Friday, October 23, 2009

The Fisher-Bernanke Snake Oil

Everyone agrees we are going through a Great Recession brought about by excessive debt; or, to be more precise, the deflation of excessive debt. The proximate cause of the crisis is, therefore, similar to that of the Great Depression during which Yale economist Irving Fisher wrote The Debt Deflation Theory Of Great Depressions (1933).

Mr. Fisher became justly infamous for his supremely ill-timed prediction of permanently high share prices just days before the Crash of 1929. What is less well known about him is that he lost his fortune in the Depression; not because he speculated heavily before the Crash, but because he kept buying all the way down afterwards and eventually had to be bailed out by his wealthy in-laws.

Well, as the saying goes, a recession is when your neighbour loses his money and a depression is when you lose your own, so it doesn't surprise me that Mr. Fisher finally "got religion" about debt's corrosive powers in 1933, four full years after the Crash.

Despite his claim of breaking new ground with his above study, the conclusion that over-indebtedness leads to liquidation, distress selling, a fall in the level of prices, unemployment and economic malaise was, in fact, very very old hat. Think of the Sumerians (5000 BC) and organized agriculture, spot and forward grain markets, loans of silver, the Code of Hammurabi fixing interest rates to avoid usury, etc.


Mesopotamian Contract For A Three-Month Loan Of Silver (1800 BC)

In any case, Mr. Fisher eventually figured out the cause of the Great Depression. Bravo, but what does that have to do with today's troubles? Enter Mr. Bernanke..

The current Fed chairman - himself an academic theorist from Princeton - is a great fan of the late Yale don and his remedies for debt-deflation depressions. Here is a revealing paragraph from Mr. Fisher's 1933 opus:

"... It is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged."

In other words, Mr. Fisher claimed that depressions could be prevented, or remedied once they were under way, "simply" with monetary policy. I strongly believe this to be utter nonsense.

The main reason is this: the production, distribution and consumption of real goods and services cannot be ultimately controlled by an artificially imposed mechanism such as money, which is, after all, a measurement and exchange convention. Claiming that money controls the real economy is like saying that how far we travel depends on how many miles we make available to measure distance with. Or, as a friend is fond of saying: "It's only money".

(In Mr. Fisher's defence, however, I must also note that he probably couldn't in 1933 imagine a currency regime so completely devoid of reality anchors; i.e. today's purely fiat money, which can be issued at will by the mere act of borrowing. Neither would he conceive of authorities so narrow-minded, so perniciously attached to free market dogma, that they would completely disavow their legally mandated regulatory and oversight responsibilities.)

My position is that the massive debt bubble created a similarly massive amount of malinvestment in surplus (and now useless) physical stock: housing, ships, office buildings, shopping centers, factories in China, call centers in India, vacation homes in Spain, and much more. Excess capacity is a common enough phenomenon of all run-of-the-mill recessions, being the result of fallible human beings optimistically extrapolating demand too far out of reality's reach. Usually, it is soon absorbed after a few quarters of creative destruction and increased demand from a rising population.

But this time it's different - very different - precisely because the huge global credit bubble blew this extrapolation, this excess capacity creation, way out of all previous experience. For example:
  • Between 2000 and 2008 there were a total of 14.8 million new housing units completed in the U.S., versus the formation of only 5.7 million new households.
  • Orders for new dry bulk ships and tankers zoomed, so that deliveries are scheduled to reach a combined 1,700 vessels in 2010 and 1,400 in 2011, versus 734 this year.
  • In Dubai 3 million square meters of additional new office space is to be completed by 2011, versus 3.25 sq. mts. in existence today.
  • In Spain, I saw with my own eyes hundreds of new "luxury" multi-unit vacation home developments, sprouting like mushrooms along the coast from Gibraltar to Almeria and further. One of them was, incredibly, located right around a polluting cement factory and the coal-fired power station of (aptly-named) Carboneras.
No, this is not my daddy's recession, not even my grand-dad's, and I claim as obvious that this type of excess cannot be remedied by monetary policy alone, as Messrs. Bernanke and Geithner (and Mr. Paulson before him), plus an army of financier-speculators now believe. They are acting much like voodoo medicine-men, applying ancient patent snake oil on a malady that instead requires a radically different and up-to-date treatment.

