A View from the Inside

If you haven’t picked up on one of the dozens of recommendations from other blogs, I recommend reading Phillip Swagel’s long and detailed account of the view of the financial crisis from his seat as assistant secretary for economic policy at the Treasury Department. It’s particularly useful for people like me who make a habit of criticizing government officials.

The writing is dry, but much of the subject matter is fascinating. It often explains or defends Treasury’s actions during the crisis, but Swagel certainly owns up to plenty of mistakes or shortcomings. For example, discussing the emergency guarantee program for money market funds, he writes, “Nearly every Treasury action there was some side effect or consequence that we had not expected or foreseen only imperfectly.”

The main impressions I get from the paper, good and bad, are:

  • Treasury had a fair number smart, skilled people who used a lot of detailed economic analysis in coming up with and vetting ideas. For example, it turns out they actually analyzed Feldstein’s proposal to offer government loans at low interest rates but with the ability for the government to use tax liens to get its money back. (They decided it was politically infeasible.)
  • They were more aware about the impending crisis, earlier, than most people would think. When he arrived in 2006, Paulson apparently expected a financial system shock because market conditions had been too easy for too long.
  • However, they consistently and seriously underestimated the magnitude of the crisis at just about every step along the way. For example:

The prediction we made at an interagency meeting in May 2007 was that we were nearing the worst of it in terms of foreclosure starts— these would remain elevated as the slowing economy played a role and the inventory of foreclosed homes would build throughout 2007, but that the foreclosure problem would subside after a peak in 2008.

What we missed was that the regressions did not use information on the quality of the underwriting of subprime mortgages in 2005, 2006, and 2007. This was something pointed out by staff from the Federal Deposit Insurance Corporation (FDIC), who had already (correctly) pointed out that the situation in housing was bad and getting worse and would have important implications for the banking system and the broader economy.

  • Bureaucratic and political constraints matter a lot, and can either prevent solutions from happening, or can produce suboptimal solutions. This is probably Swagel’s main point. He has a long discussion of competing proposals for mortgage modification, and how the parties in the debate – and the media – got confused about whether the proposals were benefiting homeowners or banks. Politics can also intervene much more bluntly:

the use of the TARP to support the automobile companies was straightforwardly political: Congress did not appear to want to take on the burden of writing these checks, and President Bush did not want his administration to end with the firms’ bankruptcies.

Swagel provides insight into how and why things happened the way they did inside Treasury, but at times he doesn’t seem much happier about the outcomes than those of us on the outside. For example, his assessment of the second Citigroup bailout in November 2008 is similar to mine:

The transaction, it turned out, did not appear to stabilize Citigroup. This could have reflected a number of reasons including that the pool of covered assets was still modest compare to a balance sheet of nearly $2 trillion, that Treasury did not provide details of the assets within the ring fence, and perhaps because many market participants saw the firm as deeply insolvent.

A key insight, however, is that under pricing insurance coverage is economically similar to overpaying for assets—but it turns out to be far less transparent. This insight underpins both the TALF and the bank rescue programs announced by the Obama administration in March 2009.

Ultimately Swagel almost reads like a critic of administration policy (under both administrations). In his playbook for dealing with a banking crisis, the first point is: “Winnow the banking system by putting out of business insolvent institutions (including through nationalization where a buyer is not at hand). The key is to avoid supporting zombie firms that squander resources and clog credit channels.” However, he says, this has not happened: “the furor [over PNC’s acquisition of National City] revealed that there was no prospect for putting out of business a large number of banks.” Instead:

TARP support for unsustainable firms is akin to burning public money while industry stakeholders arrive at a sustainable long-term arrangement. This appears to be the American approach to systemically significant “zombie” firms—to use public resources to cushion their dissolution and restructuring.

Swagel, I’m sure, would say that I don’t appreciate the importance of political constraints on policy. Fair enough. But it’s not clear that he would disagree with me on what policy should be.

67 responses to “A View from the Inside

  1. The Treasury and Fed seem awfully adept at figuring out ways to subsidize the banking industry to the tune of hundreds of billions of dollars without Congressional appropriation…

    If they used that same intelligence and creativity to figure out how to seize and break up Citigroup, Bank of America, etc. without collapsing the global economy, I am sure they could come up with something.

    So I do not buy the argument that political “constraints” are the problem.

  2. One really frustrating aspect of all this is there would not be much a question of political will if the process were actually transparent.

    Take the example of PNC’s acquisition of National City. Politicians and others construed this as the Treasury picking winners and losers. It only seemed that way because no one actually knew what PNC’s financial position was in comparison to National City. The only known value is the amount of assistance that PNC apparently needed to absorb National City, which of course begs the question as to why the Treasury did not just use the money to recapitalize National City.

    It might be that PNC and National City were worlds apart and this was a good deal for everyone involved. But when the banks’ conditions are top secret, people are going to assume the worst, which in this case was that both banks are challenged and the Treasury is picking favorites. And who would expect anyone to be okay with that?

  3. From the paper:
    House Republicans would have balked at voting to allow the government to buy a large chunk of the banking system (such “nationalization” only came into vogue among Republicans in 2009)

    A presidential administration has a pretty big bully pulpit from which to advocate good policy. But this narration suggests they gave up without even trying. And then the political constraints relaxed as the national debate progressed.

    Altogether, this thing reads like a weak, whiny load of excuses.

    It was too easy—and wrong—to believe that Secretary Paulson was looking out for the interests of Wall Street rather than the nation as he saw it

    The nation, as seen by Secretary Paulson, clearly is mostly Wall Street.

  4. I believe Swagel’s account is sincere (I read it a few weeks back, when he first released it). First of all, if you’ve ever met him, he’s not exactly full of guile. He acknowledges upfront that his account is by the very nature of his writing it, self-serving. But moving past this, what political constraints does he describe that people believe are not in fact real constraints?

    The Treasury and Fed do not have anything near unlimited powers and Congress is particularly volatile right now. The Fed, in particular, is worried about its independence going forward. That’s a real issue.

    The notion they can get around all political constraints is incorrect (they can get around some, as we’ve seen, but they’re already pushing their limits with Congress; the more they’d pushed earlier the less rope they’d have now). Now, directly asking for additional funds to be appropriated is nearly a political impossibility and that’s a huge and obvious political constraint that dramatically limits the sort of programs they can implement.

    The White House bully pulpit and all the economists in academe are not enough to control the animal spirits of Congress. You’ve never followed a House Financial Services Committee hearing if you think otherwise. And remember the financial services committee is considerably better-informed on these issues than much of the rank and file.

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  6. He is like whore who cannot imaging a world in which he is not a whore.

  7. he mentions several constraints. i read the paper a couple weeks ago, so i don’t remember all the details, but one that i remember is the idea of forcing debtholders to downgrade their claim to equity. this is something that nobody has authority to do outside of bankruptcy. the various good bank / bad bank plans hit the same constraint.

  8. a transparent process is nearly impossible in this case — if the govt asserts that a bank is in imminent trouble, there will be a run and the bank will collapse. then you will hear about picking winners and losers.

    a consistent process on the other hand….

  9. That risk exists now anyway.

    I agree that they need some sort of governing philosophy as opposed to an incremental approach.

  10. I wonder why they didn’t try to float the idea of reducing loan principal but *raising* the interest rate. You could have driven loans closer to market values, reduced monthly payments, had less of a moral hazard problem, probably more politically viable and the banks end up with a portfolio of higher performing loans.

  11. interesting idea, but why wouldn’t people then just refinance to a lower interest rate?

