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The Paradox of Deleveraging Vs Something for Nothing Economics

Economics / Deflation Oct 21, 2008 - 07:20 PM GMT

By: Mike_Shedlock

Economics Best Financial Markets Analysis ArticleEarlier today, in Keynesian Claptrap From PIMCO I spoke of the ridiculousness of the paradox of thrift . Here two more articles worth your time reading that rebut the seemingly never ending Keynesian Claptrap coming from the likes of Bernanke, Paulson, PIMCO, Roubini, and Krugman.

I make the above statement with one reservation. Nouriel Roubini has called this economic disaster as well as anyone. I commend him for many brilliant calls. However I simply cannot sit back and say nothing about the barrage of bad economic thinking in regards to the solution to this crisis coming from everyone in the group above.


With that out of the way, let's continue with a review of an article by Austrian economist Frank Shostak about the paradox of deleveraging. Had I seen it earlier, it would have been included in my previous analysis. Shostak is asking Is Deleveraging Bad for the Economy?

Is it true that if every bank were to attempt to "fix" its balance sheet, the collective outcome would be disastrous for the real economy?

On the contrary, by adjusting their balance sheet to true conditions, banks would lay the foundation for a sustained economic recovery. After all, by trimming their lending, banks by implication also curtail the expansion of credit "out of thin air." As we have seen, it is this type of credit that weakens wealth generators and hence leads to economic impoverishment.

Contrary to the proponents of the "paradox of deleveraging" we can only conclude that if every bank were to aim at fixing its balance sheet, in the process curtailing the expansion of credit "out of thin air," this would lay the foundation for a healthy economic recovery.

I ask everyone to please read the entire article by Shostak. He is among the few consistently brilliant economic thinkers that one can find.

Trying to get Something for Nothing

Inquiring minds are also reading Steve Saville's article Trying to get Something for Nothing .

As if Paul Krugman winning the Nobel Prize in economics isn't reason enough for us to be less-than-sanguine about the future, everywhere we look we see well-respected analysts advocating increased government regulation and spending -- effectively the same policies that transformed a financial crisis into a drawn-out depression during the 1930s -- while completely ignoring the root of today's problems. ....

Whether the advocates of increased government spending and the various other re-inflation policies realize it or not, at the root of their proposed 'solutions' to the crisis is the idea that it is possible to get something for nothing. It is axiomatic that an increase in production must precede a sustained increase in consumption; that saving is the basis of long-term economic growth; that no individual can become rich by spending more than he earns; and that no country can become wealthy, or recover from a recession, by consuming more than it produces. And yet, most commentators have deluded themselves into believing that you can get around the problem of inadequate real savings by simply increasing the supply of the medium of exchange, and that you can bypass the need for increased consumption to be funded by increased production by simply getting the government to spend like a drunken sailor.

Please read the entire article. I promise you that it will be time well spent.

Bush's Conference of Losers Revisited

Recently, president Bush called for a summit to discuss the problems and solutions to the ongoing economic crisis. I wrote about that conference in Bush to Host Summit of Losers .

Here are a couple of snips.

In response to the Credit crisis president Bush is gathering up all the people who did not see what was coming, denied what was happening, and then failed to see the implications of what was indeed happening.

...

Instead of holding a summit of losers, why not hold a summit for those who saw the mess coming and are far more likely to know what to do than those who did not see this mess coming.

There is one more gotcha to the summit of winners ideas. That problem is that a few of the people that did indeed see this crisis coming are proposing the same failed Keynesian policies that brought about this crisis in the first place.

Krugman and Roubini need to be excluded from the summit of winners.

Saville Added To Circle Of Winners

Something For Nothing is a very compelling explanation of what Keynesian economics is all about. Thus Steve Saville belongs in my list of winners.

Such clear thinking from Steve is actually not news to me. Rather I simply did not have a recent article of his at hand to point readers to when I complied my list.

Kevin Depew Added To Circle Of Winners

Minyanville Professor Depew has been on the right side of understanding what is going on and why for as long as I can remember.

I nominate Professor Depew to the winners circle for Five Things You Need to Know: Deflation... And the Headstones Climbed Up the Hills .

