We are not 'all dead in the long run'

1. The long run becomes the here and now

In response to the classical and Austrian critique of his advocacy of state intervention in the economy, J.M. Keynes once uttered the following 'witticism':
'In the long run we are all dead'.
The criticism was that government intervention , while possibly capable of alleviating the short term pain of economic downturns for a while, was apt to store up ever bigger problems for the long term.
The government could 'paper over' economic crises up to a point by attempting to resurrect an inflationary boom with interest rate cuts and deficit spending, but this would distort the economy's production structure further, until at some point in the future, an economic bust of exceedingly great magnitude would inevitably ensue.
In short, payment for foolish economic policies could not be delayed forever; the damage done by government's tinkering with the economy would eventually be revealed.

Today, we seem to have arrived at the point where the heretofore mythical 'long run' has suddenly transmogrified into the all too real 'here and now'.

Our once vaunted banking system is on the brink of insolvency, and economic activity has begun to contract at a speed and ferocity that has not been experienced in at least 28 years, threatening to get even worse. That episode of 28 years ago, mind you, was coupled with a deliberate and extreme tightening of central bank policy intended to rein in run-away inflation. This stands in stark contrast to the current 'zero bound' monetary policy along with both the biggest Fed balance sheet expansion and the speediest expansion in base money ever.

J.M. Keynes is indeed dead; we, alas, are still alive - reaping what he helped sow.

2. Deceptive stability

Central planning of interest rates combined with the occasional fiscal bail-out or stimulus scheme has for some time now been believed to have brought about the elusive goal of 'economic stability'.
Who does not remember the gushing over the 'Maestro' Alan Greenspan and his 'when in doubt, cut interest rates' policy, once dubbed the 'Greenspan put' by stock market traders?
In reality, Greenspan lent a helping hand to the creation of the biggest credit bubble in history , all the while lulled into dangerous complacency by the seeming 'absence of inflation' (this is to say: the absence of sharply rising prices for goods and services – asset prices 'inflated' willy-nilly of course).

It got little notice at the time, but sometime in the mid 1990's, the fractionally reserved banking system got a big additional shot in its happy-go-lucky inflationary credit expansion arm, when the Federal Reserve decided to tolerate so-called 'sweeps', whereby banks would sweep monies from demand deposits into 'zero interest bearing CDs' overnight, letting demand deposits masquerade as savings deposits. Since savings deposits require far lower reserves than demand deposits, such reserves were then freed up to inflate credit further.
Not coincidentally, it was around this time that broad money supply measures began to go parabolic, along with the ratio of total credit market debt to GDP (or the ratio of total credit market debt to any other yardstick one was inclined to compare it to, from personal income to corporate profits to, you name it).


Money of zero maturity, a broad money supply measure. click on chart for larger image.

For many years, a falling savings rate and a concurrent sharp rise in consumption-related debt was rationalized away by mainstream economists. Absurd increases in first share prices and then house prices were considered to represent 'an increase of wealth' , which had magically replaced the need to actually save.
There was no need to worry about the growing mountain of debt, they would say; after all, you only needed to look at the other side of the consumer's balance sheet, where all that 'wealth' had piled up, as if houses and stocks had been watered with 'super-gro'.

Here and there a party-pooper would ask, yes, but what if these elevated prices were to fall one day?
Such objections were routinely shouted down : Can't happen! It has never happened! House prices always go up! And so do share prices, in the long run.
They do? But.....aren't we supposed to be 'all dead in the long run'?

All of a sudden, this seeming 'permanent plateau of prosperity' and growing phantom wealth has given way to one of to the greatest bouts of economic instability in living memory, and – oops! – house prices are falling, and so are share prices – with over $30 trillion in stock market capitalization having disappeared globally.
The balance sheet looks all bent out of shape now, as the debts remain big as ever and are going sour at a rapid clip, taking down lenders and borrowers alike.


3. Keynesian policies come natural to politicians

It is only natural that politicians have eagerly adopted Keynes, and that consequently, the entire establishment has eventually sanctioned his theories to the exclusion of nearly all contrary ideas.
To become a member in the 'pantheon of establishment-approved economic theorizing' you have at the very least to be a Keynesian-in-drag, as in for instance, the form of a supply-sider (the moment you raise the slightest doubts about the need for central planning of money and interest rates, you instantly become an irredeemable pariah in the economics profession).

Note that Keynes did not come up with any radical new ideas – he basically adopted and adapted the ideas of German socialists, who had long before him advocated massive state involvement in the economy. His main achievement was to give governments around the world a philosophical/pseudo-scientific fig leaf for pursuing exactly the policies they always wanted to pursue.

