When solutions become bigger than the problems...
SLOWLY, slowly, amid all this chaos, the commentariat is coming around to espouse several key tenets of our Austrian creed, writes Sean Corrigan for the Cobden Centre.
Five years too late for many of the downtrodden victims of the crash, alas, and with nary a nod of recognition to the fact that their beloved Keynes is an idol with feet of clay, but at least they themselves are beginning to inch tentatively along the road to Damascus-am-Donau.
The first of these contentions is that the crisis itself is always the result of an inflation of money and credit—whether this is unleashed as a deliberate act of commission before, or supinely accommodated by the monetary authority after, the fact. The danger here is not so much that consumer goods prices rise as the money and its substitutes swell in availability, but is rather that the inflation distorts, if not entirely suppresses, the critical signals sent about relative scarcities and the subjective human preferences which set these.
Especially problematic are those least directly observable signals which act across time and which are therefore transmitted by interest rates in particular and by asset pricing in general. In scrambling these, inflation progressively fixes too much precious capital into the wrong, ultimately barren foundations and leads too many people to exert their limited human energies in pursuing foredoomed endeavours.
The second Austrian lemma is that when the boom turns to bust, the wisest course, that is to say the one which will involve the least long-run hardship and impose the lowest threat of a widespread descent into lingering hopelessness, is not one that will involve the exercise of either misplaced compassion (if we are charitable) or of naked, political short-termism (if we are not). The answer, when the bust threatens to push the economy beyond its self-regulating 'corridors' is to widen them as much as possible by pursuing an Auflockerung—a lifting of the man-made impediments to swift adjustment—and to eschew all attempts at propping up as much of the Boom's inherently unsound and demonstrably unremunerative superstructure as is possible by a crude and usually fruitless macro-manoeuvring.
The dispelling of the boom-time enchantment typically leaves many saddled with ill-advised levels of obligation which they cannot now honour in the easy manner formerly envisaged. It reveals that many of those in command of economic assets have woefully misapplied and mismanaged them, even where this has not been deliberately fraudulent. It shows that large numbers of people have imagined themselves more prosperous than they really were and have therefore spent and borrowed according to a perniciously false scale of values.
Once this mass deception becomes known, it would be folly to assume that the 'undeserving' can be spared any and all suffering in the ensuing bust. It is also clear that there will be far greater numbers of the plaintive than the pleased when the Wheel of Fortune starts on its inevitable downward course. But nothing in this implies that any purpose is served by indulging in a denial of the gravity of the circumstance. It is a further grave misstep to trust that a 'socialization' of the problem will somehow help, or to expect genuine benefits to accrue from a wilful attempt to further confuse the accounts—which is essentially what the unholy concert of the fiscal and monetary authorities usually seek to do. To the contrary, to act to deaden the pain through a policy of obfuscation, procrastination, and the dispersion of responsibility is not only to prolong the suffering in the here and now but to make a future recurrence much more likely.
All of the misconceptions fostered in the easy money boom require for their remedy a forthright and fearless recognition of what can hardly fail to be unpalatable facts. Like a patient confronted with the news that his ailment is at once more serious and more advanced than he had been given to suspect, or like the general who discovers to his horror that his previously quiescent foe is even now marching in strength upon his flanks, this is no time for palliatives, or for futile 'If Only's'. It is time for corrective action: for harsh treatment if necessary; for a rapid re-arrangement of one's dispositions and for an immediate abandonment of one's earlier illusions.
The more rapidly that a misguided lender and his now discomfited borrower can renegotiate their arrangement, the more resolutely they can each own up to their disappointments, and the more determinedly they can avoid the sunk cost fallacies of regret, the quicker each can disencumber himself of his past errors of judgement and so the earlier each may begin to re-establish what he has lost by acting henceforth in a manner more suited to the changed situation in which he and most of his fellows now find they must go about their business.
It is far preferable to undergo a timely, strategic withdrawal, the better to prepare both the recovery of lost ground and hopefully the advance beyond it, than to become trapped in a personal Stalingrad where a combination of an unwillingness to recognise the scale of the reverse suffered and a naïve hope in a rescue miraculously being effected from above condemns one both to an unavailing struggle and to a final reckoning of loss far more shattering than what was initially required.
One of the most insidious ways to postpone this catharsis is for the central bank to slash interest rates and to flood the world with liquidity, goading the populace into repeating that very falsification of price of assets and of the discount between today and tomorrow which led its members to their present state of ruin.
If we recognise that our savings have been wasted, that our investments have gone sour, that our wealth has been reduced, then the price of what must be a more scarce endowment of productive capital should reflect this. Rates should be higher, not lower. Moreover, with yesterday's attempts at providing for our present needs having been led so far astray, we will all have to put more emphasis on securing current rather than future provision. Again, rates should be higher, not lower. With the sorry lesson fresh in our minds that any chancer can start a business when credit replaces capital and when its rent is set artificially low, we should all be more choosy about whom we are to entrust with our savings. A third time, rates should be higher, not lower
To clarify this last point, it should be obvious that we should never be overly willing to see funds placed, willy-nilly, at the disposal of men who, however praiseworthy their initiative, are sufficiently foolhardy as to want to undertake projects of such a marginal nature that they will fold at the first whiff of adversity—at the merest uptick of interest rates, the first drop in sales or hike in costs, at the smallest fluctuation of exchange rates. Instead we should look for men whose product is really likely to satisfy consumer demand, men whose entrepreneurial antennae have unearthed a reasonably durable arbitrage between input and output prices, and men whose confidence in the schedule of prospective returns to their efforts does not require a vanishingly small rate of interest for its maintenance. If this is true of start-up companies in the upswing, it is doubly true of those stranded on the beach when the flood tide of the boom recedes.
But what do we get instead? We get the present, abominable, inverted Bagehotism of lending on no very good security at all, to all and sundry, and at a highly subsidised rate of interest. By this perverse means we attempt to perpetuate people in the errors of the boom, to succour the weak at the expense of the strong, and to practice Aufhalterung—a gumming up of the system—in place of Auflockerung.
Miracle of miracles, there are those who are beginning to recognise this, whether from the ranks of Britain's recovery professionals at R3, or in the shape of well-known UK investor John Moulton, who severally risk much ill-informed opprobrium by daring to bemoan the policy of allowing zombie companies to hoard resources, manpower, and space on overburdened bank balance sheets. On another tack, Ronald McKinnon and his Stanford University colleague John Taylor (he of 'Rule' fame) argue correctly that ZIRP discourages much lending — whether direct or disintermediated — since risk palpably outweighs a return which is deliberately 'repressed' to or even, in real terms, below zero.
In Axel Leijonhufvud's pithy characterisation, when depressions occur, we are made captives of the past while inflations act to preclude us from mapping out our course into the future. He also suggests that, in the former case, monetary policy may be less effective than might be thought because once it has percolated, as it inevitably will, from the wallets of the income-poor to the pockets of the income-sufficient, the latter may have little incentive to re-employ it—whether they seek to hold it as a backstop amid economic uncertainty, or from a Ricardian-equivalence foreboding about higher taxes, or again because an elevated appraisal of risk seems vastly to outweigh a purposefully scanty reward. If prices, moreover, are not allowed to fall out of an irrational fear of 'deflation', the real value of their reserve will not increase and so gently encourage them to transmute a portion of it back into a medium of exchange: the Pigou effect will not come into play and so another means of self-equilibration will be denied us.
Can we really say that such is not the fate to which Ben Bernanke will consign us, strive though he will to dissolve our contractual ties in the acid of inflation instead?
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