  12. adios amigos

    Nemo,

    I believe the real question that needs to be asked, is why did the US Government choose to bailout these deeply insolvent banks at all. What was the governments motivation to do this at all? It is clearly a mindless repeat of what Japan did not very long ago, and was a huge mistake in Japan. The answer lies with the institutional holders of debt, specifically US bank debt. I believe country’s like China, etc, advised the Obama administration that if there are any further defaults on bank debt they held, they would boycott US Treasury debt auctions. That scenario is pretty much the end for America.

    Carl Denninger reports this on his blog today. It can be found here:

    http://market-ticker.denninger.net/

    AA

  13. adios amigos

    America needs to de-leverage. There are no magic bullets that will make that simple and plain fact go away. Until deleveraging is accomplished, nothing will improve. Until the creditors face that reality, and move on, nothing changes. There are three ways, and only three ways to deleverage. Earn your way out of it (good luck with this option), default, and bankruptcy. I would suggest the final option.

    Printing cash and trying to inflate your way out of this will only create even greater problems in the not very distant future. The reality of the situation is clear. You need to rinse this, and start fresh. MANY will suffer, but it’s clearly the only way. There is no way to “stimulate” your economy enough to earn your way out of this. In fact, what are you stimulating exactly? More deficit spending, more borrowing, and more debt loads that you REALLY can’t afford anymore.

    You aren’t having a financial crisis, as much as a “facing reality” crisis.

    AA

  14. Sure, like in the Feldstein proposal (didn’t get off the ground):

    “Participating homeowners would not be able to walk away from the government loan because it would be a tax lien that could not be escaped in bankruptcy.”

  15. To a great extent I agree, but the problem with deleveraging is how to accomplish it without throwing the economy into a deflationary spiral with associated liquidity trap. That’s a Hard Problem.

    Capitalism works only when money has a stable or slightly declining value, because if money has a rising value the inclination is to stash money under mattresses instead of spending it (that’s rational, after all, if it has a higher future value, why spend it now rather than wait for later when it has a higher value?). And of course if money has a rapidly declining value (a.k.a. hyperinflation), you drain lenders of money needed to leverage current assets into future growth because the money gets churned too fast in order to get rid of it before its value declines too far, and because of the speed of turnover, economic efficiency declines significantly (you simply can’t spend money that fast without bringing inefficiency into the process). The goal of a monetary policy wonk has to be to maintain a slightly declining value of money (i.e. slight inflation), enough to encourage people to pull it out of their mattresses and spend it, but not enough to discourage them from parking it in their banks for a while when they’re trying to decide how to best spend it. Money which is not being used for economic activity of some sort is just funny shaped toilet paper with pictures of dead people, as far as its economic effect is concerned.

    So maybe I’ve missed this (I don’t follow this blog as closely as I should). But has there been any reasonable proposal for accomplishing the deleveraging needed in order to solve the core solvency problem, without the side-effect of crashing the money supply and triggering further deflationary pressure on the economy? While Friedmanesque monetarism may have been trumped by Keynesian propensity to spend in the current crisis, the core principles of money supply stability noted by both still apply — significant deflation is still to be avoided at all costs if we want to avoid an economic crash like 1932-1934 that threatens the very stability of the nation.

  16. adios amigos

    Bad,

    Perhaps a collapse, and rinse would in fact be best FOR THE CITIZENS, not for the bankers however. When a forest burns to the ground, a more flourishing forest typically grows back. I guess what my point is, is that sometimes there is no magic fix, just a forest fire, then rebuild.

    I guess I just don’t see how it’s possible to effectively borrow and spend your way out of a borrowing and spending spree, and expect a different result. There is definatly another motive.

    My opinion? I believe the governments “plan” is to see to it that the financial elites get back all the money they potentially could have lost, saddle those losses onto the taxpayers of America, then let it implode…..and it will implode ultimately. I can’t help but notice that the Wall Streeter’s that are running The Federal Reserve and Treasury are also making all these command decisions. The same people who stand to lose everything if the banks are allowed to be nationalized. Are they capable of cutting their own throats? Not likely.

    I have learned over the years, that when something the government is doing makes NO sense…..follow the money trail, and you will find your answers. This “plan” is about saving the bankers, and the hell with everybody else. You watch, once the bankers have all their own cash out…the banks will implode.

    AA

  17. I will repeat (as I have many times) a proposal I offered a few weeks ago:

    Create a phased increase in capital asset-ratios to permanently take down maximum leverage allowed. Then permanently increase the monetary supply by having the Fed extend zero-financing loans to Treasury in order to finance expenses, including:

    – repaying some portion of existing federal debt as it rolls over
    – extending tax breaks in six month intervals, subject to economic conditions
    – support domestic infrastructure investments (e.g. a crash program in renewable energy – vastly more aggressive that the modest 15 billion a year now being deployed)
    – and critically, distributing funds to cash-strapped states to maintain services and invest in local infrastructure projects (modern hospitals, modern schools, modern water treatment systems, modern transit, etc.)

    The reduction in cap-asset ratios reduces the potential for inflationary rebound that can occur when velocity recovers (e.g. cash comes off the sidelines). It also reduces the need to inflict debt on future generations to finance the recovery, and gives the Fed more direct control over the money supply. Bu decreasing allowed leverage, it’s likely to increase long-term interest rates (this is the bad part) for secure loans, but if this is phased in the impact on asset prices should be moderated over time. This will partly compensate cash based savers for the inflation these actions would cause.

    Politically, rather than “Recapitalizing banks”, this approach would help “recapitalize the middle class”.

    Ideally, this activity should be coordinated with the world’s other reserve currencies, but even if not, it should still work. It may require the US to play hardball to get other countries to increase their capital-asset requirements as well, or US capital will flee to other banks. “Playing hardball” could include such actions as refusing to allow any lender who does not meet US capital-asset ratios to lend in the US or to US firms (or refusing to allow US firms or firms operating in the US to take credit from such lenders). Ideally, however, the EU cooperates – certainly they are pushing more aggressive regulation than the Obama Administration is seeking.

  18. I seem to recall someone with a similar notion that the best solution to a deflationary crisis was to allow a deflationary spiral to continue until everything was liquidated, at which point the economy could then be rebuilt upon more sustainable lines using the newly-liquid resources. His name was Andrew W. Mellon. That worked out well. (Sarcasm intended, for those not familiar with Secretary of the Treasury Mellon’s contributions to the Great Depression).

    The disaster of 1933-1934 did not arise from a void. It arose because the prevailing economic theory of the time was that liquidation via a deflationary spiral was necessary and proper. The problem is that this ended up hurting the elites almost as badly as it hurt the peons. Yes, their millions of dollars were worth more and more as the economy deflated, but they became poorer too as production and income of their many enterprises collapsed.

    In other words, I don’t think liquidationism as such (the notion of “let it all burn, then rebuild”) is in anybody’s best interests, whether they be peon or elite. We have ample data from 1933-1934 of the end game of that particular concept. And while you may pooh-pooh fiscal policy as a way of re-inflating the economy, the experience of the world in the 1930’s pretty much repudiates any notion that fiscal policy is not capable of ending a depression. The Depression ended in major economies as a direct result of massive increases in government spending, albeit in the United States the final end had to wait until the massive fiscal stimulus of World War II.

    StatsGuy just posted a very interesting proposal that might actually work. I will have to think about it some.