The political life-cycle is partly to blame . If one's main job is to get as many votes as possible in the next election, one can hardly be expected to worry about the long term impact of one's economic policies – especially given the fact that due to the lag times involved , few people actually realize how cause and effect are related in economics.
Furthermore, the contingent of the citizenry interested in growing the power of the state grows along with the state – and if one thing is absolutely certain, it is that a true 'laissez-faire', free market oriented policy is not conducive to the growth of the state.

Nowadays there seems to be a growing consensus that Greenspan's attempt to inflate away the last big bust is partly responsible for our current dilemma.
And yet, what is being done to 'fight' the current bust? Don't look now, but they're doing exactly the same thing again ,only bigger.
This, in a word, is insanity.

Naturally, one had to be truly comatose not to realize that Greenspan's 1% Fed Funds rate helped to ignite the mortgage credit bubble and the associated bubble in real estate prices, so it's not as if this represents a great revelation – what is interesting is only that it is being discussed in the media at all.

The most recent glimmer of hope on that front came from an unexpected source – the chancellor of Germany, Angela Merkel.

To the aghast invocations of imminent doom from interventionists around the world were she not to recant immediately, or even better, retroactively, she recently defended Germany's decision to refrain from joining the global 'stimulus package' orgy whole hog thusly:

“Excessively cheap money in the US was a driver of today’s crisis,” she told the German parliament. “I am deeply concerned about whether we are now reinforcing this trend through measures being adopted in the US and elsewhere and whether we could find ourselves in five years facing the exact same crisis.”

One can imagine the reaction of the menagerie of bail-out clowns – what? Five years? That, in terms of the political life cycle, is the 'long run' in which we're allegedly all dead. It is definitely further away than the nearest election. Such a daring look beyond one's own nose is considered impolitic.

(it must be noted though as an aside that Mrs. Merkel is very reticent to lower taxes, as demanded by Mr. Seehofer, leader of the CSU, a party allied with her CDU; just to make sure there's no misunderstanding: I'm not a big fan of Mrs. Merkel – i merely note that it is a hopeful sign that an establishment figure of her stature speaks out critically on the money pumping issue. It may have to do with Germany's socio-economic memory – the inflation of the Weimar regime and all that flowed from it is embedded in the German psyche as a deeply negative experience).

4. What to do, and what to hope for

As an individual who understands the current situation one can only watch with growing dismay and desperation as governments the world over are practically falling over each other trying to repeat Japan's mistakes of the 1990's, and Hoover's and FDR's mistakes of the 1930's. It's almost as if there were some sort of competition on about who can implement the most insane and costliest 'solutions' from the interventionist cook-book in the fastest and most grandiose manner.

There is little to no chance that governments will suddenly get free market religion, short of a collapse so total that they are wiped out in a collective global bankruptcy. Mind you, we should not necessarily wish for that, for a number of reasons (more on that will follow in a future blog).

Current events have a certain deterministic quality – more intervention is certainly on its way , and so is its long term result, economic depression – one can only try to prepare for it on a personal level, on the general principle that one should hope for the best and prepare for the worst.
Do not count on government promises to bail you out when push comes to shove – unless you're a Wall Street banker, chances are your role will be that of a cow to be milked. A paymaster who has no say in the proceedings (since there is no-one you can vote for who is not in principle aboard with the interventionist schemes).

So what can we hope for? It's a fairly distant hope, mind you, but it's always possible that Keynesian interventionism ends up discredited in the public's eye, on account of its assured failure.
One should not let an opportunity pass to discredit it. In economic matters, the press is unfortunately positively infested with statism, and that includes most of the so-called 'conservative' press.

In fact, i have been quite dismayed when at a recent hedge fund conference in Vienna a bunch of professional investors likewise loudly proclaimed their economic ignorance by demanding more government intervention!
A professor of economics who somehow had found his way to the conference was found singing from the same hymn sheet; one thing he said is worth mentioning:
The authorities, he averred, must engage in just the right amount of monetary and fiscal pumping, i.e. not too little, but also not too much , to keep all sorts of unintended consequences from rearing their head.

Full stop. Let's point out what should be obvious:

They always have this problem, and it is exactly the same problem that the Soviet Union's GOSPLAN agency had when it tried to determine how many nails, screws or hammers it should produce - a central planner can never know what the 'just right amount' should be – this is precisely why we're in the trouble we're in now!

The only possible solution to the crisis is not intervention, it is also not more, or faster, or 'better' intervention – it is to do nothing.
Let the market fix itself.

5. Judge them by their results

Yesterday, Bern Bernanke held a speech at the Austin chamber of commerce, that received some attention as he basically announced that the Fed was about to go down the 'quantitative easing' path in earnest.
A J.P. Morgan economist, Michael Feroli, promptly christened him 'Bernanke-san' in a research note.
From the Bloomberg article on the speech:
"„One option is for the Fed to buy “longer-term Treasury or agency securities on the open market in substantial quantities,” Bernanke said. “This approach might influence the yields on these securities, thus helping to spur aggregate demand.”"

