Thursday, March 26, 2009

Monetary Measures

When we talk about economic recovery or growth, we talk about life and living.

We talk about how to live, ways of living and how to be excited about life.

The current talks about policy measures and responses to the economic collapse are like the talks of pharmacists and doctors. You have a headache, take a panadol. You have stomach cancer, remove your stomach.

But the economy to come alive only when the world has a direction.

Where in the world is the future?

Economic planners have to sit down with bankers to figure out which way to go in future. If economic planners know where the future lies.

Or do we leave it to the innovators to come up with new products to excite new customers.

Or do we leave it to the speculators and holders of cash to take advantage of sharp asset price reduction as a basis for the world to engineer for itself somehow a recovery?

An economy grows because there are investors who are brave enough to put their assets on the line to produce goods and services for which there is a demand.

What does the world want?

Certainty, investment, production and consumption - in this order.

Certainty is currently being bought by the holding of cash.

Investment will come in when asset prices are seen to have stopped falling - and only after what potential investors feel have fallen to their proper values and not because some politicians stopped the decline at some inflated prices.

Production will then arise out of those investments.

After investments comes growth in income and hence consumption.

Monetary measures, ha!


hishamh said...

etheorist, I'm not sure I understand your reasoning here.

Are you in fact advocating central planning? Your narrative suggests that you are deeply suspicious of market mechanisms in general, and the role of Keynes' "animal spirits".

I agree that asset price deflation is necessary. Investment cannot occur unless future income flows exceed the cost of investment, that is, it must be profitable to invest. That applies to both capital and labour.

Yet, if 'hard' asset and labour prices are downwards sticky (I'm not talking here about so-called financial "assets" - the faster those are written off the better off we will be), then "monetary measures" as you put it is a less painful recourse to equilibriate real valuations with nominal valuations. IOW, we may need a spot of 1970s style stagflation to achieve this.

Doing it the other way - adjusting nominal valuations to real valuations - is a recipe for creating and sustaining a depression. The US housing market is a case in point. Since house prices are not as sticky downwards, the adjustment can occur without intervention but with predictably painful consequences for wealth and consumption. Expanding the monetary base in this instance can cushion the blow going forward, assuming we do see some inflation and a sharper depreciation of the USD.

I cannot advocate non-intervention on the monetary side at this point, even with the potentially hazardous economic consequences. Better to have the adjustment to occur in money and relative prices (i.e. the exchange rate), than to deal with the real costs of higher unemployment and capacity (as opposed to wealth) destruction.

etheorist said...


Of course, as you can probably see, I am pressing on all the painful spots.

1. I am not suspicious of market mechanisms. I am advocating that the markets be allowed to function - fully and not partially.

2. This means allowing the depressive forces that are now developing to build up to their appropriate levels and explode.

3. I am saying that there has been too much intervention in the market place for too long - since 1990 in this current round - that things have at last come to a head.

4. This means that if the depression is not allowed to occur - if prices are not allowed to fall - then I am afraid that we will merely be postponing doomsday and not solving the problem.

5. I am saying that instead of desperately trying to keep up aggregate demand so that the economy does not falter and hence preserving status quo, it is far better to focus on the foundations to build a new future which should be radically different from what we have been seeing in the last few decades.

6. I am saying that we should all bury Keynes - because he has outlived his usefulness - and that we should begin to think for ourselves from first principles - of ethics and the environment and the world we want to live in - rather than that which is dictated by the industrial revolution.

7. I am saying that monetary policy is the pharmacist and we should be listening to real doctors to tell us the root of our problems today rather than applying band aid.

8. I am arguing that depression may not be a bad thing taken in proper perspective - in that after a very heavy meal we should be digesting rather than trying to get ourselves re-bloated every other second - although there could be heavy social costs - to which I do not mind casting a wide and deep social safety net - but I do mind throwing good money after bad business decisions.

9. I do fear stagflation and that is why I do not favour monetary measures to solve a fundamental economic problem - which Greenspan had applied in the US to such a resounding fiasco. Instead of stagflation, I would rather have stagnation without the inflation.

10. I don't think we can pretend that this global crisis is the result of a small loss in aggregate demand within a structurally sound global economy which a simple fiscal expansion or easy money policy that gloss. I think the current global crisis signals a significant structural change for the world - the end of the US economic dominance - which requires appropriate structural changes by the world including the US itself - in order for the world to evolve into a diametrically different creature from what we know it to be.

11. I think the world should change all its central bank governors and political leaders, and probably chief economists if there were any in practice in the first place.

But thank you, hishamh, for your enthusiam!

de minimis said...


When you get categorical, you are at a higher plane of communicative clarity. It's scary, but, the proposition that you have made is compelling. This is thinking out-of-the-box. It is scary to abandon Keynes. And, it is quite obvious that, unlike you, conventional economic thinkers fear a non-Keynesian paradigm. It is an unknown.

The dilemma of policy makers is that their brief (and, therefore, their paid job) is to ensure minimum pain. The pain-killer being used by all governments - capitalist or communist - this time around is fiscal deficit policy which is Keynesian in substance.

This may turn out to be a case of using water to douse a chemical fire - it won't work and the fire will rage on.

If one were to trouble oneself to read your blog from alpha to omega, one would have a clear picture of the increasingly coherent line of your thoughts.

Keep 'em comin!

etheorist said...

de minimis,

I had two beers over lunch.

de minimis said...

Well, then, more pints to you. Wasn't it Edgar Allan Poe who did his best writings in an inebriated state...not that you are, of course. IN VINO VERITAS!

hishamh said...

Interesting line of thought, thanks for the clarification.

