17 reasons America needs a recession
Think positive, this 'slow motion train wreck' is good for the U.S.
By Paul B. Farrell, MarketWatch
Last Update: 6:53 PM ET Nov 19, 2007
ARROYO GRANDE, Calif. (MarketWatch) -- Yes, America needs a recession. Bernanke and Paulson won't admit it. And investors hate them. We're all trapped in outdated 1990s wishful thinking about a "new economy" and "perpetual growth." But the truth is, not only is a recession coming, America needs a recession. So think positive: Let's focus on 17 benefits from this recession.
To begin with, recession may be an understatement. Jeremy Grantham's GMO firm manages $150 billion. In his midyear report before the credit crisis hit he predicted: "In 5 years I expect that at least one major 'bank' (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private-equity firms in existence today will have simply ceased to exist."
He was "watching a very slow motion train wreck." By October, it was accelerating: "Train hits end of track at full speed."
Also back in August, The Economist took a hard look at the then emerging subprime/credit crisis: "The policy dilemma facing the Fed may not be a choice of recession or no recession. It may be between a mild recession now, and a nastier one later."
However, the publication did admit that "even if a recession were in America's long-term economic interest, it would be political suicide" for Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson to suggest it.
Then The Economist posed the big question: Yes, "central banks must stop recessions from turning into deep depressions. But it may be wrong to prevent them altogether."
Wrong to prevent a recession? Why? Because recessions are a natural and necessary part of the business cycle. Remember legendary economist Joseph Schumpeter, champion of innovation and entrepreneurship?
Economists love Schumpeter's "creative destruction:" Obsolete firms get destroyed and capital released, making way for new technologies, new businesses, like Google. And yet, nobody's willing to apply Schumpeter's theory to the entire economy ... and admit recessions are a natural part of the business cycle.
Instead, everyone persists in the childlike fairy tale that "all growth is good" and "all recessions are bad," a bad hangover of the '90s "new economy" ideology. So for the folks at the Fed, Treasury and Wall Street, "eternal growth" is still America's mantra.
Unfortunately, the American investors' brain has also developed this blind obsession with "growth-at-all-costs," coupled with a deadly fear of all recessions, as if recessions are a lethal super-bug more powerful than Iran with a bomb.
Our values are distorted: It's OK to be greedy and overshoot the market on the upside -- grab too many assets, take on too much debt, make consumer spending a religion, live beyond our means, ignite hyperinflation along the way. Growth is good, even in excess.
[!!??!! -- hyperinflation is not currently in the cards. It also seems unlikely, unless the US government falls apart. As I’ve argued elsewhere, hyperinflation is a symptom a state’s collapse.]
And yet, recessions are a no-no that drives politicians, economists and investors ballistic.
Well, folks, you can block all this from your mind, you can argue that recessions are not a part of Schumpeter's thinking, that they are inconsistent with your political ideology. But the fact is, we let the housing/credit boom become a massive bubble, it popped and a recession is coming. So think positive, consider some of the benefits of a recession:
1. Purge the excesses of the housing boom
No, it's not heartless. Not like wartime calculations of "acceptable collateral damage." Yes, The Economist admits "the economic and social costs of recession are painful: unemployment, lower wages and profits, and bankruptcy." But we can't reverse Greenspan's excessive rate cuts that created the housing/credit crisis. It'll be painful for everyone, especially millions of unlucky, mislead homeowners who must bear the brunt of Wall Street's greed and Washington's policy failures.
[This author should quote Andrew Mellon, Treasury secretary during the 1920s: "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." His whole idea is that a recession would purge the imbalances from the US economy -- i.e., those factors that are screwing up financial and real-world markets. This is a very 19th century way of looking at things. For example, Marx saw the bankruptcy of thousands and the destruction of a lot of capital as the result of a recession ("crisis") and also as allowing a new recovery. The “Austrian school” of economics (von Hayek, von Mises, Rothbard, etc., but not Schumpeter, despite his ethnicity) also believe in this binge-purge theory of the business cycle: the recession (purge) is the punishment for having an excessive boom (binge), while the purge allows recovery.
Of course, neither Mellon nor Marx nor the Austrians anticipated that a cyclical recession could cause the US economy to jump the rails, going from a normal business cycle to a serious depression, as during the 1930s. Okay, Marx had some ideas along these lines. In some Marxian interpretations, in fact, a serious recession would encourage revolution.
The Austrian school, on the other hand, who Farrell channels via Schumpeter, have no idea about the economy’s potential to spin off into depression. Their concern is instead with a business cycle where (somehow) full employment is maintained.]
