A Simple Explanation of the Great Recession and Why It Has Years To Go
August 31, 2010
– Comments (13)
Yelnick has an excellent new post up. He draws upon Steve Keen's work putting GDP + private sector debt into perspective as a measure of the magnitude of the problem that is faced. The current macro environment for the US (and many advanced economies) is highly deflationary. The Fed has thus far been crediting and shoring up bank reserves hoping they will lend (which they haven't) in order to spur more consumption. What the Fed has also done is go around the banking system to monetize private debt directly. So while crediting banks is inflationary only if the banks lend, taking over private sector debt directly is highly inflationary. I would expect (or at least seriously consider) the Fed to attempt more of this in the future to spur 'aggregate demand'.
I continue to stand by the idea that we will not get either monolithic inflation or monolithic deflation. We are going to get something far uglier and far more mixed. Something akin to stagflation. But whereas 70's stagflation was caused by an oil shock + out of control deficits, this one will be much more sinister. Because it is not some 'exogenous' event, but rather a homegrown balance sheet recession which the economy has not faced in over 70 years.
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A Simple Explanation of the Great Recession and Why It Has Years To Go
Tuesday, August 31, 2010
http://yelnick.typepad.com/yelnick/2010/08/a-simple-explanation-of-the-great-recession-and-why-it-has-years-to-go.html#more
From 1987 when Greenspan took over the Fed until 2009 when the US hit Peak Debt, the US private sector added $34T of debt while US GDP only went up by $9T. Rather than seeing this as a classic Ponzi Scheme, economists praised it as financial innovation. Steve Keen, an economist out of Australia, writes a trenchant essay on this topic entitled What Bernanke Doesn't Understand About Deflation that explains why this Ponzi Scheme is the greatest failure of the Fed and central banks around the world.
His point can be understood this way: what an economy produces (GDP) plus the increase in private debt equals the aggregate demand for stuff. The increase in debt ahead of GDP means the country is living beyond its means, consuming more than it produces. At some point this cannot go on, and the debt begins to shrink. As it shrinks, GDP less the change in private debt equals aggregate demand. As debt shrinks the drop literally sucks demand out of the economy.
* At the peak of our credit bubble, new debt drove US demand to an astounding $18T, $4T beyond GDP of $14T
* By 2010, the decrease in debt turned GDP of $14T into demand of $12T - an absolutely brutal turnaround of -$6T in two years
From $18T to $12T in two years means a third of the wind got sucked out of the sails of the US economy. In 2010 alone demand is headed to a drop of 17% - about what happened in 1930.
The next two years (1931 and 1932) saw drops of 27% and 24%.
While our recent massive increase in govt debt cushioned our drop, it cannot overcome it, especially with State governments now facing a estimated $1T shortfall over the next three years, and political pressure rising against taking on any more massive Federal debt.
... [more at the link above]
but the end is great. Here it is:
Somewhere Bernanke is making a huge mistaken presumption. His critique does not comport with the real world. Steve points the finger to Bernanke maintaining that presumption of equilibrium. In an irony of history, the presumption of equilibrium which Fisher abandoned has crept back into modern economic thinking. Steve's conclusion is priceless:
We might not be in such a pickle now if economics had started to become more of a science and less of a religion by following Fisher’s lead, and abandoning key beliefs when reality made a mockery of them. But instead neoclassical economics completely rebuilt its belief system after the Great Depression, and here we are again, once more experiencing the disconnect between neoclassical beliefs and economic reality.
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