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Recovery Defined

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August 01, 2010 – Comments (19)

At least in a modern economic sense, here is what "Recovery" really means.

Imagine a heroin addict on a next-day crash.  Now picture our poor friend at the clinic describing all of the symptoms of his current deplorable condition to his neo-Keynesian doctors.  Finally, picture them solving his woes by doubling the normal amount of heroin in the addict's body.  He walks out of the office high as a kite.  And no need to concern yourself with those nasty track marks.  That's a lagging indicator.

Of course this analogy isn't complete without a group of sanctified media heads commenting on how wonderful he looks compared to just a few hours ago.  Oh, and a Nobel Prize winning economist openly questioning whether he was given enough heroin in the first place.

David in Qatar

19 Comments – Post Your Own

#1) On August 01, 2010 at 10:54 AM, whereaminow (20.25) wrote:

And in case you don't like the heroin analogy, I offer you this: Forcing interests rates below market levels is an effort to purposefully distort reality.  That's the same purpose drug users have when they inject themsevles.

David in Qatar

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#2) On August 01, 2010 at 11:01 AM, binve (< 20) wrote:

David,

I am just sitting at my desk and smiling as I read this. This analogy is a lot closer to the mark than most would like to admit. I of course am in total agreement with your description. Perfect.

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#3) On August 01, 2010 at 11:14 AM, whereaminow (20.25) wrote:

binve,

I'm also sitting my desk (although I'm finding it hard to smile these days - as the work keeps piling up.)  The question is, when are we going to chuck off these golden handcuffs and retire to drink long island ice teas in the carribean with chris and the rest of the crew?

David in Qatar

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#4) On August 01, 2010 at 11:31 AM, Momentum21 (82.06) wrote:

David,

Certainly a profound and interesting way to look at the dilemma...

The only problem I have with the analogy is that most agree that not even a little heroin is "good" and we all would have a very different opinion of what levels of economic consumption are healthy. There is certainly a tipping point but going cold turkey would not be the solution unless you were suggesting an entirely new economic platform.  

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#5) On August 01, 2010 at 11:35 AM, binve (< 20) wrote:

David

>>The question is, when are we going to chuck off these golden handcuffs and retire to drink long island ice teas in the carribean with chris and the rest of the crew?

Now that is an excellent question to ponder! My thoughts are that we have 5-10 more years where the debt avalanche collapses (actually I think the debt collapse is within the next 3-5). I hope (and am very optimistic) that there will be some major political change during this time. The people are so fed up with neo-keynesian-economists and the politicians who listen to them (because it is poltically expiendient to give voters debt fueled spending without any up front cost). Their complete and utter failure at both predicting and handling the next stage of the crisis (soverign debt) will leave voters a) disenfranchised, b) angry, and c) a little bit smarter / less gullible. I think a combination of all 3, but hopefully with a bit of b and c. This means that the time of the politician who understands economics and will not make politically expedient decisions for the sake of disatrous long term consequences will be at hand. I am thinking of Ron Paul but there are several less prominent others who fit that bill. These will be non/minimal interventionist politicians. This means the debt will clear and the market is in a position to start fixing itself. Once that sea change occurs (and I am very optimistic it will), it will be as the markets are likely still breaking and gold is near the apex of it parabolic run. That is when I sell my gold fortune, buy quality dividend stocks, and (it would be nice :) ) retire. I think we have a 'darkest hour' coming up economically, but after that I am quite optimistic for the future. Because if the darkest hour comes with some real change then the future will be so bright 'that I gotta wear shades' :) Then, I belive, the market really will be the buy of a lifetime, and a few years after that, economic indicators will start turning sustainably positive because the underlying growth will be healthy again (becuase it will be driven by savings and captial investment, not debt). Then, I believe my friend, it will be Long Island Iced Tea time :)..

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#6) On August 01, 2010 at 12:08 PM, whereaminow (20.25) wrote:

Momentum21,

The body needs to be cleansed.  The most important point that I can stress is that the bust/crash is a symptom of the boom.  Treating the symptoms without addressing the disease (the boom itself) does not work.  The Austrian Business Cycle Theory posits that an excessive expansion of credit (which can be produced through artificially low interest rates) causes a misallocation of resources (the boom) which inevitably must bust.  Re-inflating does not help cure the disease.

binve,

Be careful.  Your optimism might get contagious ;)   A little less optimistic on the long term political picture, but like you I'm very optimistic about our own ability to use the tools available to us to make our lives better.  We just keep plugging away bro and it'll all work out :)  Heck, I just got back from vacation, sippin Heinekens on the roof of a 5 star hotel in Athens with a view of the Acropolis, and I'm already complaining that I need another vacation.  Wtf is wrong with me? 