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  20. adios amigos

    And after the depression of the 30’s ended….how did things do after that “rinsing”….say up until 2007? About 65-years of relative prosperity, no? And what would the result have been, had there been no war, and massive government spending happened anyway? No one knows. Interesting questions. So, in fact….no one REALLY knows what to do today, as we have no crystal ball into the future. Everything is, frankly, mere speculation as it relates to what the “right” corrective action truly is. Maybe re-inflating the economy is exactly the wrong thing to do, long term. Maybe a complete melt-down will bring about some long overdo changes. Perhaps a total collapse would help the world resolve the “big” global problems, as the world would have no choice but to do so. Sometimes a little pain is a good thing. Ever get a tooth fixed? When it’s over, the tooth is fixed….permanently.

    There will be huge financial problems going forward if we don’t address the big picture, and now we have everyone’s attention…..opportunity knocks. All these pension funds that are totally underfunded. Another time bomb. All these country’s that have massive debt loads, and growing faster than GDP. These are ALL economic time bombs that we KNOW are there….waiting.

    This current storm is an opportunity to solve this insanity. But….the political will is lacking.

    I just worry about my kids, and their very questionable futures.

    AA
    AA

  21. Badtux,

    You must have learned your economic history in college. Mellon’s injunction to “liquidate, liquidate, liquidate” is the plan that was expressly NOT followed. Hoover basically ignored him for 3 years. Hoover was the biggest, rootin’ tootin’ interventionist of his time. Then Roosevelt did him one better.

    The collapse and recession of 1920-21 is a case when the govt. DID allow debt to be liquidated. Fortunately Pres. Harding put his own Commerce Sec, one Herbert Hoover, on a short leash, allowing the recession to be sharp, but quick.

    The debt we have today will be liquidated one way or another. We simply don’t have enough money (or the capacity to borrow) in order to fill up the black holes on the banks’ balance sheets (these will be getting bigger, by the way). I’m doubtful that a Japan-style, continuous bailout is even feasible for us — the bubble is much bigger and the population as a whole has too much debt. In private life the Japanese were savers.

  22. You quote Swagel as saying, “Winnow the banking system by putting out of business insolvent institutions (including through nationalization where a buyer is not at hand). The key is to avoid supporting zombie firms that squander resources and clog credit channels.”

    All I can say after reading this is THANK GOD someone in Treasury feels this way. I have never understood the strategy of propping up the zombie banks as a means to protect “the system.” How long can we keep pumping money into companies that are alive thanks only to the fed’s life support system?

    The privatization of profit and socialization of loss for the financial sector cannot be healthy for our country in the long run. Good for the guys on Wall Street, but deadly to the country as a whole – for so many reasons.

    We have spent trillions of dollars to prop up the financial system at a time when the rest of the country is experiencing a crash of its own – in the form of rising unemployment, stagnant wages for those who remain employed, higher prices for groceries, higher credit card interest rates, decreased value of the home, and significant losses in 401ks, college plans and retirement funds.

    Using “public resources to cushion [the zombie banks’] dissolution and restructuring” is ultimately a very narrow focus that sucks up massive amounts of money.

    With consumers scrapped for cash, businesses in many industries will continue to suffer. Not sure that gearing Wall Street up to resume business as usual is going to change things for the other America.

  23. I read numbers that are wildly divided. The government has given somewherebetween 12 and 4 trillion dollars to the banking sector alone. This wide disparity in calculus is disturbing. Why can’t anyone, someone be honest about the real numbers the government has forked over to the predator class cronies, cabals, and oligarchs in the finance sector.

    I read excuses parroting why these criminals and PONZI scheme sharlatans are still employed, – but a rose is a rose, a pig is a pig, and fraudulent, collusionairy, PONZI scheme and criminal enterprize – is – a fraudulent, collusionairy, PONZI scheme and criminal enterprize.

    No good can come of this work. Certainly the oligarchs will profit wantonly, but the majority of the mammals on earth, – the other 99% of the human population will suffer, burden, and hazard extraordinary hardship and deprivation, while the predator class stands Olympian, untouchable, and imponderably weathly.

    In a world where there are no laws, – there are no laws for anyone predators. We know how this will end.

  24. Please address the substance of the post rather than engage in personal insults. Thank you.

    From what I’ve read from primary sources and prominent historians, your notion that Hoover ignored Mellon is belied not only by Hoover’s very own autobiography (where he bitterly complains that Mellon led him into disaster), but by the clear record of bank failures and other such deflationary actions allowed to happen during the Hoover administration. In short, you appear to be engaging in historical revisionism. Please provide some primary sources for your rather interesting statements that those bank failures were not allowed to happen and that Hoover ignored Mellon, given that the historical records seem fairly clear — there were over 9,000 bank failures(1/3rd of all banks in the USA) and $140 billion in vaporized deposits (back when a billion dollars was actually big money) by the time FDR took office. That’s $1.4 TRILLION disappeared out of the economy (thanks to the marvels of fractional reserve lending), or a sizable percentage of the money supply at the time.

    In short, the liquidationist’s theory that the problem in the Great Depression was that the economy wasn’t allowed to liquidate is belied by the historical facts. There was significant liquidation, and that liquidation led to significant suffering that the people would not have long endured since human beings do not starve on demand just because liquidationists say it is their moral duty to do so. Saying that more liquidation was the solution to this suffering is like saying that more cyanide is the solution to cyanide poisoning, there would have been no more United States as we know it if there had been any more liquidation because there were already food riots by the time FDR took office and only one harsh winter away from a nationwide uprising that would have resulted in either a Communist or Fascist revolution, an uprising headed off only because FDR immediately created a massive jobs program (the CWA) that winter so that people could afford to buy home heating oil and food for their families. In short, the liquidationists were leading the nation into national disaster, and no amount of revisionism can change that stark history of failure. I see no reason to believe that liquidationism is any better a solution now than it was in 1932. Both the monetarists of the Chicago School and the Keynesians are pretty clear on that point, as is the biggest lesson of 1930-1933 — deflation is toxic to capitalism.

  25. Banks are special in that banks actually create and destroy money via lending and not lending. As I’ve previously pointed out, capitalism relies on having a stable (actually, very slightly inflating) money supply, deflation is poison because it kills current economic activity (since nobody spends anything other than what’s necessary since they expect their money to be worth more in the future), as is hyperinflation for the opposite reason (since it again leads to the collapse of banking and thus of the ability to leverage current assets into future economic growth as people withdraw their money from banks to spend it before it becomes worthless). Money is a token that exists for a single reason — as a stable signifier of value to ease economic transactions that would be untenable under a barter system. I recently computed that one of our computing systems had over 15,000 major components in it… I cannot imagine a system of barters that would allow me to acquire each and every one of those 15,000 components needed to build that computer, but with a stable token of exchange, it was easy. Once deflation or hyperinflation is allowed to take hold, this destroys the value of money as a lubricant for economic transactions and results in a collapse of economic activity. That computer with 15,000 components simply does not get built if we are reduced to barter due to the collapse of the monetary system.

    In short, the focus on banks might be irritating to you, but if we do not come up with a solution to the banking problem and manage to collapse the money supply, we face an even bigger disaster — possibly even the collapse of capitalism as an economic system. Given the unrequited history of failure of alternatives to capitalism (the training of economic systems via tokens simply is more efficient than any planned economy ever could be, see: neural network theory), that would be a major problem indeed for all of us.

  26. Liuqidation of debt is entirely in the cards, one way or another. Any attempt to keep all obligations intact and force repayment will create an even more intense downturn. The question is simply how…

    Ultimately, debt will be “restructured”. Actual mutual debt restructuring is one method. Bankruptcy is another. Inflation/currency depreciation is yet another.

    There are also multiple types of debt to liquidate… Liquidating bank debt (bondholders) helps, if it can be executed quickly and decisively, SO THAT EXPECTATIONS OF FUTURE LIQUIDATION ARE MINIMIZED.