2. U.S. dollar wake-up call
Reverse the dollar's free fall and revive our [i.e., US capitalist] global credibility. Warnings from China, France, Iran, Venezuela and supermodel Gisele haven't fazed Washington. Recession will.
[I don't see why a recession would do this. If the US recession "goes global," it won't just be US imports that fall, helping the US$. It will also be foreign exports (US imports) that fall, which would hurt the value of the US$.
By the way, any effort to prop up the dollar, i.e., to prevent or slow its further fall, would involve raising U.S. interest rates relative to those in Europe, Japan, the U.K., etc. This encourages recession in the U.S., all else equal.
This kind of contractionary monetary policy in the face of recession was one factor that helped make the Depression so Great. Of course, the U.S. and world economies were already ready to fall, but that’s another story…]
3. Write-offs
Expose Wall Street's shadow-banking system. They're playing with $300 trillion in derivatives and still hiding over $100 billion of toxic off-balance sheet asset-backed securities, plus another $300 billion hidden worldwide. A lack of transparency is killing our international credibility. Write it all off, now!
[again, purge, purge! Let's be the capitalist Stalin, purging them all!
I don't see how this is the result of a recession, however. What’s needed instead is serious financial regulation -- imposed by the government, not by a recession.]
4. Budgeting
Force fiscal restraint back into government. America [by which he means the government sector] has been living way beyond its means for years: A recession will cut back revenues at all levels of government and cutbacks will encourage balanced budgeting.
[This is the "starve the beast" theory in a new form. It doesn't force fiscal conservatism, however. In fact, a recession would make the governments' deficit that much larger. It could cause a bunch of state and local governments to go broke, as in the 1930s. Given the current balance of political power, it likely would cause a much greater cut-back in public services than we've already suffered. Rich people like Farrell won't suffer, but most others will.]
5. Overconfidence
A recession will wake up short-term investors playing the market. In bull markets traders ride the rising tide, gaining false confidence that they're financial geniuses. Downturns bruise egos but encourage rational long-term strategies.
[A recession could also cause a 1930s-type funk to dominate the financial mind-set. That may encourage rational long-term strategies. But even more important is having serious and intelligent financial regulation of the sort that kept the US financial system "sane" during the 1950s and 1960s. How about the idea of bringing back sanity-making regulations without having a recession? Perhaps that’s too easy for Farrell.
Also, note that a recession could impose such a deep funk that it could cause an even more serious credit shortage than seen recently. This could deepen the recession further, rather than forcing “investors” to clean up their collective act.]
6. Ratings
Rating agencies have massive conflicts of interest; they aren't doing their job. They're supposed to represent the investors [i.e., stock-holders, bond-holders, speculators, etc.], but favor Corporate America, which pays for the reports. Shake them up.
[but at what cost? why not use financial regulation instead?]
7. China
Trigger an internal recession in China. Make it realize America's not going into debt forever to finance China's domestic growth and military war machine. A recession will also slow recycling their reserves through sovereign funds to our equities.
[A Chinese recession would mean a big fall in US exports. The US doesn't just import from China, you know.
It’s quite possible for there to be an international multiplier effect: a US recession depresses China, which in turn depresses the US, which in turn depresses China, etc. With the Chinese currency fixed to the dollar, this is quite possible, since exchange-rate changes can moderate the international multiplier effect.]
8. Oil
Force the energy and auto industries to get serious about emission standards and reducing oil dependency.
[I don't get this one at all: it's government regulation and/or high oil prices which encourage reducing oil dependency. It's government regulation which forces better emission standards. A recession could simply drive a lot of companies up against the wall, making them even more resistant to the necessary regulations.
One thing that a recession could do is to cause oil prices to fall drastically. That sounds good, but it could undermine any “market forces” encouraging companies and individuals to economize on oil. And then oil prices could rise again when the recession ends.]
9. Inflation
Expose the "core inflation" farce Washington uses to sugarcoat reality.
[This is total crap. He's saying that "Washington" under-measures inflation, using the core inflation rate (which leaves out energy & food inflation). But it's only fools like Farrell who read it this way.
Instead, the core inflation rate is an effort to get a handle on what part of inflation is persistent rather than being a flash in the pan. (Energy and food prices often go up, but then end up falling soon thereafter.)
Farrell may be right that inflation is under-measured (given the Boskin commission changes in the measurement of the CPI), but a recession wouldn't expose anything about that. This stuff about core inflation is just Farrell's hobby horse.]
10. Moral hazard
Slow the Fed from cutting interest rates to bail out speculators.
