High rates of growth, based on the increase in consumption of the mature economies of first-world countries, cannot be sustained for a prolonged period. First-world countries have low or zero demographic growth, an inverted demographic pyramid and already very high standards of living. The maintenance of a high rate of consumption growth depends, both on the creation of new consumption needs and on the permanent expansion of credit to families with ever higher levels of debt. The rich central countries consume, financed by ever higher levels of debt, in order to satisfy ever more artificial needs, with products made in China, which controls its labor costs and buys raw materials from emerging countries. No need of a profound analysis to conclude that in the long run this model is unsustainable.
...............
There is a major difference between the present conditions and those prevailing at the time Keynes elaborated his theses. The General Theory is of 1936. Before that, from 1932 on, sketches of the argument could be found in his essays. In 1932, the economy was still in profound depression, but - as known today - due in a large extent to the errors of monetary policy, the excess of debt of the private sector had been eliminated by the collapse of the financial system. The generalized bankruptcy of banks and firms solved the problem of excessive indebtedness. Banks, enterprises and households were broken, but with no debts. The costs were dramatic, but the excess of debt disappeared. The fact that the mistakes of 1929 have not been repeated, lead to circumstances far different from those of 1932. Financial collapse was avoided and despite the severity of the recession, we are still far from the thorough disorganization of the economy and massive unemployment -close to 30% of the labor force - of the Great Depression. The economy, however, almost two years after the beginning of the crisis, continues to be overwhelmed by unredeemable debts. As long as households and firms continue to bear the brunt of excessive debt, they will try to reduce expenditures and increase savings. Until debt is reduced to levels which are perceived as reasonable, the private sector expenditure will be exceptionally low. After the Great Depression, in the early thirties, there was a lack of demand because there was no economic activity and no income. Today, the lack of demand is the result of the exceptionally high rate of savings required to bring back private debt to reasonable levels. These are very different situations.
The American economic condition of today has more similarity with the Japanese economy after the real estate and banking crisis of the nineties. In Japan, the government avoided the bankruptcy of the financial system. Monetary and fiscal policy became aggressively expansionist, interest rates approached zero and, nevertheless, the economy remained virtually stagnant for more than a decade. A faint economy, but with no debt, can be jump-started through an increase in public spending. Once reanimated, an exceptionally high percentage of the generated income is no longer saved in order to reduce debt, but spent in order to rebuild firms and households standards of living. It thus creates demand and gives rise to the virtuous circle of recovery. In an economy paralyzed by the excess of debt - as it is the case of Japan since the early nineties and as it is now the case of the US - neither monetary policy nor fiscal policy can reactivate the economy. A large proportion of the income generated by the increase in public spending is saved by the private sector in order to diminish its debt. The virtuous circle of the Keynesian expenditure
multiplier is thus interrupted.It was not Keynes, but Irving Fisher, the American economist who lived between 1867 and 1947, who did the most insightful analysis of economies in deflation, paralyzed by excess debt. Keynes’ analysis dealt with how to reactivate an economy where debts had been decimated by the depression. Keynes, at least the one of the General Theory, is the economist of the post-depression period. Fischer is the great analyst of depressive periods in themselves, when the question of excessive debt and deflation prevails. Fischer studied the depressions of 1837 and 1873, as well as the one from 1929 to 1933. He argued that neither monetary policy nor fiscal policy is able to stimulate the economy while excessive debt remains present. An idea of the relative dimensions of the current debt problem can be grasped by the fact that, in 1929, the total of American debt was 300% of GDP; it reached almost 360% of GDP at the end of 2008, after staying between 130% and 160% from the beginning of the fifties to the end of the eighties. Ben Bernanke, the Fed chairman and an academic with relevant contribution to the understanding of depression periods, is well aware of the difficulties to escape from the deflation trap. When visiting Japan some years ago, he remarked that the best way to get out of deflation is not to get into it.[5]
There is symmetry between inflationary and deflationary conditions. The inflationary condition to be contrasted with deflation is not the one of small inflations, always present in a healthy economy. It is not even the inflation that, given circumstantial pressures, might reach two digit annual rates. The inflationary condition that should be compared to deflation is the one of great chronic inflations, as those encountered in the Brazilian economy, from the seventies until the Real Plan in the nineties. While chronic inflation is essentially a question of excessive debt of the public sector, deflation is essentially a question of excessive debt of the private sector.