    This is like the ORTHO theory of debt-killing… “Once and Done”.

    However, IMF projections and our own data suggest that we’re likely to see mounting bad debt through 2011, which will cause “rolling waves” of bankruptcy, concomitant with deflation and massive household bankruptcy, as well as earnings losses in previously very solvent firms (inducing layoffs and salary cuts). We are hovering on the edge of a deflationary spiral, perhaps already in one.

    In other words, liquidating banks will not restore confidence due to fears of more banks to follow (some reports place us only 40% through the loan loss cycle, and every time we start to think we’re nearing the end, we’re told the problem has gotten bigger and longer). This will perpetuate.

    We are already in a situation where we’re not just losing the bad firms… we’re starting to lose the perfectly good ones too. We’re not just seeing bad loans go under, but perfectly good ones too. Contagion is the rule, not the exception.

    Many people cite the case of Sweden. Unlike Obama, I don’t dismiss this case (“they had, like, 5 banks”). I do, however, note that Sweden was a negligible fraction of the global economy with strong exports. The US is not, and this recession is global in any case. Sweden is not helpful.

    Inflation, in moderation, is the best, fastest, most efficient answer. It simultaneously renegotiates all dollar-denominated debt contracts, and penalizes cash for staying on the sidelines. And reflates asset values, which increases liquidity in core markets (like equities and housing) so that when loans become unpayable, banks can recover value by seizing and selling assets (or the asset owners can sell them).

    If we don’t start seeing some level of healthy inflation soon, we’re going to see spillover progressing and intensifying. Commercial property, thought resilient only 9 months ago, is gone. Small business is toast. Emerging markets have become net capital EXPORTERS as they seek to repay debt, and the capital flows are artificially propping up the dollar (and will continue to do so through 2010 unless this is changed).

    Pension plans are next on the list. Sovereign governments are also suffering.

    It seems unlikely the US govt can renegotiate debt fast enough to keep ahead of this monstrosity. We’ve spent nearly 6 months on GM and Chrysler, and STILL can’t get even an agreement in principle. And look at the abject failure of the HOPE program.

    As a signal of the unwillingness of capital markets to take on risk, even risk associated with very senior debt, consider the implosion of DIP (debtor in possession) financing for bankrupt companies. If you can’t get financing for DIP, how does you even execute a bankruptcy effectively?

    Moderate inflation is the best answer. And if we stay in denial much longer, default on US debt will start to become a very real possibility.

  27. One thing that seems clear from reading this paper is that the Paulson Treasury(and the Bush administration in general), was completely unprepared for an intrinsic shock. Their planning revolved around extrinsic issues. “How do we cushion the economy if terrorists blow up a building”, “How would the economy respond if we have an earthquake or hurricane”. Look at the language and examples that they use.

    Perhaps, this reflects the challenges that the Bush administration already faced, but I think it also shows a somewhat myopic trust in the financial system. It seems to me that the financial system being the problem and not the solution was the last thing that they expected and their planning suffered from it.

  28. The fiscal and economic policies followed after WWII were those of FDR, not those of Herbert Hoover. And you are correct, those policies led to 40 years of prosperity and growth, followed by 25 years of income stagnation for the middle class and industrial decline as those policies were incrementally reversed.

    The problem with allowing the collapse of capitalism is that we simply do not have a viable alternative to capitalism. Communism as an economic system (as distinguished from totalitarian dictatorship as a political system) proved to be an abysmal failure because of its inability to efficiently allocate resources to produce the goods that individuals desire. The final result was a dramatically lower quality of life and standard of living in Communist countries. We are moving towards more socialism in order to add some inefficiencies to our economy due to the fact that we’ve become *too* efficient — we can now produce all the goods that the world’s resources are capable of producing with only a small pittance of the world population — but socialism as a replacement for capitalism again is one of those ideas that simply *does not work*, socialism can work in conjunction with capitalism (see: Norway), but not as a replacement for capitalism. And past that point, we simply have no organizing principle for economies that seems viable.

    In short, warts and all, we seem to be stuck with capitalism as the primary organizational mechanism for our economy. Like democracy, it’s the worst of all possible systems, except for all others that have been tried. And capitalism depends on a stable / predictable token of exchange (i.e., a stable / predictable value for the dollar) in order to work. Given that, it seems more realistic to figure out how to fix capitalism than to decide, hey, let’s try something new and improved.

  29. The problem right now is what Keynes called *propensity to spend*. Right now, people (and banks) view the future value of their money as being greater than the present value of their money, and thus they stuff it under mattresses (figuratively speaking) rather than spend it or lend it. In short, they have deflationary expectations, and this is leading to money fleeing the money supply. Bernanke says he lent the banks $4 trillion — and all that $4 trillion ended up on deposit at the Federal Reserve.

    So simply printing money isn’t working at causing inflation, because the money is simply disappearing under mattresses as fast as Helicopter Ben can print it. Thus the importance of fiscal policy. Thus Krugman’s continued grumping, “we need a bigger stimulus”. Money must be handed out with strings attached that get it to go through at least two sets of pockets (e.g., if it’s a construction project for a bridge, the contractor can’t just pocket the money — he must pay for steel, he must pay the steel workers, he must pay for concrete, etc.), or it’ll just disappear under mattresses rather than doing anything at all to foster economic activity.

    And talk of just allowing banks to collapse are completely unhelpful, due to the role banks play in creating (and destroying) money via the mechanism of fractional reserve lending. Banks really *are* special. They are how capitalism leverages current assets into future assets. If you don’t have banks, you don’t have capitalism, it’s as stark as that. And capitalism is one of those things that, like democracy, suck big time… but they suck less than any other alternative we’ve thus far tried.

  30. Stats, you’ve been bitten by the monetary solution bug.

    Let me see: permanently indebted states to a federal government permanently indebted to the Fed. Why don’t we all just declare an oath to the Fed and promise that all our progeny for all time to come will do the same. Let’s also hook a generator up to Jefferson’s grave.

    Infrastructure only goes so far. Government does not create the general products and services people need, the kind that sustain employment, the kind that create real growth and wealth. What your proposal will do is further solidify state spending and the attendent class of government artificial “haves.” Where the middle (non-government) class fits into this trickle-down scheme I don’t see. We can only train so many to pave potholes and so many non-productive paper-pushers to manage them.

    All this appears dressed up to me as a soviet-style command econmony, without the political control.

    Mellon will be proved right in the end. Liquidate, liquidate, LIQUIDATE. Let the rottenness be purged from the system. Why? Because there is no WW2 this time around.

  31. Funny I read this after my post referencing Mellon. Stats stopped me dead in my (scroll) tracks!

  32. Erich Riesenberg

    Hear Hear, absurd for people to babble on about forcing debtholders to downgrade their claim to equity. That would be ILLEGAL outside of bankruptcy.

    Curious, though, have you ever heard of TARP? My understanding is it was also ILLEGAL, until a law was PASSED, allowing Treasury to buy stock in banks!

    Lots of things are illegal until they are legal. Here in Iowa, gay marriage is not going to be legal until next week, I think!

  33. Erich Riesenberg

    The statement that anger at TARP money being used to buy out weaker banks somehow puts to definitive rest the notion of FDIC receivership for failed banks seems nonsensical. A non sequitur?

    In one case tax money is being used to acquire a rival, in the other the insurance fund is being used to facilitate the closure of the already failed bank.

