Wednesday, May 13, 2009

Understanding economic crises [update 3]

Here’s a good deal.  Most of the country’s business reporters – and nearly every single one of the mainstream economists – have no idea what actually happened in the Great Depression.  With these bargain buundle of four myth-busting books, offered at the Mises Store, you can get one huge step ahead of them all:

GDKCCB918 Four telling books for just US$49 – four books that will help you understand what went wrong then, and how so many of the policies that made the Great Depression deeper in the US are being repeated around the world nowHead to the Mises Store to find out more.

If you’re keen, you could add Meltdown, the best short introduction to what just went wrong to cause this latest economic disaster, and Lionel Robbins’s 1934`book The Great Depression, which gives a rational British perspective on the world disaster.

Good reading.

UPDATE 1:  Roosevelt got away with so many of his boondoggles because, for the most part, he had a compliant media on side.  He didn’t have to contend with the blogosphere.

But the ObaMessiah does. 

Blogger Geoff at Innocent Bystander has been checking Team Obama’s projections of US unemployment with and without Team Obama’s pork-barreled stimulunacy  – checking them against reality – and guess what: The charts show that after the passage of the most costly legislation known to man, the US is doing worse not only than the 'With' curve, but even worse than the 'Without' curve.

What do you think that says about the success of spending gobs of money you haven’t got?  What do think that says about the ability of the Messiah’s economists to predict the future? What do you think that says about the sense of all that fiscal child abuse?  As John at Powerline says, "Does it suggest that the administration's wild, wasteful spending and impending tax increases are actually destroying jobs? Shouldn't someone at least think to ask these questions at Obama's next press conference?” [Hat tip Jeff Perren at Shaving Leviathan ]

UPDATE 2:  I posted this here below as a reply to an anonymous commenter yesterday.  Looking at it again, I figured it might be good enough for the front page.  (I’ve tidied it up slightly.)

My interlocutor berated me for criticising Krugman without reading him, and for saying that far from being a bad thing, a collapse of prices would be the very means by which springs to recovery would open up.  “Piffle,” said my un-named adversary, “The recession is caused by a vast drop in demand. And your solution is to reduce wages, ie reduce demand. You're mistaking micro-economic changes with macro-economic outcomes. Unsurprising, since that's the classic blunder of Austrian economics.”  Here’s how I replied:

Yes I will criticise Krugman. He deserves it. And yes, I'm fully aware of what he's been saying. As I said in the post, it's the very Austrian economists Krugman so frequently derides who’ve been pointing out for some time that there is no choice at all about experiencing the pain of retrenchment and slump -- the only choice is whether recovery is allowed to be short and quick (by rapid liquidation of malinvestments) or, like Japan in the nineties, those malinvestments are propped up like corporate 'Weekend at Bernies' survivors that drain the economy for years to come.

That even Krugman is finally starting to wake up to the truth of that, even partially (since he gave it no credence a year or so ago when Jim Rogers et al were making that case) is actually reason not to criticise him in this case -- which is why I didn't. At least, not explicitly. :-)

Piffle? Yes, piffle is certainly a very good short summary of your mainstream economists' understanding of depression economics. You mistake so called "macroeconomics" for something fundamentally separate from "microeconomics," hiding all the important economic 'news' beneath your aggregates, and then you and your colleagues wonder why so called "macroeconomics" is in crisis.

Talk about a classic blunder.  Who exactly are the fools here?

As Ayn Rand said, Macroeconomics is in effect
"a science starting in midstream: it observed that men were producing and trading, it took for granted that they had always done so and always would—it accepted this fact as the given, requiring no further consideration—and it addressed itself to the problem of how to devise the best way for the "community" to dispose of human effort. . .
    "But, in fact, consumers qua consumers are not part of anyone's market; qua consumers, they are irrelevant to economics. Nature does not grant anyone an innate title of "consumer"; it is a title that has to be earned—by production. Only producers constitute a market—only men who trade products or services for products or services. In the role of producers, they represent a market's "supply"; in the role of consumers, they represent a market's "demand."    
    “The law of supply and demand has an implicit subclause: that it involves the same people in both capacities.
    "When this subclause is forgotten, ignored or evaded—you get the economic situation of today.
"

True, huh?

Mainstream economists say that "The recession is caused by a vast drop in demand."  They say that it’s caused by “a general collapse of prices.”  Not much of an analysis, is it? But that's the only answer your mainstream economists have got. That's really the best they can do.

In fact, the Depression isn't caused by either a vast drop in demand or by a general collapse of prices  -- in fact those are both part of what, by definition, constitutes a Depression. They’re actually two of the defining characteristics of a Depression. But so far are they from being a primary cause of depression, they’re actually the result of earlier actions. But your mainstream economists know nothing about that.