What needs to be done? I have laid out my proposals several times, so I will only provide the headlines here:
  1. Straight debt cancellation for a portion of debt, particularly for the "bottom" 80% of the population.
  2. Anchor the dollar and money supply to the real Green/Sustainable economy via The Greenback.
  3. Focus government action on income creation, instead of asset/credit/debt protection.
Have a nice weekend.

22 comments:

Trebuchet said...

I've always liked those three ideas of yours.

1. Cancel debt.
2. Anchor money.
3. Create income.

So simple. But can it really be done? The modern world has a phobia of simplicity.

Joe said...

Excellent post. I especially liked your description of today's purely fiat money. Whereas, it is devoid of reality anchors.

It will return to its intrinsic value of zero, like all fiat has throughout history. Much sooner than anybody realizes.

Joe M.

London Banker said...

I'm visiting one of the bubble economies that used debt to accelerate its development path straight to over-capacity. Demand for housing and CRE here is unlikely to catch up with supply in less than 25 years. And yet . . .

If someone were to ask my opinion of similar places, including Dubai, I would say that these are the new Miami. Miami saw its real estate markets crash catastrophically during the Great Depression. That promoted the influx of low wage immigrants from the Carribean and South America and retiree Snow Birds from Canada. They took up the slack at much, much lower prices and created a major regional hub in the process.

Sure value is going to be destroyed. But something of value will remain, and provide the basis for future growth.

Debra said...

London Banker has a point.
Once the pitchfork wielding southerns whose habitat has been destroyed by our unadulterated inane greed (and indifference...) manage to catch the ferry, they will be inhabiting those luxury vacation homes as squats, whether the owners like it or not...
What COULD be a source of despair is that every generation just has to learn the hard way, right ?
Most people just seem to conclude that... it happened in the past, and the past is.. THEM, whereas, US, well, that's a different story.
As Greenie said, for US, the sun is going to rise in the West...
Thanks for the history, Hell. You do that REALLY well.

Keenan said...

But throughout the world money is also debt. It seems to me that this would have to be a global reset so, Hellasious, is the proposal tantamount to canceling 80% of the world's money ?

Debra said...

Anybody care to call my hand ?
I kind of get the impression that the relationship between money and debt COULD be a little bit like the relationship between... food and shit.

fajensen said...

the result of fallible human beings optimistically extrapolating demand too far out of reality's reach.

And yet one cannot really do anything else but to run with the crowd can one?

You are a fund manager, Being a smart guy you *know* that Dubai will blow up; you are also painfully aware that your colleagues are taking 10,20,30% pro/anno on leveraged bets with Dubai property investments, that your performance review is coming up and "they" sack from the bottom up.

Maybe Dubai wont blow up after all, or at least not soon, not before your promotion anyway, so its OK.

Edwardo said...

By my runes, Do Buy might be able to look forward to a bright future (pun not intended) had its creators possessed the foresight to tap the region's abundant endowment of solar energy. In the absence of doing so, I say, let them eat sand.

Debra offers that money is to debt as food is to shit. What an intriguing idea. Let's see, if we define money as "a store of value" and define debt as money that has been, by hook or by crook, denuded of its store of value, the comparison is most apt. Food is, after all, synonymous with a value add mechanism, and excrement is, by definition, what remains after the value add has been, as it were, subtracted.

At least farmers can find some use for ca ca, not so bankers with dead CDS.

Hellasious said...

I believe that the concept of fiat money as a storehouse for "value", is inherently flawed and thus prone to instability.

Economic value is stored only in assets and knowledge. Yes, we can measure it in dollars and euro, but we can't substitute one for the other.