Behind chronic inflation is the lack of inter-temporal compatibility for the budget constraint of the public sector, independent of the tax function to be adopted. It is usually the consequence of the government having abused to such an extent its capacity to extract resources, be it from present generations - via taxes as well as via the so called “inflationary tax” -, be it from future generations - through indebtedness -, that its credibility is in the end exhausted. Public debt is then perceived as irrecoverable and the national currency is replaced by parallel currencies. The end of great inflations requires necessarily the reduction of public debt, either through the socially costly hyperinflation or, instead, through some form of default. In the case of Brazil, the Collor Plan, despite its failure to stabilize inflation, may be understood as a complex - and probably even more aggressive than a negotiated default - way to reduce the public debt. Without the significant reduction in the Brazilian public debt it implied, the sophisticated de-indexation of the Real Plan would have had less chance of success.
Behind deflation is an inter-temporal lack of compatibility of the budget constraint of the private sector. After a certain point, the private sector debt can only be perceived as sustainable as long as asset prices are perceived to be in continuous growth. Since the rise of asset prices is fueled by rising indebtness, from a certain point onwards, the process acquires a pure speculative character. When the rise in asset prices is interrupted, the private sector discovers it is insolvent. Real estate bubbles, especially residential real estate bubbles, being a speculative process based on assets of a wider ownership, are the ones that more damage cause when exhausted. The option not to throw public resources into the rescue of an insolvent private sector in a deflationary situation is the symmetric equivalent of letting the economy slide into open hyperinflation in a chronic inflation environment. It was the choice made in 1929. The insistence on fiscal balance and on the maintenance of the gold standard led to the Great Depression. The result, the same as with open hyperinflation, was to have the ground cleared, so to say, through generalized bankruptcy. No need to stress how absurd the costs are of solving excessive indebtedness - be it public, via hyperinflation, be it private, via depression - through an economic disruption such that nothing survives.
The experience of 1929 taught us that to stick to orthodoxy and to refuse to deploy public resources to avoid the collapse of an insolvent economy is an error no to be repeated. Unfortunately, as known since Keynes, monetary policy is incapable of stimulating the economy in these circumstances. It could have avoided its collapse, as learned from subsequent studies by Milton Friedman and Anna Schwartz. Yet the decision to use monetary policy to keep alive an economy drowning in debt turns also fiscal policy incapable of stimulating the economy, as noted by Irving Fisher. As long as excessive debt is not digested, both monetary and fiscal policies are inefficient. There is not much of an alternative. Either to let the economy collapse, in order to reduce debts, and then use fiscal policy to revive it, or inundate the insolvent economy with public credit, to avoid the collapse, and loose the ability of fiscal policy to pull it out of a prolonged lethargy. Either a horrible end or an endless horror.
The US will most likely face a long period of stagnation. The option for an aggressive and heterodox monetary policy should avoid a depression like the one of the thirties, when GDP fell nearly 50% and unemployment reached more than 30% of the labor force. There is however a trade-off: the digestion of excessive debt of the private sector will take several years. Since the excess of debt is relative to income and GDP, the lower the rate of growth, the longer the required period of digestion. Or inversely, the stronger is aggregate demand, the higher the growth rate and the faster is the digestion of the excessive debt. This explains for the paradox of trying to stimulate consumption when the economy faces a monumental crisis provoked exactly by excessive debt and excessive consumption. A cartoon line best captured the spirit of it: “country addicted to speculative bubbles desperately searches a new bubble to invest in. ”
Huuuhh! Only time will show ...
No comments:
Post a Comment