  • What caused the slump itself? Don't ask a mainstream economist, they have no idea – and no genuine interest in knowing.
  • What caused the drop in demand? Blank out.
  • How should businesses respond to such an economy-wide drop in demand? Blank out.
  • In which part of the capital structure has the drop in demand been greatest? Blank out.
  • What are the implications of a greater demand drop in the earlier part of the capital structure? Blank out.
  • What is a capital structure? Blank out?
  • How come those mainstream economists who were in the driving seat, who never even saw it coming -- who had no idea then it was about to happen and no idea now what to do -- how come it's those same mainstream economists who are still in the driving seat now (fixing the mess they had no idea they were even creating) whereas those who did see it coming and know what needs to be done now are derided as cranks.
    Doesn't that strike you as something worse than "piffle"?

You might deride Austrian economics as "piffle," but frankly on all these important questions above the Austrian school has answers where your mainstream boys don't even know there are questions -- and what the mainstreamers do know (or think they know) amounts to less than piffle.

Let me show you what I mean by giving some Austrian-based answers to those questions.

Q: So what caused the original slump then?
Well, it sure as hell wasn't laissez-faire!
But let's face it, your "demand drop" theory has a very real problem in getting traction: you see, it only explains what happened after the crash, after the bubble burst.
But what caused the bubble to inflate in the first place?
What fed the bubble for years? (Yes, that is a pun.)
What organisation and which mainstream economic theory was fundamentally responsible for the economy-wide misallocations of credit, and consequently for all the malinvestments[1] for which there is now too little demand?
If you don't know the answer, then why not read those (unlike Krugman) who did know it before it happened. Check out those classic 2006 videos of Peter Schiff for example[1], or the writings of Austrian economists like Stefan Karlsson, Mark Thornton, Thorstein Polleit et al, who were saying this back in at`least 2003[2] (or George Reisman, who was saying it back in 1975!). Or Ludwig von Mises, the development of whose business cycle theory[3] won Hayek his Nobel Prize, and who predicted the 1929 crash and resulting slump -- and whose theory was used by the economists above to make their forward assessment.
1. "Malinvestment" at Mises Made Easier.
2. There's a link to that Schiff compilation video
here.
3. Check out the Mises Bailout Reader: Scroll down to
'Who Predicted This?'
4. Check out the Mises Bailout Reader: Scroll down to
'The Austrian Theory of the Business Cycle'

Q: So what caused the subsequent drop in demand?
Fundamentally,
i) it’s because a substantial amount of real capital was destroyed in all those collapses, bankruptcies and malinvestments -- things that looked profitable on the back of all the counterfeit capital flooding out of the central banks -- and the pool of real savings has now been largely consumed. (Which means that for recovery to happen, the existing capital has to be entrepreneurially reallocated, and the pool of real savings will have will now need to be built up anew.)
So the money supply is reduced, and what were thought to be real assets turn out not to be.  Which means people have less with which to exercise their demand.
ii) it’s because in a slump there's more demand for money than there is for goods -- which in mainstream terms is to say that both the "velocity" and quantity of money has dropped.
People want to hold more money to protect themselves from job uncertainties and the like, and banks (particularly in the inherently fragile fractional reserve banking system) need to urgently rebuild their own reserves (and not just with little bits of new printed paper) and are reluctant to lend out what they do have on bad risks.
But note again that none of this caused the crash: this is all the result of the crash.

