Tag: economics

Okay, it’s more of an anecdote than a parable. But it’s an important one anyhow:

Our daughters are 15 and 17. Most of their friends are very concerned about their parents’ financial situations and tell me their parents have too much debt. Whether their parents know it or not, these kids know exactly what is going on and they are scared.

My oldest daughter told me this week that her friend “K”‘s mother is jealous of me. I asked her why, and she said her friend’s mother thinks I never worry about money and seem carefree. I told my daughter that is only because we don’t have debt.

I reminded her of the years when her friend K’s family went on cruises while we were tent camping in a state park. I told her that her dad and I made a decision when we first got married that we weren’t going to buy anything, not even a car, until we had the cash to buy it.

We previously had a mortgage, but we paid it off in 13 years. I told her we just didn’t want the stress. She gave me a hug and walked away without saying anything.

What you give your kids isn’t limited to the material possessions you give them. In fact, those are the least important things you can provide.

While Thomas Sowell is generally right as to his theme of government intervention converting the crash of 1929 into the Great Depression, he is woefully incorrect with regards to the details of how and why it happened:

The widespread belief is that government intervention is the key to getting the country out of a serious economic downturn. The example often cited is Pres. Franklin D. Roosevelt’s intervention after the stock-market crash of 1929 was followed by the Great Depression of the 1930s, with its massive and long-lasting unemployment.

This is more than just a question about history. Right here and right now, there is a widespread belief that the unregulated market is what got us into our present economic predicament, and that the government must “do something” to get the economy moving again. FDR’s intervention in the 1930s has often been cited by those who think this way.

What is on that one page in Out of Work that could change people’s minds? Just a simple table, giving unemployment rates for every month during the entire decade of the 1930s. Those who think that the stock-market crash in October 1929 is what caused the huge unemployment rates of the 1930s will have a hard time reconciling that belief with the data in that table.

Although the big stock-market crash occurred in October 1929, unemployment never reached double digits in any of the 12 months after that crash. Unemployment peaked at 9 percent, two months after the stock market crashed — and then began drifting generally downward over the next six months, falling to 6.3 percent by June 1930.

This was what happened in the market, before the federal government decided to “do something.” What the government decided to do in June 1930 — against the advice of literally a thousand economists, who took out newspaper ads warning against it — was impose higher tariffs, in order to save American jobs by reducing imported goods.

This was the first massive federal intervention to rescue the economy, under Pres. Herbert Hoover, who took pride in being the first president of the United States to intervene to try to get the economy out of an economic downturn. Within six months after this government intervention, unemployment shot up into double digits — and stayed in double digits in every month throughout the entire remainder of the 1930s, as the Roosevelt administration expanded federal intervention far beyond what Hoover had started.

While Thomas Sowell was among the economists I liked and respected most in college, I knew that he had lost his fastball when he wrote a column defending Michelle Malkin’s In Defense of Internment that contained some factual errors regarding Pearl Harbor. When I emailed him information demonstrating that both he and Malkin were factually incorrect and her conclusions were false, he basically hemmed and hawed and said that it really didn’t matter because he likes her work. After that, I pretty much ceased to pay attention to his columns. But a number of people have emailed me this column on the Great Depression, thinking that I would approve of it. And while the cited example of historical employment statistics is a really useful one that I wish I had included in RGD, I have already shown that Sowell’s contention here about the root cause of the unemployment to be false there.

For many years, it was supposed that the Smoot-Hawley tariff of 1930 played a major role in the economic contraction of the Great Depression. As more economists are gradually coming to realize, this was unlikely the case for several reasons. First, the 15.5 percent annual decline in exports from 1929 to 1933 was less precipitous than the pre-tariff 18.3 percent decline from 1920 to 1922. Second,
because the amount of imports also fell, the net effect of the $328 million reduction in the balance of trade on the economy amounted to only 0.3 percent of 1929 GDP. Third, the balance of trade turned negative and by 1940 had increased to nearly ten times the size of the 1929 positive balance while the economy was growing.”
– The Return of the Great Depression, p. 192

Because Sowell subscribes to neo-classical economic theory, he has no idea why the Great Depression occurred and he still hasn’t recognized that we are in the Great Depression 2.0. His instincts are sound enough; he knows that government intervention can’t solve the problem but because his economic model doesn’t account for debt, he can’t figure out what the core problem is. So, like most free market-oriented mainstream economists, he casts about for something that the government did that fits his model and assumes that it must be the causal factor, even when the evidence clearly shows that it was, at most, a trivial factor.

The thing that is so patently absurd about the Smoot-Hawley tariff theory of the Great Depression is that America was not an import/export-based economy 80 years ago. The percentage of imports and exports as a percentage of GDP was so small that not even shutting them down completely could have caused such a massive contraction in the 1930s American economy. Debt was the problem then and debt is the problem now. The federal stimulus exacerbated the problem then, and the global stimulus is exacerbating the problem now. And given the relative size of historical debt+stimulus to present debt+stimulus, it should not be hard to understand why the Great Depression 2.0 will be worse than its historical predecessor.