Why would anyone want to 'spur aggregate demand?' Oops, i forgot – our monetary crank-in-chief is a dyed-in-the-wool Keynesian. He actually believes there's something wrong with demand all of a sudden. It's, don't you know, an 'animal spirits' induced calamity that has befallen consumers. The very people who normally are insatiable, are now mysteriously 'demand deficient'.

The economic model on which this notion is based has absolutely nothing to do with reality - it assumes that goods for consumption can somehow be plucked from a tree, if only they are 'demanded'.
Just drop some cheap fiat money in someone's lap (if necessary, from a Friedmanite helicopter, so that that someone goes to Circuit Ci..,err, Best Buy, where he then demands his third plasma screen , even if he doesn't need one. Presto, demand deficiency problem solved, the economy is healthy again!

Good grief. It might work if we could get something for nothing, but alas, not otherwise.

The markets greeted the Bernanke announcement thusly: the already severely dislocated government bond market (which recently has made a parabolic move in the wake of the Fed announcing that it would buy up $800bn. in MBS and ABS) continued to blow off – and the S&P index , for want of a better word, crashed by 8,9%, with financials in the index getting crushed by 17% - their biggest one day decline ever.

Bernanke, the alleged expert on the Great Depression (all the books worth reading about that time have apparently managed to escape his attention), presumably knows what government bond yields did in that period; or what they did during Japan's slo-mo depression of the past 20 years.

Did it help? Was 'aggregate demand spurred'?

In the q&a after the speech the depression actually was talked about. Bernanke sotto voce announced his firm belief in the conceit that has befallen just about everyone: namely that policy makers would 'of course not repeat the mistakes that were made then'.

This is what contemporaries have always believed of the interventionist institutions of their day whenever a bust started to unfold. In 1873, the powers of the treasury secretary – who surely had a plan – were believed to be capable of averting the calamity – a 20 year long depression promptly ensued.
In 1929, the Fed was firmly believed to be able to avert the downturn - after all, this institution with its 'flexible currency' built on sound scientific principles could not possibly fail at the task.
Well, they believe it again. You could say, Bernanke actually believes his own bullsh*t.

Not only is he already repeating all the mistakes made back then, he has already made new ones on top of them, and is set to make even more. The difference is only in the details, not in the substance. He is doing what the Fed did in the 1930's, only on a much grander scale. Why anyone would expect a different outcome will remain a mystery for now, but you can be sure that there will be no shortage of excuses.

Let us briefly look at the result of the interventions to date. After $8,5 trillion in bail-outs and bail-out pledges , we have:

the biggest one year decline in the stock market in all of history; the biggest decline in real estate prices since the great depression; a complete collapse of the structured finance market; an economic contraction that is so fast and deep that it promises to make the history books as one of the worst on record.
(we are showered with scary economic numbers from all over the globe daily, but just to name one example illustrating how big the catastrophe already is: the Baltic Dry index that measures international shipping rates has suffered a 95% plunge from its highs).

This is what we've got so far, for a $8,5 trillion price tag. Not exactly a satisfactory result you say? You bet.

Due to the ad-hoc manner in which the interventions to date have been implemented (whereby the Fed and treasury seem to be constantly trying to outrun a widely feared implosion of the otc derivatives markets), a great deal of uncertainty has been imparted to the markets. Of the 'what will they think of next'? type. The whole process lacks both predictability and credibility, as Linda Rowley notes in an excellent article here.

A final note: the downturn is the end result of the previous boom. The biggest credit and malinvestment boom ever, as one must keep stressing. There is no way of averting or avoiding the bust. It has to happen. It may be painful, but underneath the pain, the economy is actually healing and repairing itself. It makes no sense to intervene, as every attempt to avert the bust will only delay this healing process.
Anyone with an ounce of common sense should be able to see that an artificial lowering of interest rates in order to 'spur demand' and 'spur lending' can not be the proper cure for an economy groaning under the weight of an imploding credit bubble, where many are already up to their eyeballs in too much debt.

Given the fact that the bust can not be averted, our societal goal should be to see to it that it passes as quickly as possible, without fresh malinvestments being added atop the old ones.
This can only be achieved if government keeps its hands off the economy. Bernanke's idea to suppress interest rates across the yield curve is completely useless voodoo-economics trash, to put it politely.
It has all been tried before and it has never, ever helped, and never will.


Voodoo economist Bernanke


...and 'We're all dead in the long run' Keynes, the man whose prescriptions governments keep following religiously, in spite of incontrovertible evidence that they have always failed. They don't work in practice, because they don't work in theory either.