A few important conceptual milestones on the macro front over the past weeks.
First, it’s pretty clear the real economy is now collapsing both due to tight credit as all financial actors deleverage and as a result of a revision in growth expectations such as Keynes wrote so clearly about. Forced liquidity was not enough. An “intact” banking system and zero(!) USD interest rates are not enough. The world’s investors have decided that reduced prospects are in view; and that is a self-fulfilling forecast if held widely. Skidelsky:
The basic question Keynes asked was: How do rational people behave under conditions of uncertainty? The answer he gave was profound and extends far beyond economics. People fall back on “conventions,” which give them the assurance that they are doing the right thing. The chief of these are the assumptions that the future will be like the past… and that current prices correctly sum up “future prospects.” Above all, we run with the crowd. A master of aphorism, Keynes wrote that a “sound banker” is one who, “when he is ruined, is ruined in a conventional and orthodox way.”… But any view of the future based on what Keynes called “so flimsy a foundation” is liable to “sudden and violent changes” when the news changes. Investors do not process new information efficiently because they don’t know which information is relevant. Conventional behavior easily turns into herd behavior. Financial markets are punctuated by alternating currents of euphoria and panic.
In the “new” convention investors are placing a higher value on liquidity, expecting more defaults, and worrying more about what they don’t yet (or cannot) know. (DeLong)
Secondly, increasing numbers of people are pointing out that to the extent that current circumstances resemble the leadup to the Great Depression, and so there might be policy implications for our present predicament, it is China that now has the role of the surplus-generating USA in that prior era, and the USA has the role of an indebted Europe (all of whom defaulted on their WWI debts).
Liberally paraphrasing Yves Smith, Pettis and Setser,
Keynes not only wanted the US to run even bigger budget deficits back then, but he also said it was unreasonable for the US to expect is overconsuming, indebted trade partners such as the UK and Germany to go deeper into debt to support the US. Asian economies simply lack the scale to act as the global locomotive.
Thirdly, there is a vigorous debate this week on the relative dangers of deflation, and inflation; specifically whether it would be better to endure the latter later in order to hold off the former today.
Perhaps perversely, the attack by Willem Buiter on the ECB (and Steinbrueck) for lagging behind in it’s inflationary efforts has me now considering them the most reliable central bank, and the EUR likely to be the safest currency over the medium term.
The independence of the ECB is embedded in the Treaties. A unanimous decision by all member states is required to change the Treaty. Given this operational independence ‘on steroids’ of the ECB, it is unlikely that any Euro Area national government or coalition of governments could bully the ECB into engaging in a burst of public-debt-busting unanticipated inflation.
I’m also with London Banker in his final post, deflation is at least initially in store as investors go on strike. The damage to confidence from bungling governments is at least as severe as the underlying financial issues.
During the reckless boom years, savings collapsed in bubble economies as retail and commercial and financial actors alike chased speculative yields with greater and greater leverage. During the reckless bust years, savings will collapse further as retail and commercial and financial actors chase safety by hoarding their meagre remaining assets from further erosion by refusing to lend at negative returns and refusing to finance failed corporate and investment models that only enrich poltically-connected management and intermediaries… Each bailout further undermines the market discipline which is bedrock to a saver or investor’s decision to part with hard-earned cash by trusting it to the intermediation of the management of a bank or business… It’s this simple: I won’t invest in a country that bails out failure and punishes savers… I will know when it is safe to reinvest when policy interest rates, bank/intermediary oversight and accounting standards give me confidence I am better protected than the corporate or financial elite…
It appears that in aggregate the world is inevitably going to suffer a substantial decline in both production and consumption in 2009 and possibly 2010; and substantial losses on financial assets whose value was premised on higher values for both.
The arguments now are on allocating the pain – who, where and when. (Hint: not me, not here, and not now.)