Friday, July 30, 2010

Hooray for the Economic Recovery … of 2016 [update 2]

Back around 2007, when things were beginning to get hairy economically, a few of us were saying that governments must not help to prop up all the bad positions that had been taken in the boom; that the poison of all those malinvestments had to be expunged before recovery could take place; that propping up the malinvestments would simply leave zombie companies walking around eating the economy’s sustenance; that there was no choice at all about the economic pain we now had to endure for awarding ourselves an unsustainable boom—the only choice was whether it took a year or so of short, sharp pain or (like Japan) ten years or so of long drawn-out misery.

Sadly, three years and several trillion dollars too late, the US Federal Reserve might finally be coming to that same conclusion.
“Notes from the latest Fed Beige Book that make it clear that the Fed is (finally) beginning to understand the entrenched and endemic nature of this crisis. While the notes are written in shamanic double-speak, the point is clear: members of the Fed don't expect the economy to get back on track until 2015 or 2016.
'Participants generally anticipated that, in light of the severity of the economic downturn, it would take some time for the economy to converge fully to its longer-run path as characterized by sustainable rates of output growth, unemployment, and inflation consistent with participants' interpretation of the Federal Reserve's dual objectives; most expected the convergence process to take no more than five to six years.’
     “The simple reality the Fed is waking up to is that the structural underpinnings of the economy are damaged beyond any quick or easy fix.
    “That's because until the excess and/or bad debts are wrung out of the system - either through default or raging inflation - there's no chance of any sustainable economic recovery. Each new government initiative - the latest being financial reform - that doesn't decisively address the debt, but rather tightens the government's around private enterprise, only serves to delay or prevent economic revival. And so each new day will bring more distress and bankruptcy to homeowners, businesses, and banks.”
Crikey, in an alternative universe we could have seen economic recovery in February, 2009. Instead, here we are eighteen months later getting deeper into the mire.

As we’ve said here before countless times and with every metaphor we can muster, the poison has to be allowed out of the system before the economic patient will come right. No amount of phoney funds is going to turn the lead weighing us down into gold. Letting real prices and wages fall to match the new demand and monetary conditions—remembering that one man’s prices are another woman’s costs--allowing everybody to do more with the lower amount of money and demand now going round--is in the end the only sustainable way to effect that process.  Keeping up prices with unsustainably low interest rates and truckloads of funny money is not.

There is no choice about the pain of correction.  It has to happen.  Unprofitable businesses need to be liquidated and the resources therein transferred to something more profitable. Bad loans need to be liquidated, and any assets involved used as fertiliser for real growth.  People have blundered, and we have no choice about the need to liquidate those blunders so they don't go on consuming real resources.
We have no choice about correction. The only choice is how long it takes -- how long the pain of correction will last -- and how many real resources are consumed along the way.

Here’s Peter Schiff talking about Alan Bollard’s rate rise this week, and why The Fed can’t do the same.  Not for years. And why that's not something in any way to be happy about.

UPDATE 2: In this exchange with Congressman Ron Paul, monetarist Dr Allan Meltzer explains two things.

First, even while they’re contemplating firing up the printing presses for Quantitative Easing II, they still have no plan whatsoever to mop up after those truckloads of dollar bills were pissed away in Quantitative I. Scary.

Second, he asks (quite sensibly) what sensible investor is going to risk his money at the moment when he has no idea what the government or its agents are going to try next. This, people, is precisely the regime uncertainty that Robert Higgs argues helped extend the Great Depression out for more than a decade-and-a-half. [Hat tip The Cobden Centre]

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