  34. D. Christopher Leonard

    While the discussion of policy alternatives is certainly important, it ought not to be conducted in a vacuum as if economics were a discussion of natural law and ‘political constraints’ an unfortunate and external distraction. Perhaps a more sustained analysis of just what those political constraints are and by whom they are imposed is appropriate. Johnson’s Atlantic piece noted that the IMF’s experience with political economic elites as obstacles is instructive. Jared Diamond noted that how societies respond to crises appears to reflect the degree to which elites can insulate themselves from the consequences of their interests in accumulation (whether it’s monumental architecture or capital may not matter much). In this regard, Mellon’s advice to ‘liquidate, liquidate, liquidate is intelligible just as is the current management of the very large banks (and non-banks) influence on both the executive and Congress.
    Focusing only on the Great Depression as an historical precedent may be too narrow – a broader comparative historical perspective is in order

  35. I suppose one can only train so many people to make B-17s… And tanks… And single-prop-engine fighters… And battleships…

    All of which are far more productive over time than, say, hospitals that are designed to avoid cross-contamination, have microbe-resistant surfaces and state-of-art air processing systems, and new surgical centers…

    Or wind turbines… Or geothermal energy plants, or traveling wave nuclear breeder reactors…

    Or fixing the 550 billion dollars of backlog on US roads/bridges…

    Or creating municipal sewage systems that don’t dump massive amounts of phosphates into dying rivers, streams, and bays…

    In any case, just a couple more serious notes:

    1) The government can easily direct resources without Soviet-Style command and control – it’s called contracting, which uses incentive-based (market) mechanisms to allocate effort and material.

    2) Historically, the post-war era which followed the govt.-led expansions of the latter 1930’s through the 1940s was a time of immense opportunity (and equality) for the middle class in the US.

    3) The proposal I offered does not set up a permanent Nanny-state, nor does it leave states permanently indebted. Zero-percent interest long term loans are effectively printing money. Moreover, the policy could only be continued for a limited period (while cap-asset ratios are being adjusted) to keep the total money supply stable. Just as the cap-asset ratios have hit target, the system ends, and normal financing limitations resume (this can be built into the legislation with a Sunset Provision, ensuring a Senate fillibuster can prevent renewal).

    Remember, the FUNDAMENTAL problem in the economy is too much debt – not merely insolvent banks.

    The question is whether you want Great Depression 2.0 as rolling waves of bankruptcy wipe out debt, or you want inflation? If we get rolling-waves of bankruptcies and deflation, the fear is that by the time we’ve restructured current bankrupt entities, we’ve acquired a new set of bankrupt entities precisely because economic conditions continue to deteriorate. The bankruptcy liquidation process is always one step behind of the economic collapse, and there’s no source of stabilization.

    Re-writing history to argue that tight monetary policies (e.g. Mellon) in the early Great Depression “saved” our country in the “long run” pretty much contradicts every credible economic analysis of the era. If, after 3.5 years (1929-1933), the country was still headed downhill with no upwards direction in sight, how can one credibly make this argument?

    Moreover, how does one make the argument that if only Hoover had done _less_, the Depression would have fixed itself… while at the same time arguing that only WWII got us out of the Great Depression? Are these not contradictory positions?

  36. Note that the proposal above involves a considerable amount of spending as well… With a built-in mechanism to prevent an inflationary rebound, and stabilize the long term international financial system (aka, take leverage down across the board).

    If the problem is too much leverage, _reduce leverage_. Instead, we are trying to build it back up to pre-2007 levels, even as we’re fighting 9% unemployment and 15+% underemployment, and modest deflation. But we’re terrified of printing money. It’s unreal. Totally unreal.

    Also, Bernanke has actually _not_ been printing money that fast compared to the rate of debt destruction. A Goldman Sachs report noted that the Fed would have to be expanding its balance sheet 7 to 11 trillion dollars to get the implied Fed Funds rate negative enough to match the recommendation of the Taylor Rule. Bernanke’s problem is that base money does not turn into debt automatically (there’s little demand for credit from qualified borrowers). So we have the _potential_ for inflation, but no inflation. Eventually, the Fed can generate inflation, but the Fed is terrified of an inflationary rebound when velocity kicks back in (e.g. everyone suddenly realizes inflation really will happen, and moves en masse out of dollars).

  37. bobgreenfest

    Although it shouldn’t, it constantly amazes me how common sense and logic are disregarded by the Government and programs such as TARP get implemented (a word to be used loosely in this case) for political reasons. For additional common sense insight, see http://www.bobgreenfest.wordpress.com.

  38. Pingback: Treasury: Regrets, I've Had A Few - The Plank

  39. The historical precedent of the consequences of a deflationary spiral long pre-dates the Great Depression. Thomas Jefferson noted them in the early 1800’s, for example, though since he lacked access to the works of John Maynard Keynes and Milton Friedman he had no idea what to do about them other than to mutter darkly about how banks were a tool of elites out to impoverish ordinary Americans. The U.S. economy during the 19th century was characterized by inflationary and deflationary cycles as banks expanded lending and collapsed, and the deflationary part of the cycle was the part that was most painful to ordinary people because their debts had been written in inflated dollars but now were expected to be paid in deflated dollars, and of course were not, so their assets were seized by the elites who were their lienholders and transferred en masse to those elites. So of course Mellon’s advice seemed quite sensible to those elites — it had been an excellent method to transfer the wealth of the masses to the elites for pennies on the dollar during the 19th century. As a recipe for maintaining a functioning economy that maintained a reasonable standard of living for the majority of people, however, it was — and is — massive fail.

    So Mellon’s advice, as you say, was quite sensible as far as the elites were concerned. The problem is that liquidationist policy in an industrial society can only be implemented by a dictatorship. In a democracy, people simply will not endure the level of misery involved, because people will not willingly starve to death in the streets or die shivering in the cold due to lack of funds to buy heating oil. They will elect an FDR to ameliorate their suffering, or if deprived of that option, they will rebel and follow whatever Communist or fascist dictator promises them relief from their suffering, at which point democracy ends. In a society of subsistence farmers, such as in Thomas Jefferson’s time, that was not a problem because a subsistence farmer could simply move on to other lands on the frontier, outrunning the elites. But by 1929 the majority of Americans were no longer farmers, they were factory workers or service workers involved in the sales and distribution of goods, and there was no longer a frontier for people to flee to in order to become subsistence farmers if life in the cities became too harsh because too many resources had been sucked up by the elites for pennies on the dollar. This created a political constraint that Mellon, a product of the 19th century, was fundamentally incapable of understanding, and that apparently those here whose advice appears to be that people should voluntarily starve and die of cold because it’s the moral thing to do (i.e. the liquidationist point of view) are similarly incapable of understanding. In a democracy as vs. vicious totalitarian dictatorship that just does not work, and if you keep pushing it, you’ll eventually discredit your side to the point where even Dennis Kucinich (the gnome from Cleveland) looks like a viable alternative. Luckily, in 1932 we had FDR. Or else our flag today would have a red hammer and sickle on it, most probably.

  40. wow this is amazing :)
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  41. Huh? Computer-related industry has been in consistent and long-standing deflation for decades, perhaps since inception. And yet, it has thrived. Even though just about anyone buying computer equipment has known for a long time that the longer they wait, the more they’ll get for their money, they still buy. Go figure. So much for conventional wisdom.

    Whenever I read inflation advocates I wonder what it must have been like for those that concluded early on that the earth could not have been the center of the universe. There was tremendous energy expended defending the orthodox view. This has been much more so with banking because the orthodoxy generates tremendous profits for a few at the expense of many, giving an oligarchy the means to extend their rule.

    We have never had sound money (even the Gold Standard was a fiction as the dollar value of gold was constantly manipulated and paper money supposedly redeemable for gold was created in massive quantities via fractional reserve banking and other schemes) so it is next to impossible to empirically put what I consider to be the fairy tales of inflation to rest.

