tom drake... longwaves... on liquidity traps...
Paul Krugman's notion that Japan has been in a Keynesian
liquidity trap has been widely trumpeted about by him, at least until
after the 1998 Asia meltdown. ("The Return of Depression
Economics")
The usual way of putting the liquidity trap has been that it is like
pushing on a string, and that low or non-existent rates do not
create demand. Slight increases in the demand for money can and
do push rates up, and people (markets) do not believe that rates
can stay down at very low levels for very long. Thus rates tend to
rise in such a way as to counter the effects of the stimulus.
The Keynesian/Krugman solution is to create or administer
inflation so as to counter the tendency to save at the higher rates
rather than to spend or invest. The prevailing mythology, as I
showed before in quotes from Antal Fekete, was/is that it was
World War II that "saved" the economy of the 1930's by massive
inflationary spending.
As Fekete showed it was massive deficit spending throughout the
1930's which swelled the government bond market and prolonged
the "flight to safety" which bled deposits out of banks. With a much
smaller bond market the bond prices would have roared up quite
quickly and rates would soon have dropped to levels conducive to
new investment in business. As it was it took far longer, 1941 or
1942, well after the start of WW II. It wasn't a loss of confidence
per se which caused the run on banks; it was the loss of deposits
running into government bonds at high real yields which eroded the
lending base and reserve base.
(More later.)
TD
+++++++++++++++++++++++++++++++++++++++++++++++++
So far I have found that there is some confusion about what
constitutes a liquidity trap, and which part of the Keynesian rubric
is appropriate to deal with it.
Hoover and Roosevelt both threw money at it by deficit financing
which created an enormous goverment bond market which drained
liquidity from banks and kept interest rates up far longer than
during a 19th century panic. They prolonged the depression.
As someone mentioned in an earlier discussion on Fekete, banks
themselves also bought governments, but these were largely
money center banks not country banks which used to provide a lot
of the business financing in this country. Country and small banks'
wealthy customers pulled funds out and bought treasuries. Banks
couldn't compete with the Treasury and had no funds to lend.
So lower the interest rates instead? But the huge Treasury
issuances prevented that happening quickly: not until 1941 as both
Fekete and Krugman agree. So we have a circular affair.
Much of the deficit spending ended up in people's pockets one way
or another but it scarcely replaced a fraction of the loss of incomes
with more than 20% of the work force out of work. And again the
effect on interest rates was countervailing.
With ownership of gold outlawed for Americans and with few outlets
for foreign exchange vehicles with every one else devaluing their
currencies, devaluation of the dollar could only occur by fiat. This
made gold stocks and treasuries the premier investments of the
1930's.
None of this stimulated the demand for goods which was or ought
to have been the goal.
Japan has tried the infrastructure deficit spending as did Hoover
and Roosevelt. They tried cutting "funds" to zero. It didn't work.
Krugman's ultimate solution is to create the "image" that prices will
go up inexorably so that people will stop hoarding and saving
dollars or yen and buy "stuff" or goods and turn the economy
around. If prices are to go up 4% per year who wants to save?
Better get it while it's cheap. But how do they do this when interest
rates and deficit spending didn't work,and unilateral fiat devaluation
is out of the question?
Basically the idea is "talk it up" and flood the systen with liquidity:
increase the money supply consistently and persistently and
prices will rise. Sure, interest rates were already low or non-
existent but only for "prime borrowers", like failing banks and
international hedge funds. Let's pump it out for everyone.
But wait. Isn't that what caused the stock and real estate bubble to
start with?
Does anyone in economics wonder why these things happened in
the 1980's and 1990's? Mexico 1982, agriculture 1986, Japan and
S&L 1990-91, Mexico II 1995, Thailand, etc. thereafter? First time
since the 1930's? "The Return of Depression Economics" indeed.
Are the solutions "pushing on a string" or pushing on a Wave?
(More later.)
TD
+++++++++++++++++++++++++++++++++++++++
n essence a liquidity trap is almost definitive that a Kondratieff Long
Wave down cycle is in progress. Neither reducing interest rates, indulging in
massive deficit spending, nor cranking up the money supply results in
increased demand for goods and services as they will do during the up
cycle of the Long Wave when interest rates and demand are naturally
increasing.
Paul Krugman catches a glimpse of the issue, for a moment, when he
approvingly mentions Lawrence Summers (ex-Treasury Sec/y) and his own
idea that "moderate inflation may be necessary if monetary policy is to be
able to fight recessions". ("The Return of Depression Economics", page 79)
If inflation and rates are rising, one can do good by cutting them when
recession looms. The flip side of that coin is that when rates are
declining it means one has no room as a policy maker/politician to improve matters.
Much of the failure to learn from past cycles is due to the Myth of Morgan
and the Myth of Keynes. Morgan (and Sec'y of Treasury Cortelyou, who
rarely gets a word of mention) bailed out the panic of 1907 and set the
model for the FED of 1913. With the FED ostensibly having even more
power than Morgan, rescuing from a future panic was thought to be a
basketball "slam dunk".