David in Qatar

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#7) On August 01, 2010 at 1:20 PM, Starfirenv (< 20) wrote:

  David, Pretty right on in my book. Had you used Alcohol in your analogy even Mo21 would agree.
  B-Man, as for 3-5/5-10, that's a tough call. Long as we retain "Reserve Currency" status we should be able to stay in denial. When that is "fixed", (basket of currencies and maybe some SDR's), then we may well see your "darkest hour" (or darker for sure).
  I have to warn you both- nobody drinks Long Islands in the Carribe- unless you are at a Club Med. Think local Rum with a little fresh mango/pina/guava/orange/etc or Coke (bleh). Goes good with a BBQ full of conch and fresh speared grouper. See you there. +1. Regards.

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#8) On August 01, 2010 at 1:59 PM, 1315623493 wrote:

Consider this analogy.

A man gets shot in the chest and is taken to the hospital. There are two doctors on call and both come to his bedside. They discover the man is bleeding to death at a rapid rate. The Keynesian doctor says the best course of action is to operate immediately to stop the bleeding, and give the patient blood transfusions. But the laissez-faire doctor simply says, "Let nature take its course. Nature is always right and if his body is healthy enough, he'll survive, and if not, die." The Keynesian doctor understandably looks at his colleague in disgust.

Which doctor would you choose if you were the dying man on the table? 

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#9) On August 01, 2010 at 2:08 PM, whereaminow (20.25) wrote:

Well, since the Keynesian doctor shot him, I guess he should seek a second opinion :)

David in Qatar

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#10) On August 01, 2010 at 2:25 PM, zymok (< 20) wrote:

David,

Funny, to the point, and painfully accurate.

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#11) On August 01, 2010 at 2:34 PM, binve (< 20) wrote:

Starfirenv ,

Hey man!

>>Long as we retain "Reserve Currency" status we should be able to stay in denial. When that is "fixed", (basket of currencies and maybe some SDR's), then we may well see your "darkest hour" (or darker for sure).

I agree. What I am saying is that I put non-trivial odds on precisely that happening during this crisis, like I talked about here: http://caps.fool.com/Blogs/a-response-gold-vs/418401.

Now, I don't mean the the US Dollar will implode / become defunct / become extinct (at least not within most of our investing lifetimes). Nor do I think the the world returns to a gold standard. But I do think that the Dollar will be a weaker currency that it is today, and I do mean this with respect to other fiat currencies and also with respect to Gold. And I do think the odds are not trivial that the Dollar does lose its Reserve Currency status..

>> have to warn you both- nobody drinks Long Islands in the Carribe- unless you are at a Club Med. Think local Rum with a little fresh mango/pina/guava/orange/etc or Coke (bleh).

I know man :) I was in Nassau and a few islands, and I have fond memories of Rum and pineapple (great) and Rum and Mango (outstanding!). Rum and coke makes me want to puke :)

>>Goes good with a BBQ full of conch and fresh speared grouper. 

You are speaking my language!

>>See you there.

You betcha!

whereaminow and BetapegLLC ,

>>Well, since the Keynesian doctor shot him, I guess he should seek a second opinion :)

Exactly. For Beta's analogy to hold with the original analogy in the post, you must establish root causes. And too much deficit spending and too much debt is the high for the heroine addict or the bullet that shot the the patient is Beta's analogy.

So the "prescription" from the doctor in comment #8 would be to pull out his 0.45 and shot him again. :(.

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#12) On August 01, 2010 at 3:10 PM, ChrisGraley (29.74) wrote:

Agreed, but the next time he shot him, it would be with a machine gun.

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#13) On August 01, 2010 at 3:56 PM, 1315623493 wrote:

Guys, the patient was involved in some "gangster shyt", i.e. over-leveraging themselves, that got them shot. The Keynesian doctor, and government, weren't, for example, in the boardroom of Lehman Brothers telling them to get into sub-prime mortgages. Additionally, Keynesian economics says government should operate a fiscal surplus during economic expansions. So the assumption that Keynesian economic policy is to blame for all this government debt and deficits is in my view fallacious. The government has not been following Keynesian economics, only until 2008, did they do so, when they really had no choice. The 30 years preceding the Obama administration saw the rise of laissez-faire-like economic policy and 2008 only proves to me that the market is not perfect, and can get "shot", and need "medical treatment".

So in essence, our government, follow Keynesian economics when a recession threatens, but forget that Keynesian economics demands a surplus when times are good. Anything outside that is not Keynesian economics.

More specifically...

Keynes′ theory suggested that active government policy could be effective in managing the economy. Rather than seeing unbalanced government budgets as wrong, Keynes advocated what has been called countercyclical fiscal policies, that is policies which acted against the tide of the business cycle:deficit spending when a nation's economy suffers from recession or when recovery is long-delayed and unemployment is persistently high—and the suppression of inflation in boom times by either increasing taxes or cutting back on government outlays. He argued that governments should solve problems in the short run rather than waiting for market forces to do it in the long run, because "in the long run, we are all dead."