    There isn’t even any way to know whether we can learn from experience or are doomed to endlessly repeat these boom-bust cycles (like in a Twilight Zone episode.)

  42. Jefferson brilliantly noted that destructive deflation is preceded by inflation (“If the American people ever allow the banking system to control their money, first by inflation, then by deflation; their children will one day wake up homeless on the continent their fathers conquered.”)

    There is no evidence that “ordinary” productivity-induced deflation is harmful (see above my response to your post on the computer industry.) The disastrous deflation you cite has always been preceded by inflation, typically as a result of credit growing faster than the economy.

    When you advocate inflation, you are, in effect, advocating the very thing you warn against.

  43. It is the job of the smart experts to find good policy proposals, NO MATTER THE POLITICS. Let the elected representatives implement thneir flawed politics in broad daylight – force them on the record. If the politics starts pruning the policy proposals, then you already have oligarchs – rule by experts that claim for themselves political judgement.

  44. Sigh… yet another person who can’t figure out the difference between price reductions caused by a reduction in inputs and monetary deflation.

    Okay, setting aside monetary inflation that has occurred over the past thirty years for the moment: Price reductions in the computer industry occur when there is an increase in productivity that reduces the inputs to the product. For example, new lithographic techniques allow putting far more circuits onto one semiconductor chip with no increase in the price of a semiconductor chip, which in turn means far fewer semiconductor chips needed to build a modern computer as vs. a 1970’s IBM mainframe of equivalent power and thus a far lower price for a modern computer with the power of a 1970’s IBM mainframe. This has nothing to do with monetary deflation, which is a money supply measure. The reduced number of inputs to the modern computer allows creating more of those modern computers as compared to 1970’s mainframes, and thus the match between value received and value given (i.e. the value of the monetary token) remains a constant even though there is price deflation of a specified commodity (computers, in this case). A decrease in prices caused by a reduction of inputs — e.g., getting 5 ounces of tuna in a can of tuna rather than 6 ounces of tuna in a can of tuna — is *not* monetary deflation, which is a decrease in prices caused by a decrease in the money supply (or by failing to inflate the money supply sufficiently to account for increased overall economic output).

    Note that we have not had boom-bust cycles of the severity of the pre-WWII cycles in the post-WWII era. We’ve had moderate recessions from time to time, but no outright liquidationist bust with 20%+ unemployment and the collapse of the economy into a deflationary spiral. Monetary and fiscal policy works to moderate these cycles, we have 65+ years of experience showing that this is true. It utterly baffles me that some people will continue to defy reality and insist that monetary and fiscal policy do not work, when we have so much experience showing that they *do* work. They do not completely eliminate the economic cycle, but they moderate it significantly compared to the pre-WWII experience, and I see no reason why we should abandon them now and return to the pre-WWII liquidationist policies that worked so well in 1929 (sarcasm intended). It’s as if some people have spent the last 65 years with their hands in their ears and eyes closed shouting “I see no-think! I hear no-think!”. Sgt. Schultz is *NOT* a good model for wise economic policy…

  45. “There is no evidence that “ordinary” productivity-induced deflation is harmful”

    Once again you are confusing price decreases with monetary deflation. Monetary deflation is a money supply vs. total economic output measure. Price decreases caused by reduced inputs to a specific product do not affect the money supply, they simply re-allocate resources since the inputs no longer needed to produce n copies of widget X now get re-allocated to produce either more of widget X or to produce widget Y. The overall money supply and overall value of a dollar in terms of value received for value given remains stable even though the price of widget X declined.

    As for whether monetary deflation is evil or not, we have significant evidence that it is. The banking system ceases to operate at negative interest rates, and the banking system is how we leverage current assets in order to produce future assets. Without a banking system, you do not have a functioning capitalist system. And that’s a major problem, because we simply do not have a viable substitute for capitalism as a mechanism for maintaining a reasonable standard of living for the majority of the people. Fiscal and monetary policy in the post-WWII period has prevented monetary deflation from taking hold, and the result has been a far better standard of life for most people as compared to the pre-WWII era where there was 25%+ unemployment during the down cycles. In short, we have 65 years of proof that preventing deflation moderates the business cycle. Ignoring that and doing a Sgt. Shultz (“I see no-think! I hear no-think!”) is not a wise way to conduct economic policy…

  46. A quote from Badtux: “Please address the substance of the post rather than engage in personal insults. Thank you.”

    First, please accede to your own request. Thank you.

    Next, please refrain from setting up straw-man argumentation. It is counter-productive.

    I am not aware of _anyone_ that argued, least of all me, that “A decrease in prices caused by a reduction of inputs — e.g., getting 5 ounces of tuna in a can of tuna rather than 6 ounces of tuna in a can of tuna — …” represents any sort of deflation. Please supply a reference, it should prove interesting.

    The computer industry example is simply meant to illustrate that declining prices (actual ones, not your invented type) do not lead to a decline in economic activity. If anything, the opposite is true.

    In a sound money economy, it is likely that increased productivity will lead to generally declining price levels (not across the board and not always, but for the most part.) If we make the assumption that lenders and borrowers will ignore this fact and lend/borrow at unsustainable interest rates, then of course, by definition, that would be, well, unsustainable. But that is a false assumption. As always, prudent lenders and borrowers will observe the economic environment and take it into account in setting terms.

    I rarely, if ever, see inflation advocates talk about the various distortions inflation produces. There is good reason counterfeiting is outlawed. While it is legal for banks to create money from nothing, it is in every other respect functionally equivalent to conterfeiting, with destructive results to show for it.

    Inflation reduces overall productivity by allowing some to get free or heavily subsidize money without needing to earn it through productive activity.

    Moderate inflation produces moderate busts as the distortions accumulate, but those are busts nonetheless. While it’s certainly possible to have a growing economy with moderate inflation, let’s not mistake correlation with causation. I submit that it is possible to have prosperity _despite_ inflation (up to a point.) You can finish a marathon with a backpack of sand, but not because of it. So, why burden ourselves for the benefit of bankers and speculators?

  47. Right, Bernanke printed money, and then the money just disappeared under (virtual) mattresses due to the core solvency problem, so he’s pretty much abandoned that as a mechanism for re-inflating the money supply and turned to open market operations instead via purchases of private debt on the bond markets. This at least is preventing major companies from going bust due to inability to roll over their debt due to the locked-up credit markets, but is not a particularly effective way to solve the core solvency problem and is not increasing the money supply significantly because, again, the money ends up disappearing under (virtual) mattresses before it gets a chance to create any economic activity.

    As for buying U.S. Treasuries at 0% via open market operations, the problem there is that U.S. Treasuries are *already* trading at effectively 0% on the open market as investors flee to the safety or perceived safety of U.S. Treasuries. The latest auctions produced an annualized rate of 0.137 percent for three-month bills and 0.335 percent for six-month bills. A new stimulus package completely funded via 0% T-bills might work, but it is clear that right now that there’s no shortage of investors willing to turn over their money to the U.S. Treasury to be spent. That is probably a good thing since it at least produces *some* economic activity, since it has to come out from under a (virtual) mattress in order to purchase Treasuries and the U.S. Treasury at least makes sure that it hits one set of hands before it disappears under any other mattresses… but this does eliminate the ability of the Federal Reserve to print significant sums of money via open market operations on U.S. Treasuries unless the volume of Treasuries being sold is significantly increased (i.e., we have a *much* bigger stimulus program to get that money into people’s hands with strings attached requiring them to get it into other people’s hands, such as bridge and road construction, or food stamps that cannot be saved but must be spent in full every month).