But it is forgotten that the period from the late 1890's commodity, stock
market and interest rate lows was a period of inflation. The London Bank
Rate (LIBOR) went from 0.8% in 1896 to 4.5% in 1907, and annual average
long rates on the US rose from the depression levels of nearly 3% to
nearly 4% in 1907, hardly remarkable in our age, but quite dramatic then. (see
Sidney Homer's chart below or appended.) This was an era of growth *and*
shrinking P/E's and inflation.
Therefore the Morgan bailout in the midst of rising prices, rates, and
corporate growth worked quite well. But it may have had a lasting effect
in convincing economists and politicians that "can-do" *would do*.
Likewise Keynes concept that spending one's way out of recession was
music to the ears of the new social democrats of the 1930's, and spend
they did. And devalue. But, as Antal Fekete,and others has shown,
("Deflation: Retrospect and Prospect", monograph 45, Committee for
Monetary Research and Education, 1986) the spending and attendant
deficit financing did very little. Also the myth that it was only WW II
spending which turned the tide belies the fact that WW II started in 1939
(with buildups starting earlier), and it was not, in fact until interest
rates had run down and turned up in 1941 that it became economic to expand
business once more.
There is a lot to be said for safety nets and social spending, especially
if one is being saved himself, but to sell them as finely tuning the economic
cycle is more public relations than reality.
But what about the economic cycle? Well, most economists of our era do
not believe that they exist, or at least they wouldn't exist if
politicians/policy makers would only do what economists say to do. An exception might be
made for the 39-48 month business and stock market cycle which is
convenient to blame on the presidential cycle. But for the rest there is a
(realistic) fear of career-damaging disaster if one touches on longer
cycles which have about as much credibility in academia as astrology or palm
reading . There are exceptions such as Brian Berry or Ravi Batra, but
their work in these areas is considered a personal idiosyncrasy or hobby, like
those of a wealthy Victorian idiot savant. After all, Batra has been
well-regarded, by some at least, for his work in others areas.
Since the problem in analysing and dealing with a liquidity trap involves
depressed prices of goods and interest rates, a look at the history of
prices and rates would seem to be in order. Nikolai Kondratieff, the Russian
economist who was by all accounts a good one, did just that in "The Long
Wave of Economic Life". geocities.com
I won't belabor Kondratieff's findings since the 1925 article is short,
succinct, and extremely clear on the issue of a long wave of interest
rates, wages, wholesale and commodity prices and other economic data series:
none of the abstruse economic models looking for a problem, which
Professor Kindelberger has deplored; no calculus; just common sense and
an eyeball and a few simple statistical tools.
Oddly enough, despite the upheavals of the 1930's and 1940's and almost
90 years of the US FED, the Long Wave has marched right along with the
next low after Kondratieff generally conceded to have been in the 1940's,
and the subsequent high to have been in the 1970's. (See Homer's chart
and that of Moodys seasoned Aaa bond rates.)
If one thinks about what the general price levels (actual or rates of
change) and interest rate charts are telling us, we ought not be surprised by what
happened in Mexico (1982 and 1995), Japan, the "oilpatch" and US
agriculture, US median family incomes, the Gini coefficient of incomes
distribution, Asia 97-98, etc. Disinflation, and in some cases actual
deflation, was simply unfolding in its "normal" Kondratieff pattern and
all the surprises were to the downside. Nor did the usual "proven" ways of
dealing with them during inflation work. It was indeed "the return of depression
economics".
Inventories and infrastructure were being run down since everything would
be cheaper later. Just-in-time inventory practice was was cleverly
marketed as a Japanese breakthrough in technology, but was actually a way of
managing diminished demand in a less costly manner.
The first uptick in GDP (above subsistence levels) after the 1998-99
blowout commodity lows exposed, first in energy, just how rundown
inventories, infrastructure, and development really were. California
airhead environmentalism and Arabs are blamed for the problems, but the facts are
there was peersistently diminished demand which did not make increased
investment for new supply profitable or a budgeting priority for industry
or government.
Nascent GDP growth and neo-inflation were hit with both a tripling of
energy proces (in some cases) and increased interest rates all at the same time.
We are about to see whether the curious notion that shortages of energy
could be cured by increased interest rates will in fact send us back into
true disinflation or worse for a while longer. In other words, did the
Long Wave in fact bottom in 1998-99 and what we now have is a first inflation
scare recession, as in 1946-49; or is the bottom still out in the future.
I think it's the former, but we'll see over the next six months.
In either case, the evidence suggests to me that we are in a transition
period from disinflation to reinflation as in the 1890's and 1940's. And
soon we will all pat ourselves on the back for persisting in whatever it was we
did which turned it all around.
TD
TD@TenorioResearch.itgo.com
tenorioresearch.itgo.com
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