Keynes, John Maynard (1924). "The Theory of Money and the Foreign Exchanges". A Tract on Monetary Reform

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#14) On August 01, 2010 at 6:13 PM, whereaminow (20.25) wrote:

Beta,

That is well argued and I think we might have fruitful discussion.

I wonder what contraction Keynes was arguing was too lengthy to allow market forces to perform the correction.  The essay you cite is written in 1924, 5 years before the crash.  The 1920 crash was corrected in 18 months.  That had to be fresh in his memory, you would think.  1907? 1893? A misreading of 1873 (quite common to think it was a long depression, but in fact it was brief and followed by spectacular growth)?  1836? 1819? 

My point is, these were all moderate-to-severe corrections fixed quickly by market forces. 

Since modern economists like to lean on empiricism so heavily, what empirical evidence did Keynes (or any of his students) marshal out to support this idea that market forces move so slowly, especially before the Great Depression?

David in Qatar

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#15) On August 02, 2010 at 12:51 AM, 1315623493 wrote:

whereaminow,

The period of 1929-1933 saw so many banks fail, that many states didn't have a single bank in operation. What would have been your solution outside of government action? A person can fight off most diseases by themselves, but there are times when someone can get really sick, and need hospitalization. Going by that analogy, the market, yes you're right, does usually correct and life moves on. But there are times when the market systemically does/can fail, and only a "hospitalization, i.e. government spending and quantitative easing, can restore order to the markets. Nothing in this world is perfect, but collectively, the right balance of government and markets, both imperfect, can and has brought millions out of poverty. Because of my axiomatic belief that markets are imperfect, I do not believe the market can fix itself any and every time, as the Austrian School believes.

This book pretty much goes through economic history, theory by theory, to prove that markets are not perfect. I'd suggest listening to the audio version. 

 

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#16) On August 02, 2010 at 1:02 AM, whereaminow (20.25) wrote:

BetapegLLC,

When I did I, or anyone else at The Austrian School, say that markets are perfect or rational, or that they need to be?  I'd like to check out the book when I have time, but I don't see how a book showing that markets are irrational refutes a theory that doesn't claim they are rational (or need to be) in the first place.  I think you have Austrian Theory confused with something else.

The period of 1929-1933 saw so many banks fail

Yes. The banking system broke.  But, that doesn't have anything to do with my question in comment #14.  Do you have anything on that?

David in Qatar

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#17) On August 02, 2010 at 12:22 PM, 1315623493 wrote:

whereaminow,

Then what do you think the market is, and if it's not perfect, what do you do when it utterly fails, but without government intervention as the solution. Because when the financial system fails and and all hell breaks lose, government fiscal and monetary policy is the only answer at this point. 

I don't have empirical data to show you, if that's what you want, but that doesn't mean "this or that". I'd just rather defer to a Keynesian professor of economics or something. 

I can only say that government intervention is justified in my view. 

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#18) On August 02, 2010 at 3:10 PM, whereaminow (20.25) wrote:

BetapegLLC,

Then what do you think the market is, and if it's not perfect, what do you do when it utterly fails, but without government intervention as the solution. Because when the financial system fails and and all hell breaks lose, government fiscal and monetary policy is the only answer at this point.

This is really two different items.  First, we don't have the same view of what a market is.  For Austrians, the market doesn't have goals and targets.  It's not important if GDP is up 1% or down 1% (for a couple of reasons - one being aggregates are meaningless, see the USSR, and two being that markets don't have goals, only individuals do.) The important thing to us is that individuals are free to engage in market bahavior - the voluntary exchange of goods and services - regardless of how that turns out.

When the market does crash, we investigate the root cause first.  That investigation has led the Austrian School to the belief that excessive credit expansion causes a boom that must crash.

The way we look at it, the economy is not a machine with ends.  It is merely a means  It is an ecology, and a delicate one at that.  Tinkering with it destroys it.  If you put the Fed in charge of the water supply in the Amazon rain forest, they'd run all kinds of equations, then up the amount of water and lower the amount of water, ad nauseum, until there was no water left and the rain forest died.  Then they'd blame the forest itself for failing.

I don't have empirical data to show you, if that's what you want, but that doesn't mean "this or that". I'd just rather defer to a Keynesian professor of economics or something. 

That's fine. I just find it interesting. I guess we can come back to that later, but it appears that Keynes' ideas rest on theory and not empiricism.  That's fine and he could be right, but it is ironic when modern day Keynesians like Krugman and his little sister Bard DeLong (and their papa, the Soviet lover, Paul Samuelson) tell you that there is either empirical "science" or hack ideology.

David in Qatar

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#19) On August 03, 2010 at 9:16 PM, ExploitTopFools (95.08) wrote:

love the discussion here. thanks to all posting here. this is a keeper

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