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Saturday, October 18, 2008


the egalitarian defense

there are many views on the credit crisis, but perhaps few that offer an honest dissent from the underlying framework -- one which crosses party lines -- of market-based capitalism of varying degrees of regulatory weakness and the resolution of a quantitatively large but qualitatively normal credit boom/bust that was the product of that weakness.

here is one from economic historian james livingston -- part one and part two -- and a worthwhile one.

Contemporary economists seem to have reached an unlikely consensus in explaining the Great Depression--they blame government policy for complicating and exacerbating what was just another business cycle. This explanation is still gaining intellectual ground, and it deeply informed opposition to the bail-out plan. The founding father here is Milton Friedman, the monetarist who argued that the Fed unknowingly raised real interest rates between 1930 and 1932 (nominal interest rates remained more or less stable, but as price deflation accelerated across the board, real rates went up), thus freezing the credit markets and destroying investor confidence. ...

The assumption that regulates the argument, whether conservative or liberal, is that these two crises [the Depression and the current one] are like any other, and can be managed by a kind of financial triage, by treating the immediate symptoms and hoping the patient's otherwise healthy body will bring him back to a normal, steady state.

[But] [t]here is another way to explain the Great Depression, of course. It requires looking at the changing structure or "long waves" of economic growth and development, digging all the while for the "real" rather than the merely monetary factors. This explanatory procedure focuses on "the fundamentals," and typically treats the financial system as a tertiary sector that merely registers the value of goods on offer--except when it becomes the repository of surplus capital generated elsewhere, that is, when personal savings and corporate profits cannot find productive outlets and flow instead into speculative channels.

livingston thereafter articulates the long wave structural drift in the distribution of the fruits of declining net investment and growing productivity, which began to trend in the late 1960s away from wages and income to profits and capital -- resulting in record corporate profits concentrating wealth in the hands of the few, resulting in the long decline in real wages which has been observed -- even as consumer spending became increasingly critical for economic growth. this is, as livingston notes, exactly the same dynamic witnessed in the decades leading up to the great depression.

Look first at the new trends of the 1920s. This was the first decade in which the new consumer durables--autos, radios, refrigerators, etc.--became the driving force of economic growth as such. This was the first decade in which a measurable decline of net investment coincided with spectacular increases in nonfarm labor productivity and industrial output (roughly 60% for both). This was the first decade in which a relative decline of trade unions gave capital the leverage it needed to enlarge its share of revenue and national income at the expense of labor.

These three trends were the key ingredients in a recipe for disaster. At the very moment that higher private-sector wages and thus increased consumer expenditures became the only available means to enforce the new pattern of economic growth, income shares shifted decisively away from wages, toward profits. At the very moment that net investment became unnecessary to enforce increased productivity and output, income shares shifted decisively away from wages, toward profits. ...

So the "underlying cause" of the Great Depression was a distribution of income that, on the one hand, choked off growth in consumer durables--the industries that were the new sources of economic growth as such--and that, on the other hand, produced the tidal wave of surplus capital which produced the stock market bubble of the late-1920s. By the same token, recovery from this economic disaster registered, and caused, a momentous structural change by making demand for consumer durables the leading edge of growth.

the similarity to today is striking. one result of such an analysis:

More astute crisis management could not have saved the day in the early 1930s, no matter how well-schooled the Fed's governors might have been. The economic crisis was caused by long-term structural trends ... So even when the federal government offered all manner of unprecedented assistance to the banking system, including the Reconstruction Finance Corporation of 1932, nothing moved. It took a bank holiday and the Glass-Steagall Act--which barred commercial banks from loaning against collateral whose value was determined by the stock market--to resuscitate the banks, but by then they were mere spectators on the economic recovery created by net contributions to consumer expenditures out of federal deficits. ... if a "credit contraction" was not the "underlying cause" of the Great Depression and its sequel in our own time, then no amount of "credit expansion" will restore investor confidence and promote renewed economic growth.

the implication for today is obviously difficult. as eager as government is to throw money at the banks, few on either side of the aisle are prepared to use government to coerce the wealthy and redistributing purchasing power down the ladder.

it's been previously considered that we may be at what thomas kuhn called a paradigm shift -- where the generally accepted principles of the current way of considering issues and problems has effectively run its course, where continuations of the paradigm are rendered counterproductive by vice of their perpetuation of imbalances which are not exactly unseen but are perhaps unappreciated.

rejecting the monetarist view of a normal credit cycle aggravated by inept monetary policy as the cause of depression -- or, acknowledging the bust to be not central but symptomatic of a deeper problem of income disparity resultant of the social priorities of the reigning paradigm -- is at least unusual if not novel in indicting the paradigm grounded in the principles of managed credit and monetary policy as espoused by friedman -- what might be disparaged as "free market fundamentalism". but it may be precisely what we are witnessing.

herbert hoover has unfairly got short shrift despite heroic efforts proffered through the lens of the 1920s paradigm not far different from what we've lately seen, in part on friedman's indictment. could it now be the turn of the late friedman and his acolytes -- ostensibly among them alan greenspan, ben bernanke, and hank paulson, not to mention the entire republican economic mythology as well as much of the democratic! -- to be revealed before a withering crisis?

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The way in which concentration of wealth aggravated both the Great Depression and this crisis have been under-appreciated until recently... I had thought until last year some time that it was a somewhat recent observation, but apparently one of key famous figures in finance following the Great Depression wrote about it in detail in the 40s or 50s. Unfortunately I can't think of who, nor find the blog post where I learned that :(

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it's particularly tough, hbl, with capital being concentrate in hedge funds and other yield-seeking vehicles that hold all these ponzi securities -- which are only now starting to be liquidated in earnest. as finance delevers, capital is getting punched in the mouth -- it'll be hiding in its room for a while after this (what's left of it), and that will make recovery difficult.

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Ah, it's right there on wikipedia now -- Federal Reserve chairman Marriner Eccles. Most likely you knew this already but I found it interesting how long this theory has been around.

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that's a great catch, hbl -- nicely done. i know that a. gary shilling is forecasting a freefall in consumer spending -- he had suspected it might come in for september not the (-1.2%) it was but closer to (-5%). he may just get that in october. and that could catapult equities deeper into the abyss.

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