    So yes, we can fund a much bigger stimulus in the manner you propose without unduly stressing future generations, via printing money (the Fed buying Treasuries), but we’ll need more stimulus to do that because otherwise there aren’t enough Treasuries being sold to do it. And BTW, the inflationary rebound problem you mention has already been mentioned by Bernanke and he claims he has a plan to deal with it. I’m dubious, myself — it took months to print all that money, and it’ll take months to un-print it once everybody realizes inflation is actually happening, and in the meantime I figure we’ll have six months to a year of some serious inflation before the Fed gets things back under control. But given the alternative of completely collapsing the money supply and banking system by being too stingy with the money printing… maybe that’s not *too* bad. Just the least bad of all the bad scenarios we face, where I can’t really figure out a *good* scenario, just scenarios that result in survivable badness for a short time vs. scenarios that result in unsurvivable badness for a long period of time. As others have noted the U.S. is *not* Japan, and the patience of the American people will *not* allow a decade of misery in order to slowly wind things down. And given the rather nasty characters lurking on the periphery muttering about things like revolutions and overthrowing the government… frankly, I don’t like what happens if we don’t wrap this up as soon as possible and return to something resembling normality. The Swedish solution combined with printing massive amounts of money as part of a massive stimulus program might have some unwanted short-term side effects (perhaps a short burst of high inflation), but at least it would be done and over with then once the Fed manages to un-print sufficient money to get inflation back under control.

  48. Uhm, you are the person who stated the computer industry example, not me. I pointed out that the computer industry is decreasing prices by decreasing the number of inputs in a computer — i.e., by putting less tuna into a can of tuna. This is a price reduction. This is not monetary deflation. Declining prices for a product are not monetary deflation if the declining prices are caused by a reduction of inputs into a product, i.e., by putting fewer microchips into a product or by putting less tuna into a can of tuna. You are still getting the same value (in terms of inputs that went into the product) for your unit of monetary exchange.

    This is not a straw man, this is the man you actually introduced into the discussion. You are confusing price reductions caused by efficiency gains with monetary deflation. One is an efficiency measure, and the other is a money supply measure. They are two different things.

  49. I address your points in my reply to your comment above.

    I’ll simply reemphasize that the destructive deflation you talk about is typically brought about by excessive debt creation inherent in an inflationary banking system.

    While such a banking system does indeed “cease to operate at negative interest rates”, it is because it is poorly designed, except, of course, for the bankers and the speculators they favor as borrowers. For them, it is brilliantly designed – to legally take money from the rest of us, against our will. We can do much, much better (the rest of us, that is.)

  50. Finally, regarding a small amount of inflation as desirable: The goal is to have sufficient inflation to draw capital out from mattresses and put it to use (because in an inflationary environment it would otherwise lose value if left under the mattress), but not sufficient inflation to cause drastic declines in the value of the unit of money (and thus distortions caused by people trying to dump money as fast as possible rather than investing it wisely into goods and services and future production). Money has value to an economy only when used to foster economic activity as a token of exchange. Otherwise it is just funny shaped toilet paper with pictures of dead people on it. We have ample evidence that 0% or less inflation (i.e. deflation) reduce economic activity by turning money into mattress stuffing (either real or virtual), at which point it ceases to have any meaningful contribution to economic activity.

    The EuroZone has set a goal of 2% inflation for the European Central Bank. That appears to be a good target for maintaining money supply velocity and thus economic activity. Milton Friedman won a Nobel for his equations describing the effects of monetary inflation upon economic activity, and thus far the evidence appears to support his thesis — capitalism works best with a small, constant, predictable amount of inflation, because otherwise the token of exchange (currency) loses its ability to contribute effectively to economic activity.

  51. It appears that your issue is with the whole notion of fractional reserve banking. I don’t know what to say to you at this point. It is like me arguing with someone that the world is round rather than flat. We have over 400 years of history showing that a fractional reserve banking system is the most effective way to leverage current assets into future income, and while you correctly point out a significant problem with the way fractional reserve banking operates, I have seen no proposal from you for a realistic alternative to fractional reserve banking that equally effectively allows leveraging current assets into future income. Given that, I pay attention to proposals and mechanisms to patch up the current capitalist system to eliminate or at least reduce in severity the problems you have noted, while you, apparently, want… ??? A Communist revolution? Or what? I do not know. I just find it odd that I, someone often accused of being a left-wing “socialist”, am the person defending capitalism here :-).

  52. Erich,

    It was ILLEGAL in that it was UNCONSTITUTIONAL. Regardless of whether Congress passed a law to make it “legal”, it is still UNCONSTITUTIONAL. Congress has done similar things in the past to have them struck down by the Supreme Court. Your gay marriage thing in Iowa is an example of this at the state level.

    Unfortunately, nobody is bringing this to the Court because banks, the Executive Branch, and Congress are happy that this money is getting spread around.

  53. “…I pointed out that the computer industry is decreasing prices by decreasing the number of inputs in a computer…”

    If anything, there are many more inputs in a computer than there were decades ago, it’s just that they have gotten much cheaper and more powerful, allowing for sharp price/performance improvements. Counting the number of chips means nothing.

    It is distinctly possible to get the same sort of effect in many other areas as a result of a combination of increased resource availability and improved utilization of same (within limits, of course.)

    If the money stock is stable, this productivity improvement will lead to generally declining prices, which has typically been characterized by pro-bank economists as the dreaded “deflation.” It is only dreaded because of the self-serving design of banks by bankers to allow them to create money from nothing and charge as high an interest rate as they can for it, only to have taxpayers pick up the tab when their bubbles inevitably burst.

    I submit that any level of monetary inflation represents the involuntary taking of resources from those that contribute to creating them to those that do nothing in exchange for the money they created out of thin air (the banks.) If you reject that assertion outright, then we’ve reached a dead end in this debate. If you simply argue that the benefits outweigh the costs, then maybe we can get somewhere. Which is it?

  54. Hey Stats,

    One point on your #1 serious note…

    You make it sound like this contracting will be fair and equitable to all contractors, and that the process is fairly static, with no waste or corruption. Also, that the work will be done to specification, within budget, and on time.

    We all know that this is not real world. The contracting process is riddled with corruption. Kickbacks and graft are common. What prevents this? Certainly not yet more government oversight. Waste or corruption on the job? Government was the entity that was supposed to watch out for this in the first place. Are they really the key to solving the problem? Ask those poor people in Boston who died in the TW Tunnel. We all know how well that Big Dig money was spent.

    Larger government control is not the answer.

  55. You surmise correctly. It is the fractional reserve banking we have that is inherently flawed (arguably fraudulent, though that’s a more slippery debate.)

    Under the best of circumstances – when it is tightly controlled by regulators – it causes moderate harm. In fact, it may even be sustainable indefinitely when tightly controlled, but the bankers make so much money (by taking it from the rest of us) and have never hesitated to use it to loosen, if not eliminate those controls, eventually plunging us into depression.

    The 400 years of history you cite is replete with the abuses I cite. You say it is “the most effective way…”, and yet we have nothing to compare it against. We do, however, have the ability to analyze its perniciousness, as well as observe the destruction it has wrought over the centuries. Like I said, we can do much better by making it illegal to lend money you don’t actually have (ordinarily, and properly, considered fraud, except that it was legalized and formalized long ago.)

  56. Uhm, wrong answer with the computer industry one, guy. The computer industry is one that I know quite well, and I can assure you that my Apple Macbook has far, far fewer components than the Lear-Siegler ADM-2 terminals that I was repairing in 1978 (discrete TTL! 1kx1 SRAM chips! Watching the squiggles of NTSC swoosh across my o-scope screen, woot!).