Q: So how should businesses respond to such an economy-wide drop in demand?To state the problem precisely is to see the remedy clearly.
First of all, bear in mind what demand actually is: it's desire backed by the means to pay. Fundamentally, that means exchanging real goods and services for real goods and services. Now that real capital has been wiped out, and both the quantity and "velocity" of money have diminished, the "means to pay" has diminished and goods and services now are no longer worth what they were before.
So it's not that demand itself has now dropped, it's that demand at the prices now being offered has dropped.
Fundamentally, the only way to sell now is to lower prices to meet the new lowered level of demand. (Remember the simple equation, Prices = Demand/Supply?)
And since to sell goods and services at that new level means essentially selling at a loss (another defining characteristic of depressions) then we see the urgency of businesses adapting to the new lowered level of demand by lowering their costs to suit the new economic realities. It's either adapt or die.  (If only governments would get out of the way so this could happen!)
It's in this way that "deflation" (as you and your colleagues would call it) is not the cause of the problem, but actually the solution to getting things back on track again.[5]
But, you might object, why not just reinflate the world's various money supplies, as all the world's central bankers are now trying to do (the most vigorous along these lines being Mr Bernanke and Mr King)? The short answer to this, to paraphrase Ludwig von Mises in a similar context, is that trying to reinflate the money supply in the hopes of achieving economic recovery is like backing over a man you've just run over in in the hopes of effecting a medical recovery.
The eggs are already scrambled -- the body is already mangled. Reinflating simply exacerbates every problem created by the slump, it sustains every zombie malinvestment, it rewards every failed lender and borrower, and it puts every unstable position on life support -- not to mention the new misallocations brought about by the new bubble and the enormous sums now being printed (and the theft from savers such profligacy represents).
This is fundamentally what Japan tried in the nineties -- and Roosevelt tried in the thirties. Didn't work then, won't work now.  Japan’s stimulunacy led to what they still call “the lost decade.”  Roosevelt’s led to an extension of the depression. The fundamental reason is that the "lack of purchasing power" is not the fundamental problem[6]; the consumption of capital and the diminution of the pool of real savings is.
Real capital has been consumed. Stimulunacy won't help that; quite the reverse. Printing more little bits of paper won't replace it all-- and you'd have to be a very special kind of fool to delude yourself that they could[7].
5. See especially George Reisman's 'Falling Prices Are Not Deflation but the Antidote to Deflation.'
6. No, it's not. At lower wage rates, more workers are emplyed and total wage payments actually increase -- as mainstream macroeconists would understand if they looked beyond their phony aggregates. See George Reisman's '
Standing Keynesianism on Its Head: as Employment Increases in Response to a Fall in Wage Rates, the Rate of Profit Rises, Not Falls'
7. See for example on this point George Reisman's '
Capital, Saving and our Economic Crisis.'

Q: What are the implications of a greater demand drop in the earlier part of the capital structure? What's a capital structure?
No, these are not questions mainstream economists are even asking, are they - as Austrians from Robert Murphy to Mark Skousen point out it's mainstream economists’ blanket ignorance of this whole field that is a fundamental part of the problem, since at the end of the day it's misallocations in the capital structure brought about by all that counterfeit capital that kick off all the problems in the first place.[8]
But everyone from Krugman to Chicago school economists, from Keynesians to neo-Keynesians, from supply siders to the so-called Rational Expectations wallahs seemingly have no idea such a thing as the capital structure even exists -- they think you can subsitute the simple number 'k' for what is essentially the engine of the whole economy, the place where in fact over two-thirds of all spending actually does happen -- which is, as I say, really the problem here. Ignoring the structure of production (to use Skousen's title[9]) or the Macroeconomics of capital Structure (to use Roger Garrison's[10]) is just downright ignorance, and allows alleged economists like yourself, sir, to cite the easy Keynesian gloss of "a drop in demand" (what kind of demand? in what areas of the capital structure? demand backed by what?) as the leading cause of our economic collapse.
8. See Robert Murphy, 'The Importance of Capital Theory.'
9. Mark Skousen, The Structure of Production10. Roger Garrison Time & Money: The Macroeconomics of Capital

In fact, you know, the leading cause of our economic collapse is the fundamental intellectual bankruptcy of all schools of mainstream macroeconomics:

They didn't see it coming.

Their own economic models were responsible for it happening.

And now they've caused it, they're still in the driving seat trying to effect a cure with the very means by which they caused the problem in the first place.

As Thomas Woods says in his excellent book-length summary of the whole sorry saga, Meltdown[11], it's like watching medievalists applying leeches.

So finally, as Mark Brandly says: "If you are an economist and did not see this coming, you should seriously reconsider the value of your education and maybe do something with a tangible value to society, like picking vegetables.”
11. Thomas E. Woods Jr., Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse.

UPDATE 3: Anti Dismal has a note about a new British book that looks worth getting hold of:

A very interesting statement was published, 12th May, in the Daily Telegraph (UK), in which fourteen leading economists - authors of the new IEA study, Verdict on the Crash - explain how government failure caused the financial crisis and why politicians’ calls for tighter regulation are misconceived. The statement reads:

“The prevailing view amongst the commentariat (reflected in the recent deliberations of the G20) that the financial crash of 2008 was caused by market failure is both wrong and dangerous. Government failure had a leading role in creating the conditions that led to the crash. . .”

Read on here for the whole statement and more!  (And don’t neglect to check out The Standup Economist.

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7 Comments:

Anonymous LGM said...

Well written! It about sums up the mess. It also demonstrates the incometance and ignorance of the court jesters crowding on bended knee at the hem of the Obamamessiah's skirts. Economists, they call themselves. They don't have a clue what economics is. They should be called what they are- propagangists, opportunists and exploiters!

LGM

5/13/2009 09:53:00 am  
Blogger Rajesh said...

Great writing. As I have mentioned on my blog about your post "It is a lesson in the real economics (the Austrian variety) and a must read for anybody concerned about the (rotten) state of affairs in the world today.
With free-market capitalism under attack (ironic, since it went out of fashion long time back), we have a unique situation where the patient is hell-bent on kicking the very medicine which will cure him. Here we have Dr.PC telling us about the cure and why we should stop listening to the quacks (Krugmen and his tribe)."

