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Thursday, February 12, 2009


the vindication of irving fisher

must read.

Economists read the literature about the Great Depression with deep intellectual curiosity and savour in particular the still ongoing debate about its causes and remedies. Keynesians argue that price and wage rigidities and a failure of aggregate demand were the main culprits for the biggest economic catastrophe recorded in modern history. Monetarists posit that the main culprit was a terrible mistake on the part of the monetary authority, because it allowed the supply of money to contract. The new generation of Neoclassical economists argue that serious policy mistakes on the “real side” of the economy, such as the deployment of major trade barriers, turned a cyclical downturn into the Great Depression, and that issues of price rigidities, demand failures, credit, or monetary policy are at best of second-order importance.

In a seminal 1933 article, Mr. Irving Fisher offered a very different and innovative view. He focused on the meltdown of financial markets, the devastating effects of a downward spiral connecting the deflation of assets and goods prices, the process of deleveraging by households and firms, and contraction of economic activity.

Until about eighteen months ago, this was just one more of many unsettled economic questions that academic economists love to dwell on, largely because we don’t have a lot of data on Great Depressions to test our theories and because intellectual arrogance prevented us from taking seriously 1990s meltdowns in emerging markets and the Nordic countries as harbingers of what could happen to the US. Today, as we go through the catastrophic process of Fisher’s debt-deflation mechanism, there is no doubt that Fisher was right and the rest are just stories.

fallout of that admission?

Fiscal stimulus is a band-aid. ... spending will not stimulate anything, and it has nothing to do with the causes of the crisis or with putting an end to it. ... A trillion dollars of fiscal stimulus today will not avoid catastrophe if the financial stabilisation fails. ...

Being realistic, however, even if we had this ideal situation in place tomorrow, a major recession – unlike anything most Americans alive today have ever seen – is unavoidable. Catastrophe is here and we will not escape it. But even the 18-to-24-months catastrophe we are in is not the worst outcome. The worst outcome would be a full repeat of the Great Depression. The worst of the Great Depression was not so much the initial economic collapse, as dramatic as that was, but its persistence for several years. ... All the numbers we have about employment, production, world trade, the financial system, etc. show that we are already in a catastrophe. The emergency is to avoid the persistence of the stagnation that occurred during the Depression. The emergency is to prevent most of the next decade from looking like 2008.

exactly. all the showmanship over fiscal stimulus means little -- several more such stimuli will be attempted out of desperation, so whatever the first entails is not very critical. resolving the banking system is paramount, and it must entail wholesale restructuring -- and all the way up to senior debt to mitigate rising interest rates and the growing tail risk of a national bankruptcy -- and outright forgiveness of debts and contract nullification. moreover i would wager, as the indebtedness that is driving the delevering is so much greater as a percentage of income, that the devastation that will ensue without a radical financial system overhaul and resolution will make us forget about the 1930s entirely.

that makes the obama administration's slavish denial of the need of nationalization and ever-more-obvious protectorate of the predator state all the more disappointing and damning.

UPDATE: more from david merkel.

UPDATE: more from the economist -- with the inclusion of two extraorindary charts.

the first (chart 2) shows -- contra the thoughts of some to dismiss the debt burden of the economy as having been overstated -- that in fact non-financial debt is at a peak not seen since the 1930s.

the second (chart 3) replicates fisher's original demonstration of the debt deflationary dynamic of the 1929-33 period (chart 1, not shown) and shows we are incontrovertibly suffering from the very same affliction.

UPDATE: seconding the opinion at voxeu that stimulus spending is likely to do little.

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My my, I've written stuff like what Mendoza wrote 2, 3, even 5 years ago. I was called a kook and people made fun of my tinfoil hat and sent me recipes. What worries me now is what I was writing a year ago... or even 8 months ago... oh boy...

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i don't think i dared to mention irving fisher until november 2007, 421 (and the postmodern irony of being nominally the 421st iconoclast is delightful, btw). a couple things, though, your comment provoked:

-- i now see bernanke as a thoroughly tragic figure. his 1983 work brought fisher back to the academic mainstream, and he surely was aware of the potential for the dynamics we are now hazarding to reappear. yet he certainly believed -- in what must be described as hubris -- that he could dominate and defeat such dynamics with monetary policy. perhaps he still does, but i doubt it. this crisis has been his third act. the public vanishing he has conducted since the collapse of lehman -- something he was rumored to have vehemently opposed the allowance of -- hints that he knows it as well.

-- i find myself skirtng what i believe to be an trap. a modicum of self-knowledge reveals me to be a reflexive pessimist. the question is whether that pessimism is reflective of an 'apollonian' interpretation of reality or a reflection of 'dionysian' desire. as this event gets worse, i find my floor forecast steadily falling as well -- even though i have long considered, since the late 1990s, a secular depression the likely outcome of the debt bubble (much less the demographic problem which could lead to a more durable subsidance in western ambitions). so when i contemplate the possibility of social disorder and even collapse, am i being apollonian or dionysian? i can't confidently say -- or rather, perhaps i am experiencing a minor confluence of the two of the kind the early nietzsche adored.

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