I agree with your point 1 and 10 - there is and will be a secular change in the structure of the global economy. There is no question that global trade and money imbalances were unsustainable, and there can be no return to the status quo ante.

I'm still confused with your policy prescription however. Your basic argument (the rest of your points, but particularly 4,5,7,8, and 11) sounds similar to that espoused by Hayek, Schumpeter and the rest of the Austrian school, or alternatively the liquidationist view e.g. Andrew Mellon:

“Liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate... It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

Paul Krugman was particularly scathing about this idea, and the article I link to was written in 1998 with reference to the 1997-98 crisis.

The problem as I see it is that depression economics creates its own logic - nominal wage and asset price deflation increases the real debt overhang while reducing real incomes, which increases money hoarding while reducing consumption, which then reduces investment and employment, which starts the cycle all over again.

I don't see this as a good policy alternative, especially since the only way to form a bottom is through government (which you are not advocating), or through an external demand shock (which is unlikely under the current circumstances). There's no evidence that "enterprising people" will pick up where "less competent people" left off. Temporary stagflation then is a far more attractive alternative than perpetual stagnation.

I realise that this is very much a Keynesian argument, but I don't see why Keynes is not more relevant now more than ever considering his ideas have been sidelined for so long. On that score, your point 6 and 8 contradict one another - there's no way to form a decent social safety net in an environment of falling aggregate demand, without resorting to Keynesian style deficit spending.

The last thirty years has been essentially an experiment in monetarism/libertarianism. The pendulum is more likely to swing the other way than to proceed with even less state intervention.

etheorist said...


I try to be brief but I think I have failed. (A few more beers for dinner.)

1a. I am not arguing that there should be no intervention.

1b. I am arguing that if repeated interventions do not work, then we have a structural problem at hand and we should allow restructuring by the market to occur.

2a. In my mind, there is a thin line between Keynesianism and Monetarism, as Milton Friedman has declared long ago.

2b. There is the monetary implication of Keynesian-type countercyclical measures. There is the aggregate demand implication of monetary measures.

2c. Both Keynesian countercyclical policies and Monetarist easy money policies are short-term stablisation policies.

2d. They are short-term stablisation policies because they do not care about the nature of the aggregate demand that is being boosted. They simply try to flood the system with liquidity.

2e. I am arguing that this type of policy may not necessarily help to form the bottom; it could be digging a deeper bottom by being inflationary in its overall effect.

2f. An example of such an inflationary effect is the subprime problem which symbolises an extreme point beyond which the whole system simply collapses.

2g. An example of the Keynesian expansionary policy is the US war in the Middle East. It is clearly a stimulus package to fill in the vacuum in aggregate demand caused by the end of the Cold War.

2h. The US war in the Middle East appropriated the Peace Dividend of the end of the Cold War. That Peace Dividend should have been used to feed the millions of starving people in Africa.

2i. The decades of reckless US monetarism is now politely rephrased as libertarianism. Smith should roll in his grave.

2j. It was a gross abuse of seignorage enjoyed by a international reserve money issuer. With this abuse, there is need to replace the US dollar as an international reserve currency.

2k. This abuse continues with the current rescue packages. But the US has no choice without letting the whole banking system collapses and hence the US and global economy. Nonetheless, the ultimate impact will still be keeping asset prices unduly high and the US dollar as reserve money grossly abused.

2l. I am saying that there is a need for us to get out of this short-term stablisation do-loop. (OK, the rescue of the US banking system is fundamental not stablisation - but what led it there in the first place?)

3a. To solve a structural problem, we need to apply new thinking on what the new economy should be.

3b. This new economic thinking will have aggregate demand implications as well as monetary implications - which means it can be Keynesian or Monetarist in nature depending on (i) who is paying for it - the government or private investors which will then result in (ii) more government bonds being issued or more cash being issued by the central bank or more inflow of foreign issues as a result of more foreign borrowings.

3c. Having acknowledged all the attendant implications (which we should now assume to be understood at the back of our minds), let us now apply our conscious minds to how we can create a new economy.

4a. Do we continue to finance (predominantly) real estate?

4b. Do we continue to finance the whole value chain that in the end is predicated on the production of cheap consumer goods to the US and the rest of the world?

4c. Do we try to finance "new" technologies like nano or bio or whatever which could have a real impact on the way we live in future - such as by being so miniaturised or efficient that the destruction of the environment can be reduced to a fraction of what it is today?

4d. Do we place faith in our children and grandchildren in their ability to think and take care of themselves by investing in their education - either in English or any language - so that they learn how to think for themselves?

4e. Or do we take the view that since the economy is now so conducive for accumulating wealth (thanks to endless fiscal stimulus packages and easy money policies) that we should all be scrumbling for "assets" so that we pass on those "assets" to our younger generation?

4f. What are assets? How can assets values be stored? - When the supply of all types of assets has been outstripping even plausible demand.

4g. These are questions that are now bothering China - and they should be asked by all thinking economies that want to be dynamic in the coming years?

I hope my repy answers some of your very searching questions.

After this, I shall address further dissatisfaction in new posts.

Now I need to sleep off the beers.

hishamh said...

LOL, easy on the beers. I await your further elucidations with bated breath.

Just a couple of points before I leave this topic alone:

1. I would not call the Bush years as an application of Keynesian policies. Keynes never advocated running deficits in times of economic growth, nor did he discount the nature of deficit spending despite the "hire a man to dig a hole, hire another to fill it up" meme. Some of the fiscal stimulus packages being implemented (including ours and the US) are more long term in nature.

2. I would call monetarism a polite term for libertarianism (free banking or full reserve banking, the gold standard, minimal government role), rather than the other way around. If I read Smith correctly, he was never a libertarian in the modern sense. That story was neo-classical revisionism.