Tuesday, February 9, 2010


The Recession Isn't Over

[UPDATE below.]

For the documentary on the Fed, I spent about 5 hours under the hot lights today with the cameras rolling. I will never criticize a politician for saying something dumb on the campaign trail; I'm not sure I could have recited my date of birth by the end of this ordeal. Hopefully the filmmaker can edit out the nonsense and make me look sharp in the final cut.

On the flight here, I reread my Depression book. (This wasn't pure narcissism; the interview was going to be based on my book.) I ended up scaring myself all over again, and remembered why I was so sure the US economy was done for after I finished writing the book. The Fed and the government enacted similar policies back then to "fight" the downturn after the stock bubble burst, and we all know how that turned off.

One of the things that really interested me was a point Garet Garrett made on the 5th anniversary of the New Deal. Garrett pointed out that the surge in official output figures from 1933-37 notwithstanding, businesses were not replenishing their equipment through investment. In effect the US economy was consuming its capital even during the alleged Roosevelt recovery (which Krugman et al. say was aborted through premature deficit hawkishness in 1937).

So regardless of what the government and Fed did in 1937, there had to be a "depression within the Depression" or a "double dip" as we euphemistically will call it nowadays. Bernanke's insane 0-interest rate policy has ensured that the US (and indeed world) capital structure has gotten progressively more screwed up in the last two years. It doesn't matter what they do with quantitative easing, targeting NGDP futures, raising interest payments on excess reserves, or pinning the tail on a donkey... There will be another collapse. It might not be a sudden "crash"; it could be a slow-motion train wreck. But if you think interest rates serve a function, then you must concede that that function has not been fulfilled for a good two years.

Many commentators, not just Austrians, would now agree that in retrospect, it would have been fantastic if Greenspan had sat back and done nothing after the dot-com crash. Yes there would have been a painful recession from (say) 2001-2003, but it would be ancient history at this point. Moreover, that painful recession would have been child's play compared to what we have already been through and will continue to suffer over the next few years.

What we need to realize is that right now we are in the analog of the housing boom years. This is the "soft landing" that Bernanke has provided us. The bubble isn't in houses, it's in US Treasurys.

And the coming collapse will make the housing bust look as easy to cope with as the dot-com crash looks to us right now.

UPDATE: I was watching a very interesting documentary on--what else?--World War II in the hotel room. One of the historians explained that the Americans (under the command of the guy preceding Doolittle) tried precision bombing of German targets without fighter escorts. In one raid, the US lost 60 bombers--about 600 men--trying to take out a ball bearing factory. But as crazy as that is, I loved the understanding of capital structure behind it. The historian explained, saying something like, "You use ball bearings in everything. Taking out this factory would strike a crushing blow to the German war machine."

And yet a mainstream economist wouldn't be able to capture this in his or her description of the current recession. "Huh, a ball bearing factory got taken out? Well how many marks did those things fetch? Just have the German central bank print up some more, and go buy sauerkraut with the new paper. We have to boost aggregate demand back up if we want to beat the Yanks."

Interestingly, the only time another person (regardless of their political sway) ever brings up capital structure within a conversation with me seems to be when we're discussing the U.S. auto industry...and the argument is typically made in reverse (regarding higher and lower order goods). They're typically worried about the impact of the dissolution of the U.S. auto industry on people who make metals and plastics(etc). Oddly enough, they seldom offer worry or sympathy for the agricultural industry every time a restaurant-chain closes down.
Yeah, I'm fully expecting that the bottom will fall out too. It looks like several countries' economies are starting to split at the seams....I wonder who's will be the first to pop?
In addition to my "diminished chords" analogy* I have a new analogy: Keynesian aggregates as a form of air guitar. The guitar player knows and plays an intricate pattern of chords and musical notes (the complex capital structure). The non-musician (the Keynesian) just wilding flails his arm not caring to understand the complexities that the guitar player knows.

*Mention to a Keynesian that money dilution causes an invariable distortion to the structure of investment and production and their eyes glaze over. It's like trying to explain diminished chords to a punk rocker.
Great point, Dr. Murphy. With that example, the whole picture becomes clearer.

Bob, nice simile.
The joke is on you Dr. Murphy! That documentary is being put together secretly by Michael Moore!
After the next big dip occurs, and people the world over flee (again) to the dollar, how long after that will the hyperinflation strike? Will we have a year? 3 months? Are you still holding on to your gold?

That's a good question. I am certainly holding on to my gold, because what I have is for emergency purposes in case the Big One happens and gas shoots up to $10 / gallon. It is entirely possible that the USD will rise strongly if the euro crashes in the coming months, which could take gold down too (priced in dollars).

I still think the only end game in all this is Bernanke printing away. But I would need to really study some things first before giving a time frame. I am continually surprised by how long these low yields are lasting, so I'm assuming I'm like a guy in 2005 saying, "When the heck are housing prices going to pop?!"
Bob R, As a "punk rocker" I take exception to your "diminished chords" analogy. The failure by Keynesians to understand complex capital structure results in erroneous analysis. A punk rock guitarist (or any rock guitarist for that matter), on the other hand, need not know what a diminished chord is to play a perfectly good rock tune. Your apparent technique-bias for guitar players is no different from the bias of economists who say an economic theory is worthless if it isn't supported by elaborate equations, models, et al.

Now, I understand you were just comparing the Keynesians' limited understanding of capital structure to the average punk rocker's limited understanding of chord theory. But, I don't think it's fair to punk rockers to compare them to people like Krugman and DeLong.
I watched that documentary on WWII bombing strategy too (I have a fondness for documentaries)...but I meant to say, thanks for all your great posts, it is so fun to read, and also very helpful. I am giving an economic speech in about a week, about the 2008 recession, what really caused it, etc...(think Tom Wood's Meltdown in a crash course for dummies) but the info and arguments you give are so great!
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