[This guy doesn't really understand the world: a recession would create -- nay, intensify --political pressure pushing the Fed to cut rates. Having the Fed not bail out speculators is instead necessary to causing a recession. He's got the causation backward.]
11. War costs
Force Washington to get honest about how it's going to pay for our wars, other than supplemental bills that are worse than Enron-style debt financing.
[This doesn't work at all. Since when does a recession cause honesty? Financial panics do expose lies, but desperation often encourages more crime. When the savings & loans were collapsing, it encouraged some people -- such as Charles Keating -- to figure out how to fleece people as a way to save their S&L's bacon.]
12. CEO pay
Further expose CEO compensation that's now about five hundred times the salaries of workers, compared with about 40 times a generation ago.
[see comment under #11.]
13. Privatization
Stop the privatization of our federal government to no-bid contractors and high-priced mercenary armies fighting our wars.
[Why wouldn't a recession -- which cuts tax revenues -- be used as an excuse for further privatizations?]
14. Entitlements
Force Congress to get serious about the coming Social Security/Medicare disaster. With boomers now retiring, this problem can only get worse: A recession now could avoid a depression later.
[Like most jerks and Beltway insiders (I'm sorry to repeat myself), Farrell mixes Social Security with Medicare, falsely equating their problems. As serious students of the issues know, Social Security is not a big problem at all.
On the other hand, Medicare is a serious problem. This is not due to the demographic issues as much as the medical-care inflation that's hitting the private sector. It's true that a recession would slow medical-care inflation, but it would also encourage firms to dump what's left of their employees' health insurance.]
15. Consumers
Yes, we're all living way beyond our means, piling up excessive credit-card debt, encouraged by government leaders who tell us "deficits don't matter." Recessions will pressure individuals to reduce spending and increase savings.
[The problem, of course, is that a recession means a fall in consumer incomes, which makes saving more difficult. To the extent that people do save more, the extra decline in consumer spending encourages recession. The exception is where fixed investment (or exports or government purchases) rises to take consumer spending’s place in providing demand and keeps from the economy from falling. But falling consumer spending, all else equal, causes fixed investment to fall.]
16. Regulation
Lobbyists have replaced regulation. Extreme theories of unrestrained free trade plus zero regulation just don't work; proven by our credit crisis, hedge funds' nondisclosures, private-equity taxation, rating agencies failures, junk home mortgages, and more. Get real, folks.
[Maybe Farrell is thinking that a recession would stimulate a mass movement or three, as during the 1930s. This might force the government to bring back New Deal-style reforms that make capitalism work in a saner way than it does these days. Interesting theory: it goes back to the ultra-left "the worse, the better" theory, in which recessions encourage political reform or even revolution.]
17. Sacrifice
"We have not seen a nationwide decline in housing like this since the Great Depression, says Wells Fargo CEO John Stumpf. As individuals and as a nation Americans have always performed best in crises, like the Depression or WWII, times when we're all asked to make sacrifices. Pampering us with interest-rate cuts and tax cuts during the Iraq and Afghan wars may have stimulated the economy temporarily, but they delayed the real damage of the '90s stock bubble while setting the stage for this new subprime/credit crisis.
Wake up, the train wrecked. Time to think positive, find solutions, demand sacrifices.
[are rich folks like Farrell going to make sacrifices too?
More importantly, there's a strange contrast within Farrell's diatribe. On the one hand, it's like a rant by Travis Bickle, the psycho cabbie in the movie Taxi Driver: "Someday a real rain [recession] will come and wash all the scum off the streets." His hope is that it will all work out for the best for the people (or that is what he implies).
On the other hand, his goal involves nothing but sacrifice by the many. It's one big Austerity Plan. As a result of recession, there will be a mass movement to impose reform and sacrifice.
I hate to use the “f word,” but a mass movement imposing austerity sounds a lot like it.]
Jim Devine
I don't think I'll ever get this right. Somehow, every time I post something to Econoclast, it messes up.
ReplyDeleteInterestingly, it's perfectly legible with Opera using a 200% zoom, while it's microscopic at the highest magnification with Microsoft, and invisible with Firefox. This is the only time I can recall where my default browser works while others fail.
ReplyDeleteIt's also an excelent post - too bad only a few Norwegians and other oddballs like me can read it.
I get this silliness when I cut ans paste from Word. Usually, a 2nd C&P fixed the problem.
ReplyDeleteYep, Marx understood crises to the inherent to the capital system and so far surely seems to have been correct. Just as some neoclassicals suffer beliefs in the efficacy of countrcyclic policies, I've no doubt some Marxists may be sufficiently foolish and one-sided as to believe that a depression = some automatic socialist revolution, but these, I believe, would be a small minority. Others know better, understand that generalizing economic distress creates the grounds for both left and right populisms and struggle, the outcome of which is not predetermined.