“Due to the sizeable bear market rally that began in March 2009, many, if not most, economic observers are presently convinced that the global economic difficulties of last autumn are largely behind us now, courtesy of the aggressive, expansionary actions of the monetary and political authorities. They are wrong. It is not over. It has only begun. I believe that what we have witnessed to date is merely the first act in what will eventually be recognized as another Great Depression.”
– Vox Day, The Return of the Great Depression, June 29, 2009

“We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.”
– Paul Krugman, The Third Depression, June 28, 2010

It looks like my predictions are running a little ahead of schedule again. RGD readers will recall that I didn’t have the mainstream economists starting to whisper about the possibility of a Great Depression 2.0 until the end of 2010. This is supposed to be the time for talking Double-Dip and W-shaped Recovery. But then, Krugman has always been rather more dyspeptic than the rest of his colleagues. I await with interest for all of those who said that my forecast was incorrect because I dared to contradict a FAMOUS ACADEMIC and NOBEL-PRIZE WINNER to explain this mysterious failure of credentialism.

Krugman is wrong about the historical use of the term depression, of course, (depression was synonymous with recession until after the Great Depression ended), just as he is wrong about the reason the global economy is sliding further into contraction. Fame and credentials are no substitute for the knowledge of history combined with a reliable theoretical model. Longtime readers who are investors may recall that my 2002 recommendation to buy gold and avoid real estate has worked out just a little better than Krugman’s 2002 recommendation to buy real estate and avoid gold.

It’s illuminating to see what small readerships are possessed by the most popular economics blogs. Because I read Mike Shedlock and Calculated Risk, I always assumed that a number of the long list of blogs on their blogrolls were similarly well patronized. But apparently that’s not so much the case, although the omission of sites like Karl Denninger’s Market Ticker indicates that around half of the bigger fish are missing from this survey. But if EconDirectory’s list of top economics blogs is to be trusted, then this would appear to be the 11th most trafficked economics-related blog, in between #10 VoxEU’s 12,405 daily pageviews and #11 TaxProfs 8,041. It’s the same when it comes to visits, although if one adds the 1,400 feed readers – this is one of the few blogs to provide full-text feeds that negate the need to come here to read the posts – that would bump VP up to #9.

This is both scary and heartening. It’s scary, because if even the most popular econ blog only attracts 56k daily readers, it’s not hard to understand the level of economic ignorance on the part of the elite and the electorate alike. And it’s heartening, because this indicates it is feasible to reach a substantial percentage of the people who are sufficiently interested in the subject to follow it.

While we’re on the subject, it’s interesting to note that the Wall Street Journal has finally begun to wake up to the intellectual bankruptcy of the Neo-Keynesian response to the initial stages of the Great Depression 2.0:

Today’s G-20 meeting has been advertised as a showdown between the U.S. and Europe over more spending “stimulus,” and so it is. But the larger story is the end of the neo-Keynesian economic moment, and perhaps the start of a healthier policy turn. For going on three years, the developed world’s economic policy has been dominated by the revival of the old idea that vast amounts of public spending could prevent deflation, cure a recession, and ignite a new era of government-led prosperity. It hasn’t turned out that way….

Like many bad ideas, the current Keynesian revival began under George W. Bush. Larry Summers, then a private economist, told Congress that a “timely, targeted and temporary” spending program of $150 billion was urgently needed to boost consumer “demand.” Democrats who had retaken Congress adopted the idea—they love an excuse to spend—and the politically tapped-out Mr. Bush went along with $168 billion in spending and one-time tax rebates.

The cash did produce a statistical blip in GDP growth in mid-2008, but it didn’t stop the financial panic and second phase of recession. So enter Stimulus II, with Mr. Summers again leading the intellectual charge, this time as President Obama’s adviser and this time suggesting upwards of $500 billion. When Congress was done two months later, in February 2009, the amount was $862 billion. A pair of White House economists famously promised that this spending would keep the unemployment rate below 8%. Seventeen months later, and despite historically easy monetary policy for that entire period, the jobless rate is still 9.7%….

The response at the White House and among Congressional leaders has been . . . Stimulus III. While talking about the need for “fiscal discipline” some time in the future, President Obama wants more spending today to again boost “demand.” Thirty months after Mr. Summers won his first victory, we are back at the same policy stand.

RGD readers may recall that I predicted not only the failure of Stimulus II, but the failures of Stimuli III and IV as well. I expect they’ll finally give up on the fruitless endeavor sometime between V and VII. The problem, which even the new-found Neo-Keynesian skeptics don’t understand, is that these failed stimulus packages not only haven’t worked, but they are going to exacerbate the next phase of the contraction that is even now gathering steam. Although they appear to have a glimmer of concern in that regard; consider how the WSJ is ineptly attempting to construct an ex post facto cover for its backside.

