Ok, I'm going to weigh in on the "deflation" debate. I think we are headed for one in asset prices, and the Minsky theory nails it. This is not the same as input goods prices however, and both Minsky and Fisher make a clear distintion, and so do I. I think commodities and input goods will deflate some (depends on degree of gearing and speculation), but not nearly to the degree that financial assets do. And how would bonds do in an asset deflation? Terrible in my view, as the ability to service debt is crippled, bonds of all leveraged classes will be butchered and downgraded, including US Treasuries, and yields will rise not fall. For investors, the key will be holding the most solvent, unleveraged financial instruments and hard assets. Gold now? Don't really think so, speculators are in place. Are there any states that have run non-Bubble economics, or where excessive gearing has taken place? Kansas and Texas GOs?
photos1.blogger.com
The problem even with that is this, more late stage catch up Bubbles;
thehousingbubbleblog.com
Countries? Hard to find really.
Some writing on this:
itstheeconomy.blogspot.com
While few analysts have been specific, most seem to be concerned about the possibility of a 1930s-style deflation. Irving Fisher called this a "debt deflation" and Hyman Minsky was fond of pointing out that while output prices fell by only 25% during the Great Depression, asset prices fell by 85%. That is, unlike most current commentators, both Fisher and Minsky emphasized falling asset prices most prominently of equities and farms in the case of the 1930s, not falling indices of output prices.
This is not to imply that the two price systems are unrelated. In Minsky's view, competitive pressures and inadequate demand due in large part to declining investment spending as well as inappropriate fiscal policy led to falling sales and output prices. This in turn led to lay-offs and pressure to cut wages. Falling wages, however depressed demand further and led to a vicious cycle of price cuts, declining wages, and falling employment and sales. That was bad enough. But because the 1920s had been marked by a runup of private sector debt (the first consumer debt explosion occurred in the 1920s as households financed purchases of the new electronic products made available; farmers had borrowed heavily to finance land purchases; and the finance of investment by firms had changed markedly with the rise of what Rudolf Hilferding called "finance capitalism", to rely on greater external finance), and because debts are in nominal terms, falling sales prices and wages made it impossible to service the debt. Defaults snowballed and brought down the banking system, wiping out the savings of depositors.
Minsky liked to say that the financial system became "simplified" as most of the financial assets and liabilities disappeared. The lasting effects were fear of indebtedness, and hence financial conservatism, as well as destruction of banker/borrower relations that impeded recovery and contributed to the decade-long depression (made worse, as discussed below, by errant fiscal constraint).
This analysis points out that the deflation was mainly in asset prices, and the result of excessive "inflation" in asset prices that had occurred before the crash. In order to afford the higher priced assets (as well as everything else being produced), households, businesses and financial concerns borrowed heavily, and were thus unable to raise enough cash to pay those debts when economic activity subsided. Defaults spread to the banking system, to the point where the lending system could no longer function. While Minsky is mostly associated with Keynes, and Fisher was a neo-Classical economist, this is a very Austrian concept.
The three types of policies used during the Great Depression to fight deflation were price supports to prevent falling prices, employment programs to boost demand and prevent falling wages, and monetary policies (monetary injections and lower interest rates) in order to boost lending, consumption and investment. Ultimately, few of these have much impact on asset prices, as the contraction of credit is a much more powerful economic force. It is possible to re-inflate by bailing out the lenders, something that the paper notes about the Savings and Loan bailout of 1991.
When the savings and loans failed, the Bush (senior) administration's rescue plan was formulated and executed in such a way that asset prices were depressed by fire-sales of thrift assets by the Resolution Trust Corporation. As it turned out, this did not generate a general asset price deflation because the long 1990s expansion together with the post-1987 stock market bubble allowed asset prices and financial institution balance sheets to recover.
But this is not a permanent solution, as the bailout of bad lending decisions only emboldens lenders to make even riskier decisions in pursuit of profits, knowing that the government will step in to cover for any mistakes. This leads to what Minsky called "Ponzi Finance", which results in an even greater possibility of a default-driven deflation. In Minsky's terminology, today's economy (taken as a whole) is much more fragile than it was during the S&L crisis.
While the paper offers the stock solution that increasing government spending to compensate for reduced private spending is the most effective method for fighting deflation, the Austrian argument is that this fails for precisely the same reason that the monetary solution is vilified. The underlying problem is overconsumption (and its corollary overproduction) from the previous boon. Government spending thus becomes the "bailout" for bad consumption and production decisions. The case of Japan is indicative. While no recovery was apparent for more than a decade, government's proportion of consumption rose by half from 26% to 39% of GDP. Much like private businesses bad lending decisions shift to the Fed, the private sectors bad spending decisions shift to the government, which in the U.S. case is much more precarious as a global borrower than during the 1930s, when we were a heavy net creditor to the rest of the world.
The Austrian "solution" is to let the economy contract. While this is unsatisfying for most people in that it is a "do nothing" solution, there is plenty of leeway for government to relieve their citizen's suffering. We have unemployment compensation, welfare benefits, food stamps, subsidized job training programs, Medicare, and other programs that help people survive through bad economic times. But trying to prevent recessions is much like pumping oneself full of amphetamines and trying to keep working, rather than just taking cold medicine and bedrest. The medicine only treats the symptoms, yes, but there is no cure for a cold, just as there is no "cure" for a recession. Like a boom, it is half of the economic cycle.
Perpetual boom, as Minsky noted, actually makes economic agents weaker. They save less and spend and borrow more. They make poor lending decisions based on unrealistic expectations (can anyone say Internet stocks). As a result, when the economy faces problems they are less financially able to deal with them. It really doesn't help that the Administration is specifically directing benefits to the rich and privileged - you can be an Austrian and a liberal - but the Fed is not able to force banks to make better loans or businesses to make better investment decisions. Nor is the government able to get consumers to save money to finance productive investments. The current growth is just a respite. The next dip will be even more dangerous. |