    Once again, you are confusing tokens of exchange with actual assets. Money is toilet paper with pictures of dead people on it used to facilitate the exchange of goods and services in an economy, not something that has any inherent value. Money is not wealth. Assets purchased with money are wealth. Printing money does not destroy wealth, because money is not wealth — the assets you purchased with money will increase in price just as much as everything else in the economy.

    And once again, you are not differentiating between price inflation and monetary inflation. If you have a stable money supply, stable set of inputs into an economy, and increase the efficiency of the economy (i.e., reduce the per-unit inputs into a gizmo, but produce larger numbers of gizmos due to the increased efficiency of the economy), you can quite indeed have declining prices without having monetary deflation. When I talk about inflation and deflation I am talking about monetary inflation or deflation, not about prices. Prices are a measure of monetary inflation or deflation only if the overall efficiency of the economy has not changed — a statement which we know is not true.

  57. I am afraid we are at an impasse then. You appear to have philosophical disagreements with the fundamental structures of capitalism, and at this point it’s rather like a capitalist arguing with a Communist or a gay rights advocate arguing with a Southern Baptist preacher — it is simply impossible to discuss things meaningfully with someone who insists that you are inherently evil.

    As for 400 years of fractional reserve lending, note that we indeed have plenty of evidence that it leads to greater economic activity than the contrary. The Muslim world, for example, outlawed fractional reserve banking. We all know how well that turned out — the Muslim world went from threatening the very existence of the West, to being a marginalized and semi-colonized backwater of use only for the resources that can be extracted from beneath its sands.

    History did not start in 1929, or 1776 for that matter. Fractional reserve banking did not arise in a vacuum, there were multiple competing systems at the time that clever London goldsmiths realized that they could lend out a portion of the gold that people were paying them to store in their vaults and make even more money, and fractional reserve banking is simply the one that proved most effective for leveraging current capital into future income — so much so that a dank dreary little island nation that was the first to develop fractional reserve banking managed to leverage its pitiful few assets into an empire upon which the sun did not set. Economic systems do not arise out of a vacuum, they arise out of an evolutionary process where they either adapt to conditions, or are consigned to the dustbin of history. Undoubtedly there is a better mechanism of economic organization than the currently-existing capitalist system, but thus far it is the worst of all possible economic systems, except for all others that have been tried (yes, I misappropriated Winny *again* :-).

  58. Nonim, thanks for your excellent comments. I’ve basically never understood why there has to be inflation, and I’ve come to somewhat similar conclusions that you have stated here. Inflation is a myth created by bankers (led by the Fed). There is absolutely no economic reason or rationale whatsoever (except in economic fantasy land) that prices have to go up year after year after year so as to destroy all income and force everyone in society (other than bankers) to work their tails off to make ends meet as prices advance higher than income.

    If anyone disputes the inflation notion, as suggest they read thru thousands of years of economic history which proves beyond a shadow of a doubt that inflation is a creation of bankers, not a fact of capitalistic or any other society.

    Inflation is only necessary since bankers are basically involved in ponzi finance (ala Minsky’s famous finance distinctions), and forced inflation is the only means they have to refinance debt and accumulate massive wealth. Without inflation, ponzi finance is dead, and with it the $100 million a year salaries of bankers who do nothing constructive for society.

  59. Oooh, it’s a conspiracy!

  60. The _number_ of components as inputs is all but irrelevant to cost, price and value for any system, not just a computer.

    Printing money in and of itself obviously does not destroy wealth, but as soon as you circulate it, you dilute the value of a given amount of money in the hands of those that obtained it through productive endeavor. The act of involuntarily transferring wealth in that manner creates incentives to chase easy money while reducing the incentives for productive activities. In that way it destroys wealth over time.

    I am aware of various definitions of inflation and deflation. If you provided a definition of “monetary deflation”, I missed it, which is why we may be talking past each other on that point.
    I will say that I have seen economists refer to a general, sustained, decline in the overall price level as “deflation”. They argue it’s always bad. I argue it’s only bad in our badly designed financial system.

  61. Indeed we are at an impasse.

    You seem to suggest that fractional reserve banking accounts for greater economic activity. Causation vs. correlation. Maybe it was sunspots? How about earthquakes and volcanic eruptions?

    You suggest that fractional reserve banking was somehow responsible for the rise of the British Empire. What, pray tell, caused its decline? It certainly wasn’t the elimination of fractional reserve banking? Maybe it was the elimination of the faux Gold Standard? Please.

    As I said, in my view we have done well, for a large variety of reasons (knowledge, technology, climate, etc. etc.) _in spite_ of our deeply flawed financial system. You obviously disagree.

  62. I’ve read George Will’s take on this:

    http://www.washingtonpost.com/wp-dyn/content/article/2009/03/27/AR2009032702504.html

    Is TARP different in some sort of legal way than many other sorts of discretionary spending granted to the executive branch? It seems the size is unprecedented, but the type of discretion is not that far outside a lot of legislation.

    Regardless of whether I agree, I certainly understand arguments that it was legislation that should not have been passed. But I’ve yet to see a really convincing argument of unconstitutionality, but would like to see the broader set of arguments.

  63. […continuing…]

    I completely agree with you that “Economic systems do not arise out of a vacuum, they arise out of an evolutionary process where they either adapt to conditions, or are consigned to the dustbin of history.”

    It took millennia to realize that the earth is round and rotates around the sun, even with an enormous amount of evidence.
    The sooner fractional reserve banking is only history, the better, in my view.

  64. Privatization of govt. functions can certainly push corruption into the contracting process unless it is policed – less govt. is not a solution to good govt., although good govt. can operate through a range of mechanisms (some market based).

    However, pointing to the worst examples of government – corruption in Boston and incompetence in Bush II’s administration – does not constitute an argument against all government.

    Just like pointing to the worst examples in private business (of which there are many) does not constitute an argument against private industry.

  65. > There is no evidence that “ordinary” productivity-induced deflation is harmful

    clearly there is evidence of this. people lose their jobs due to increased productivity. if the economy is not expanding this will increase unemployment.

    an example is subsistence farming — it is no longer viable in the united states. people who have been able to adapt have been driven off of farms into cities and suburbs to push paper around. people who have not been able to adapt are poorer than they otherwise would be.

  66. I like your cynicism. But, of course, it’s not a conspiracy, they say it outright: We are targeting x% inflation per year. We are printing $1 trillion. Where’s the conspiracy? It is the job of the Fed to print money and create inflation, all the while projecting an image of protecting the average taxpayer who gets poorer every year due to these inane policies.

    The only obvious question is why are they targeting inflation? Why are they printing trillions of dollars? Why does a well-functioning economy with absolutely no lack of supply need to have prices increase every year? Has inflation made the law of supply/demand obsolete? Do we really need to print $1 trillion to save zombie banks? Why not print $1 trillion to research cancer.

    Surely printing $1 trillion to help basic cancer research will do alot more for the benefit of society than printing $1 trillion and shoveling into banks who have done absolutely nothing for society and have created zero value.

  67. You’re burying your lede here. You cite as only the second of your take-aways that Paulson arrived at Treasury expecting a financial system challenge. But the date on this is summer of 2006! Paulson arrived from Goldman over a year before the onset of the financial crisis expecting a systemic problem because of excessive-leverage.

    What does that say about the likelihood that ‘nobody could have anticipated … ‘? And if one Wall Street CEO had this clear an understanding, why not the others?

    But perhaps this is because you already take it as given that they all knew.