ReplyDeleteFarrell seems to treat recession as a matter of choice - it is not, but then he also understates the size and quality of financial conditions that have been facilitated through many years of dereg, global financial liberalization, rise and expansion of non-bank banks, structured finance, flawed value at risk models, concentration of exposure, etc etc that have been recognized for more than a month or two.
Too much "span", Jim. I edited the HTML.
ReplyDeleteThanks, Mr. Sandwich! or is it Lord Sandwich?
ReplyDeleteJim
Juan said: >Yep, Marx understood crises to the inherent to the capital system and so far surely seems to have been correct. Just as some neoclassicals suffer beliefs in the efficacy of countrcyclic policies, <
ReplyDeleteI agree with Marx’s theory on this matter (i.e., that crises are inherent to capitalism) except for two points:
(1) Counter-cyclical (Keynesian) policies do work. But they almost always delay and/or change the form of the crisis. For example, a recession (due to a classic squeeze on profits) was delayed during the middle-to-late 1960s by the massive spending on the war in Nam (fiscal expansion). ("Normally" the profit squeeze would have caused a cut-back in accumulation and thus a recession.) But this encouraged the ugly phenomenon of stagflation, even before the oil shocks hit, by squeezing profit rates more than they would have been otherwise. The capitalists responded to falling profitability by trying to regain them by raising prices, speeding up the price/wage spiral.
(2) Though point #1 is very 19th century in spirit, sometimes fiscal policy (or even monetary policy) can make capitalism behave better. The classic case is when the US and world economies spun off the rails of the normal business cycle and fell into what I elsewhere call the "underconsumption trap" plus what Irving Fisher called debt deflation.[*] Then, "reflation" can work – as in Sweden under social democracy and in Germany under Nazism. In the U.S. the political mix was wrong for such policies.
BTW, there is nothing in Marxian political economy that says that fiscal and/or monetary policy can’t affect the economy. In fact, Engels (in his "Socialism Utopian and Scientific") suggests that the contradictions of capitalism mean that the operations of the system become increasingly socialized in an explicit way. In plainer prose, crises can lead to an increased role for the state, propping up the system. That doesn't end the contradictions, of course. They are simply manifested in other ways. If the state plays a larger role, the economic process becomes more politicized. That means either more class struggle from below to affect the details of state policy -- or more state repression of the class struggle.
> I've no doubt some Marxists may be sufficiently foolish and one-sided as to believe that a depression = some automatic socialist revolution, but these, I believe, would be a small minority. Others know better, understand that generalizing economic distress creates the grounds for both left and right populisms and struggle, the outcome of which is not predetermined.<
right.
[*] see my article in the 1994 issue of RESEARCH IN POLITICAL ECONOMY.
I don't see any focus on the likely differential effect of recession and/or depression, Granted that everyone loses something in a serious recession, but some have so much to begin with that they may then be able to compensate from their share of lose by returning to the market and take advantage of others' loses.
ReplyDeleteWhat do you guys who have studied the result of past cycles know about this?
Conservatives have a punitive and judgmental streak, and it shows in this editorial. Paul B. Farrell is in essence 'prescribing' punishment as a consequence of 'economic sins'. This ignores the social reality that the people most exposed to the suffering, the working folks and the poor, did the least to bring these circumstances about.
ReplyDeleteOf course, prescribing such punishments is the height of arrogance - but how else could things have gone so wrong, unless the powers that be, the holders of Conventional Wisdom, weren't arrogant to the core?
Finally, note the reliance on the mechanism of the market to bring punishment to 'sinners'. This is a sleight of hand, also characteristic of conservative mentality. It allows Paul B. Farrell to avoid responsibility for the suffering he is justifying. His faith in 'The Market' allows him to use the market to make out like a bandit and then punish others. All the while claiming that regulating 'The Market' (and restraining the speculators) would be a socially detrimental inhibitor to the creation of wealth.
He gets to have it both ways: a neat psychological trick. Not so neat for those of us exposed to the raging storm.
econoclast;
ReplyDeleteWell, I agree with the obvious, that 'developed world' state policies have been able to mitigate and move crises around but it seems to me that these reactions (become near permanent crisis management) can never do more than that and do so at the cost of an accumulation of costs...even an overaccumulation.
Differently, that such policies work best when least required, that this can lead to exagerrated belief in the ability to control the cycle even as, say through promotion of the financial, they help negate themselves, arrive at limits of their own unconscious creation and that this must be especially so when taking the contradiction between global and national into account.