“With the economy in recession in 2008 and 2009, we argued that some stimulus was justified and an increase in the deficit was understandable and inevitable. However, we also argued that permanent tax cuts aimed at marginal individual and corporate tax rates would have done far more to revive animal spirits, and in our view would have led to a far more robust recovery.”

In other words, the WSJ still subscribes to the very economic idiocy they are describing as a dead end. It’s not that the magical incantation doesn’t work, it merely wasn’t chanted in precisely the correct manner prescribed in the Keynesian grimoire. This means that we can confidently expect the decision-making elite to continue digging and making the hole deeper as the situation worsens. Note that the average weekly leading indicators are now at -6.9, a decline last seen in July 2008.

This is neither the first nor fourth time that Greece has faced a serious default situation. But, as Michael Pettis of China Financial Markets explains, because so many different things have happened before, the question is less whether history will prove a guide to the future, but rather which historical example will prove to be the relevant one:

The economic recovery in the countries hit by crisis will not begin until they are recognized as insolvent and receive debt forgiveness from their creditors. Preceding every sovereign default is the fiction that the creditor country is simply facing a short-term financing problem, and that with a lot of discipline and a little bit of good will it will be able to work its way out of the crisis. During this period a number of restructuring “solutions” are proposed – all of which involve increasing debt, and often in the most financially destabilising way – which inevitably make the final resolution of the crisis much more difficult and which sharply raise financial distress costs. The most notorious recent example of these terrible “solutions” was Argentina’s disastrous debt swap in 2001, in which it dramatically increased the country’s total obligations while it desperately tried to maintain the fiction that it could somehow grow its way out of its impossible debt burden.

Greece, and probably two or three other countries, simply cannot repay their outstanding debt amounts. Ultimately they are going to default, and then in the restructuring process they will receive enough debt forgiveness that allows them to return to a sound footing and with a reasonable repayment prospect. But as long as they maintain the pretence that they can and will repay the full outstanding amount, and struggle with the burden, the resulting distortions in the economy will mean that businesses will disinvest and the country will not grow.

Historical precedence makes it clear that as long as the sovereign borrower is forced to struggle with an unrepayable debt burden, it will not grow. Eventually, as has happened in nearly every previous case, creditors and borrowers will acknowledge reality and will work out a debt forgiveness plan that will allow the economy to return to growth. Until then, expect weak growth, high unemployment, and constant battles over debt.

Although most US-based economists are convinced that the special status of the dollar somehow renders the USA impervious to economic laws, the danger of US debt default is nearly as great as it is in Europe. The fact that the defaults are likely to begin in the next two years with the state and local governments does not mean that they are going to end there. However, a partial default would be much more likely than a general one, with the USA defaulting on the third of its debt that is presently held by China coming as a prelude to war between the waning superpower and its self-appointed would-be successor.

Major economic and historical transition points are almost always accompanied by large-scale war. I see no reason to believe that this will not be the case again in this repetition of the cycle.

In which I wholeheartedly support Simon Johnson’s call for Obama to nominate Nobel-winning economist Paul Krugman to the Office of Management and Budget:

The president should nominate Paul Krugman to replace Peter Orszag as director of the Office of Management and Budget. We have previously reviewed Krugman’s outstanding qualifications for this (or any other top level) job (link to details). The main reason Krugman himself has been reluctant in the past relates to a potentially difficult Senate confirmation hearing – for example, if Krugman had been put forward to replace Ben Bernanke.

But for the OMB position, the dynamic of a hearing would be terrific for the president’s specific agenda and broader messages. Krugman, of course, is the leading advocate for continued (or increased) fiscal stimulus. This is exactly President Obama’s message to the G20 this weekend.

Plus, when Republicans push back against Krugman on this issue, he will let them have it full blast on fiscal policy during the Bush administration. Krugman has, again and again, been an outspoken critic of the Bush era fiscal policy. He has precise chapter and verse on where the Bush team went off the deep fiscal edge.

I think this is a fantastic proposal for three reasons. Consider the benefits: 1) Krugman gets the chance to prove once and for all that Neo-Keynesian economics does not work even when its foremost champion is in a position of power. 2) He will no longer be writing ridiculous opinion columns. 3) Within 18 months, the rest of the world will be forced to acknowledge that Krugman is a maleducated ignoramus who knows virtually nothing about relevant economic theory. 4) Mainstream economics can finally move on from an outdated and destructive economic theory.

And there’s no downside. It’s not as if Obama is going to appoint anyone who understands the first thing about the present contractionary crisis, after all. Krugman can’t possibly make things any worse than whatever clueless hack ends up getting appointed; for all Krugman’s willful theoretical incompetence, he’s actually less cretinous than the average mainstream economist.