5/14/2009 06:31:00 am  
Anonymous Anonymous said...

Look its really fucking simple.

Most people in the west are bludgers living on benefits that their societies cannot afford. This is especailly true in NZ. The Dole. The DBP. WFF - and even more corrosively, "free" health and "free" education. Everyone in NZ believes they have some fucking right to a car, a house, a PS2, friday night at the movies, saturday at the pub and on and on and on

While producing absolutely nothing of value.

Frankly, most Kiwis don't deserve any of the above. Most of 'em don't make enough to pay for their own power and water, let alone food.

Remember that the most productive 30% of Kiwis are already working overseas it is only the dregs who are left here.

Now we are told that a) the government is looking at a $20 Billion defecit this year - and fuckloads more debt to come; and b) the overseas bankers have finally woken up to how lazy and crap NZ is, and won't lend us any more money. Big fucking suprise
The only responsibility thing for the government to do is to drastically reduce expenditure to not only match income, also to pay off all external debt as quickly as possible!

What does this mean: at least a 50% cut in health, education and above all welfare spending: the responsible thing to do is just chop the lot as of the day after the budget. We could sell of every state asset but that won't make much difference to out debts.

Drastically reducing spending, eliminating welfare. health, and education, and eventually enabling tax cuts for business only, is basically the only responsible option we have left.

Or do you really think Key the currency trader is right to play with the future of the country the way he played *inside* his bank's risk margin? Because NZ doesn't have a risk margin, we have only one chance at this, and Key's "borrow and hope for recovery" has a great chance of crashing the entire country, making NZ the next Iceland!

5/14/2009 08:52:00 am  
Anonymous Anonymous said...

I still say Piffle!

There's so much wrong here that I don't know where to start...

Of course the lack of demand had a proximate cause - it was the collapse of a credit bubble. A credit bubble based partly on a real estate bubble. And a recession caused by credit collapse related to real estate bubble is a pattern we've seen in modern economies over and over and over since at least the 1820s.

As for the rest...

Shall we take your Rand quote in which she claims that macro economics fails to understand that consumers must also be producers. But that thing that she claims they don't get is actually Keynes central point! Consumer's won't consume if they think that no-one will buy what they're producing - because consumers must be producers too!

Shall we mention your obligatory Roosevelent link, in which (as usual) the author (a) bases the entire analysis on unemployment figures and (b) uses unemployment figures that counts all the people employed in the New Deal by govt relief agencies as "unemployed"? Show up to work each day, build a dam, get paid a wage - nope, sounds like unemployment to me...


But the fundamental problem with your view is that you base it on a distrust of capitalism. You don't think capitalism works. Seriously. If you did you'd have no fear of the govts inflating the money supply now. You say it will keep every "zombie enterprise" and every "misinvestment" intact. But that's only true if the market doesn't outcompete them. Industries restructure vastly during booms as well as busts: and that means enterprises that are losers as much as enterprises that are winners. The average employee doesn't see that as in a boom with low unemployment he just moves to another job. But as a boss I sure as hell see it. You don't need a bust to clean out bad businesses. That you think we do shows that you (and the Austrian school) distrust the mechanisms of the market.

5/14/2009 10:40:00 pm  
Anonymous LGM said...

Anonymous moron.

You're explicitly backing government interference in business with your acceptance of currency inflation. That aint Capitalism. That's you mistrusting Capitalism and supporting socialised money. In other words, you are a socialist.

The socialist economic system does not work and never has. It won't work now either. No surprises there.

It is to be hoped this recession sees the liquidation of your activities and interests as the result of government interference. That would be justice.

LGM

5/15/2009 07:30:00 am  
Anonymous Falafulu Fisi said...

PC said...
The charts show that after the passage of the most costly legislation known to man, the US is doing worse not only than the 'With' curve, but even worse than the 'Without' curve.PC, I have had clash with you on here on this blog about using future projection (forecasting, simulation, etc,...) and your position is quite clear, ie, you're dismissive of anything forecasting, future projection and so forth. My position on modeling of future trend is useful but no guarantee and your position is that such projection, forecasting is useless, end of story.

Why are you posting a chart on this post, showing a future projection (aka forecasting), when in fact , it is the very thing you dismissed as bollocks that warrants no attention at all.

Do you care to explain?

5/15/2009 09:11:00 am  
Blogger Eric Olthwaite said...

Superb writing Peter, the clarity that you / Austrian economics brings to this whole mess is very welcome. Kepp it up for all our sakes.

5/30/2009 10:55:00 am  

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