Wednesday, October 22, 2008
That whole free lunch thing
Now that the investment boom has gone bust and the necessary adjustment process has begun, we are being told incessantly that the solution to the problems caused by massive increases in the supplies of money and credit is additional massive increases in the supplies of money and credit. And given that the private banking industry is no longer capable of driving the monetary expansion, we are being told that the central bank and the government must become even more involved.This makes a lot of sense to me, and unfortunately does not bode well for the strategies that have been enacted to date. But I'm no economist. Why is Saville wrong?
The latest in a long line of policy moves designed to curtail the necessary adjustment process is the government's plan to provide capital directly to the banks. It seems that almost everyone is in favour of this idea, which suggests, to us, that few people appreciate the basic economic truth that the government has no capital. Any capital provided by the government to the banks will first have to be extracted from other parts of the economy via taxation or inflation or borrowing. In other words, the government's provision of additional capital to sick businesses can only happen at the expense of the more healthy parts of the economy.
Whether the advocates of increased government spending and the various other re-inflation policies realise it or not, at the root of their proposed 'solutions' to the crisis is the idea that it is possible to get something for nothing. It is axiomatic that an increase in production must precede a sustained increase in consumption; that saving is the basis of long-term economic growth; that no individual can become rich by spending more than he earns; and that no country can become wealthy, or recover from a recession, by consuming more than it produces. And yet, most commentators have deluded themselves into believing that you can get around the problem of inadequate real savings by simply increasing the supply of the medium of exchange, and that you can bypass the need for increased consumption to be funded by increased production by simply getting the government to spend like a drunken sailor.
(CWCID: Mish)
2 Comments:
By 
Cardinalpark, at
Wed Oct 22, 11:23:00 AM:
Well, as is the case with so many of these sorts of diatribes, there is much truth in what Saville says but not a lot of pragmatism.
One, we should take it as "axiomatic" that there is something called a business cycle, in which we have regular booms and busts, dominated by secular economic growth. This has been proven empirically throughout history. We had a boom; now there's a bust.
Things fuel both. We doled out a lot of fiscal and monetary stimulus after the internet telecom bust and terrorist attacks and 2001 recession hit to get us out of the economic doldrums we were then in. We then had a boom; a really excellent one in many respects. But then the Fed, as it may have been a little late to do, took the punchbowl away and jacked rates up from 1 to 4.5% or something. And not long thereafter, the bust came.
Now that we are in a humdinger of a bust - one which has triggered some very significant and damaging risk averse behaviors like grabbing your cash with both hands and stuffing it in your treasury laden mattress - we have to coax the animal spirits back. Risk taking goes away for too long, and suddenly we only fire and dont hire, we dont make capital investments and instead we harvest our businesses, hunkering down and waiting for a brighter day.
It takes confidence of a sort to take risk. You can't be stuffing your cash in the mattress or buying essentially non-productive metals like gold to grow an economy. You have to have capital or borrow it to invest, hire and grow.
Right now, banks can't much lend, borrowers don't want to borrow and people are not buying or investing. You need to stimulate risk taking again any way you can. Any way you can. Any way you can. Repeat after me. Any way you can.
And thats' where Saville is a little like a parent telling their sweating teenage kid to put on a sweater because they (the parent) are cold. Get over it dude.
The amount of deleveraging required by banks rather suddenly has left the taxpayer not much choice but to provide capital, because private providers didn't have enough. Those who stuck their finger in the dike (TPG, Flowers, and others) drowned. They didn't have the legs and staying power and were overwhelmed by the deleveraging process and loss of confidence. WAMU didn't get siezed by the FDIC due to the erosion of their assets. IT was the loss of $17bn in deposits in a week that did it - that's called fear.
Once the taxpayer named Hank Paulson says "no mas" the liabilities don't move, and the banks can afford to take their losses now in Q4 and begin to cautiously lend again.
How do they do that? Simple - risklessly. They borrow really cheaply short from depositors and the Fed and lend to the government long. Given the slope of the yield curve, this should help them rebuild their profits.
Having done that, they can lend to people and businesses again.
As for government spending, I don't think it does much. But running a big fat deficit through tax cuts hastens the day when we have a crisis which forces the government to spend less. In case you haven't noticed, politicians don't ever spend less. That's a bipartisan phenomenon. So you have to take the money away from them.
Anyway, I hope that spells out why I am pretty supportive of what Paulson is doing. And while I wish in hindisght Lehman could have been more gently dealt with, I won't say I would have done differently. How would we have felt if the government wrote Barclay's (a british bank) a $100m put to the US taxpayer for LEH going bust? We might be today screaming about what a bunch of idiots we were to bail out wall street and give the brits lollipops. So as I've said previously, we took our lumps on that one. Ouchie. Everybody leanred that moral hazard lesson and it cost more. But we know now. Thanks Hank. Got it.
By Georg Felis, at
Wed Oct 22, 08:23:00 PM:
On behalf of drunken sailors everywhere, I demand an apology. Comparing us to Congress, I mean that is just a low blow!
/sarc :)
