek said:
The chief task of the economic theorist or political philosopher should be to operate on public opinion to make politically possible what today may be politically impossible, and that in consequence the objection that my proposals are at present impracticable does not in the least deter me from developing them.