One Last Thing

Of course, there is a last resort, one final tool policymakers can deploy. The Fed and Fiscal Policy could come together to help foster a continuation of the game, as Bernanke says:

"[ I]n lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets. "

Yes, that would help... but the costs are not mentioned, and here we are not referring to the "dollar costs," but something more severe; a steeper price - the nationalization of financial markets.

In plain English, that paragraph is saying that, if all else fails, a government can issue public debt, financed by the Federal Reserve, to purchase private assets. And that is precisely what is taking place right now.

At that point the very question of whether capitalism survives becomes irrelevant, because a government, by issuing public debt to buy private assets, will have effectively concluded it.

Mr. Practical Added To Circle Of Winners

Minyanville Professor Mr. Practical has likewise been on the right side of understanding what is going on and why for as long as I can remember.

Here are two articles from Mr. P. worthy of reading. Minyan Mailbag: Too Much Debt and Borrowing on Our Future .

Circle of Winners

  • Ron Paul
  • Marc Faber
  • Peter Schiff
  • Frank Shostak
  • Steve Saville
  • Kevin Depew
  • Mr. Practical

I am sure there are many other worthy candidates. I cannot name them all.

Unfortunately I can state that maintream press articles and Bush administration bureaucrats are dominated by the thinking of the giant collection of Keynesian losers.

The Japanese Deflation Fighting Experiment

There are those who think that serial bubble blowing is a good idea and that the Fed always comes out on top eventually. I disagree and the great depression should be proof enough.

Additional proof comes from Japan whose Nikkei stock market close to 40,000 decades ago and is languishing at 9000 today.


Peak Credit Review

Eventually there comes a time when all such stimulus fails to produce a bigger credit bubble. That time comes once Peak Credit is reached for the cycle.
Peak credit has been reached. That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.

It took nearly 80 years for people to get as reckless as they did in 1929. 80 years! Few are still alive that went through the great depression. No one listened to them. That is the nature of the game. The odds of a significant bout of inflation now are about the same as they were in 1929. Next to none.

Children whose parents are being destroyed by debt now, will keep those memories for a long time. Contrary to popular belief, the stimulus and government intervention during the great depression were massive. Please see an Interview with Paul Kasriel for an analysis. Likewise, the current intervention by Congress, Paulson, and Bernanke is without a doubt causing lasting damage.

The more damage inflicted now by the Keynesian fools, the greater the chance the US stock market indices end up looking like the chart of the Nikkei above.

Before the barrage of responses about Japan even begins, let me end that barrage in advance. I am well aware of differences between the US and Japan and have written about them many times already. The key point is that Japan headed into its deflation with net savings to draw on, while the US is entering deflation deep in debt. That makes the situation in the US all the more dire.

Attempts to prop up the stock market, housing prices, and to stimulate lending, etc., are all doomed to fail for the exact reasons outlined by Shostak and Saville above: The pool of real savings is depleted and you can't get something for nothing.

Ironically, Greenspan, Bernanke and others lorded over Japan on how the Japanese banks needed to write of bad debts before Japan could have a sustainable recovery. 20 years of malaise suggests that Japan would have been better advised to take its medicine sooner rather than later.

Ironically, flawed economic thinking is gaining ground when it should be losing it. Economics is like physics: Austrian economics embraces sound principals where the pool of real savings, created from production and income, dictates the price of lending. Keynesian economics is like alchemy, trying to change the real into something else. It is based on short term manipulations affecting the price of lending. These manipulations create imbalances that must be corrected. Unfortunately government policy tries ever harder to keep the alchemy going.

The greatest socialist institution every created is a central bank given the authority to create money. Instead of the price of lending being dependent on production and income, the price of lending is determined by bureaucrats incented to make that price as cheap as possible at all times. This does not create wealth, only imbalances. Real wealth is created only by production and production is a function of the real market seeking profit.

In short, the simple truth is that Keynesian economic theory is based on the same failed something for nothing theory of perpetual motion. Attempts to get something for nothing are a complete waste of both time and resources and thus can only make matters worse

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2008 Mike Shedlock, All Rights Reserved

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