Best,
H.

Debra said...

Sorry, Hell, and Okie for belatedly responding to Okie's link on "naked" (like that one, good for a Puritanical country...) short selling.
Lapidary comment on my part : what happened to Bear and Lehmann is the LOGICAL result of...selling non-existant stock ON THE VERY PREMISE of a (worthless) fiat currency. It is the LOGICAL conclusion of a floated fiat currency "economy". (And I will add that the non-existant stock is the... logical conclusion of the floated fiat currency too...)
The Merchant of Venice,, Act I,iii, 90-93
Antonio : Was this inserted to make interest good ?
Or is your gold and silver ewes and rams ?
Shylock : I cannot tell ; I make it breed as fast.

One idea that you're missing, Hell. There is a certain amount of social control exerted to MAKE PEOPLE BEHAVE that can't come from any regulatory, punitive instrument ; it can ONLY come from a positive... IDEOLOGY that allows men to believe in something towards which they are willing to work and which brings them together in a spirit of cooperation. All the spanking/regulation in the world just can't ensure good behavior.
But you are definitely right to concentrate on the POSITIVE aspects of your proposals.
Will the GREEN ideology bring us together this way ? Not if it takes the form of the OLD ideologies...

Debra said...

Sleepblogging, Hell ?...

Tiago said...

My question is: if proposals like these are not enacted (and one could say that the opposite is being done: cheap money, more leverage, more big), what will happen next?
Small disfunctional (think Japan)? Depression like? Hyperinflation and war?

Also, the solutions after the 29 depression/WWII were based on "growth". Will we have a Malthusian vengeance with peal-oil and resource depletion? Therefore a composing of "mortgage the future" with resource depletion?

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marcus said...

Hel,
We are indebted to your service, I thank you. You clear writing and extensive knowledge about this problem is both educational and inspires hope for a solution.

About solutions:

What needs to be done? I have laid out my proposals several times, so I will only provide the headlines here:

1. Straight debt cancellation for a portion of debt, particularly for the "bottom" 80% of the population.
2. Anchor the dollar and money supply to the real Green/Sustainable economy via The Greenback.
3. Focus government action on income creation, instead of asset/credit/debt protection.

How do we go about effecting these and other useful fixes to the problem? What do you see as the path or strategy to implementation of solutions?

Edwardo said...

Hell wrote:

"I believe that the concept of fiat money as a storehouse for "value", is inherently flawed and thus prone to instability."

-Agreed, but for my own part, I didn't mention fiat, much less equate it with a store of value. In fact, nothing I've ever written, here or elsewhere, has ever suggested that.

Gold is money, always has been, and it will outlast every fiat currency on the planet as a medium of exchange.

Jenna's Bush said...

Miami saw its real estate markets crash catastrophically during the Great Depression. That promoted the influx of low wage immigrants from the Carribean and South America and retiree Snow Birds from Canada.

But look how long it took. Florida real estate crashed before the GD, in the 1920's. People didn't start retiring in mass there until the 60s and 70s, and Carribean and South Americans didn't arrive until the 70s and 80s. Fifty to sixty years for "a major regional hub" to come about.

Thai said...

But they made great flipper movies till then

Thee Earl of Obvious said...

If the solution is to cancel debt would creditors be overthrown by the debtors? If so then they would be the ones to decide what to anchor money to and how to create income.

Seems more radical than bringing back debtor prison or at least compulsory "work" programs.

Thee Earl of Obvious said...

Saw this posted on I tulip. Pretty good:

http://www.youtube.com/watch?v=w5EFEQ9aY6o

Debra said...

Thanks, Thee Earl, for the link. It was so deliciously brit and made my day.

Obfuscation said...

Hell,
On your previous post, you said that the short term Treasury market indicates great optimism. As a small-time trader, do you have any suggestions for how to play this imbalance?

Do you see long-term rates falling and short-term rising, with a flattening yield curve?

gael said...

Fabulous post. Great comments too.