“Confused concepts result in catastrophic consequences,” says George Reisman. This is true. The latest example of this is the confused response to “deflation,” which result is likely to be as catastrophic now as it was in the early thirties.
Seen properly, deflation is not falling prices – deflation is actually a contraction of the money supply (of which falling prices is one result), which in the present circumstances is the inevitable result of the fractional reserve banking system. And, says Reisman,
If there is a deflation, in the correct sense of a decrease in the quantity of money and/or volume of spending, then falling prices, so far from being the cause of deflation/depression are the way out of it. In such circumstances, a fall in wage rates and prices is precisely what’s needed to allow a reduced quantity of money and volume of spending to buy all that a previously larger quantity of money and volume of spending bought…
Viewing the fall in wage rates and prices that is needed to recover from deflation as itself being deflation and thus preventing the fall in wage rates and prices, as occurred under Hoover and the New Deal, serves only to perpetuate the unemployment and depression.
But the mainstream economists are still trying to pump up spending. They’re still trying to reward debtors and penalise savers by lowering interest rates and pumping up the money supply by easy credit, thereby (they hope) re-inflating the economy. But their pump priming won’t allow the economy to correct –- which is what the recession is telling us is vitally necessary: it is likely only to further deplete the pool of real savings that is needed for real correction, and to keep high the prices that need to drop if correction is ever going to happen.
They’ve clearly learned the wrong lesson from the Great Depression. Sadly, the new head of Obama’s Council of Economic Advisors is one of those who’s learned that wrong lesson, as C. August at Titanic Deck Chairs reports. Christine Romer, the newly appointed head, is another like Fed chairman Ben Bernanke who thinks the primary error of the depression years was what government did in the early thirties – ignoring completely what was done in the twenties to bring on the Great Crash. And they draw precisely the wrong conclusion about what was done in the thirties, meaning their solutions are the same toxic poison as Hoover applied: keeping prices up. In other words, she’s the same sort of “expert” who caused that crash with gobs of easy credit, and who caused the present crash by the same means. Her argument is that
“the US government's inadequate response during the Depression was a "policy mistake of monumental proportions."
Well yes it was – but not in the way Christine thinks. To Obama’s new senior advisor, the explosion of American deficit spending in the thirties that sucked capital away from productive enterprise and served to prolong the American Depression was not too much but far too little.
That may mean she will urge Obama to act aggressively to keep capital flowing through the financial system and to enact an economic stimulus package that injects government spending into the economy at the risk of ballooning the deficit.
"She'll be weighing in on the side of a large stimulus," said J. Bradford DeLong, a fellow Berkeley economist.
"Keynesian ideas have never left the rooms of government and central-bank decision makers. The essence of the thinking of the most influential economists was and still is Keynesian. So various stimulus packages that are now introduced are a continuation of the same Keynesian policies we have been subjected to for many decades. The present economic crisis is the outcome of the large dose of Keynesianism we have been given over many decades."
As was the economic crisis of the thirties – though the so-called experts still refuse to look any further beyond the Great Crash to what was being done in the twenties to cause it. Our friend at the Titanic Deck Chairs blog points to one luminary who has done that job: Henry Hazlitt.
For an alternate view, let's look at a description of what Henry Hazlitt had to say about the causes and lessons of the Great Depression. From "Hazlitt and the Great Depression" by Jeffrey Tucker (1993):
A stable market order, he said, requires an atmosphere free of shocks, or at least a government that allows the economy to correct once those shocks had occurred. The [First World War] had artificially inflated the prices of commodities and they needed to correct downward to a more realistic level. He argued the crisis of 1929 was that downward correction.
"But the focus of this collapse," he wrote, "was aggravated enormously by the whole series of post-war policies." Among these he listed the "vicious Treaty of Versailles," the "disorganization caused by reparations and war debts," the "preposterous tariff barriers thrown up everywhere," the abandonment of the gold standard [and Britain’s ridiculous adoption of the pre-war parity with the dollar] and the adoption of the "gold-exchange standard," and "reckless lending to foreign countries.
Most importantly, he blamed the "artificial cheap-money policy pursued both in England and America, leading [in the US] to a colossal real-estate and stock-market speculation under the benign encouragement of Messrs. Coolidge and Mellon." This malinvestment, caused by inflationary policies, created distortions in the capital stock which called for correction.
Those same (or similar) distortions exist now, and for the self-same reasons. And as long as governments far and near continue their inflationary pump priming, the many malinvestments will continue to suck in and consume real capital, and prices will remain uncorrected.
Which means at best that the recovery everyone one wants will be forever and inevitably delayed: the inevitable and catastrophic consequence of some enormously confused concepts.