If I recall, Fisher's account assigned primary causality to the monetary, to an (always relative) excess of credit/debt creation which seems to discount why such excess arose, seems to assume away contradiction between the real and the fictitious,,, from which its all too easy to lay blame at the feet of some band of merry specs and/or policy makers while absolving the system as a whole, as though the shifting to machine production of machines, intro and generalizing of electric power in the production processes, creation of a new and very expansive consumer durables sector, assembly line techniques, mechanization in agriculture, rural crisis and migration, first IT revolution in association with Taylorism, etc etc, could never have led to capitals overproduction of itself.
Anyway, you know the debate...
Jack,
This is anecdotal but, after returning from France and after a few years in upstate NY, a late relative of mine became a stock broker in NYC, did well, dated Ziegfeld girls,,, you know, 'man about town' thing. Was poorly positioned into '29 and lost most of his and his clients' money but stayed until mid '31 when his closest associate walked out of a 14th story window, after which my relative called it quits, moved to Milwaukee where he obtained a job with an insurance company and, I know this is hard to believe, spent decades attempting to make his former clients whole.
Long story short, I was given the distinct impression that his wealthiest clients certainly did take advantage of the asset price deflation in order to further accumulate.
Along the same lines, I've spoken with a few people who, for practical purposes, would never have known there was a great depression other than for having seen so many 'riff-raff' lining up for free meals.
Also, when I worked in FL, knew some who had to survive on swamp cabbage (palmetto hearts) and gophers (tortoise), when possible making a few cents catching cats which, when skinned and trimmed, can appear moreless like rabbits.
Econoclast said: "Energy and food prices often go up, but then end up falling soon thereafter."
ReplyDeleteThe reading I've done over the last few years points to the food and energy price escalations as being permanent.
This makes sense given that climate change and peak oil (as well as soon 'peak coal') are all permanent situations.
The overwhelming amount of evidence is that we're at peak oil now.
Brenda Rosser quoted me: "Energy and food prices often go up, but then end up falling soon thereafter."
ReplyDeleteand said: > The reading I've done over the last few years points to the food and energy price escalations as being permanent.<
This is true in nominal terms, but not in real terms. The real price of oil fell drastically during the mid 1980s, for example.
> This makes sense given that climate change and peak oil (as well as soon 'peak coal') are all permanent situations.<
how does the peak oil theory explain the steep fall of oil prices mentioned above?
>The overwhelming amount of evidence is that we're at peak oil now.<
And that's a good thing! We need to stop using oil _now_. Its use causes global warming, smog, and traffic congestion, among other things. We need to impose a large carbon tax on fossil fuels to speed up the process (and so it's not the petrol companies who profit).
Jim Devine
Jack said: > I don't see any focus on the likely differential effect of recession and/or depression...<
ReplyDeleteTenured profs like myself aren't going to lose (unless their universities go broke). Mostly, however, it's the rich who haven't borrowed very much relative to their incomes or assets who will do well.
Those with big debts lose due to recession. Assets typically fall in value in recessions, so that net worth moves toward or into the negative territory. (Homeowners are likely to end up with "negative equity," especially these days.) If you have insecure job tenure, as most people do, recession can push your income down (either by imposing unemployment or wage cuts), making it hard to pay debts.
Jim Devine
Juan said: >I agree with the obvious, that 'developed world' state policies have been able to mitigate and move crises around but it seems to me that these reactions (become near permanent crisis management) can never do more than that and do so at the cost of an accumulation of costs...even an overaccumulation.<
ReplyDeleteAs I said before, my view is (1) that in general I agree with that point, but (2) that in a severe depression, there is room for long-term mitigation.
Over the long haul, capitalist crises can be fixed -- by dumping the costs on the working class and others -- until capitalism is overthrown. The system has proven to be much more resilient than Marx predicted.
>... If I recall, Fisher's account [of the debt-deflation theory of great depressions] assigned primary causality to the monetary, to an (always relative) excess of credit/debt creation which seems to discount why such excess arose, seems to assume away contradiction between the real and the fictitious,,, from which its all too easy to lay blame at the feet of some band of merry specs and/or policy makers while absolving the system as a whole...<
I reject Fisher's main theories, but he had something to add when we deal with cases where deflation hits.
>... I was given the distinct impression that his wealthiest clients certainly did take advantage of the asset price deflation in order to further accumulate. ... I've spoken with a few people who, for practical purposes, would never have known there was a great depression other than for having seen so many 'riff-raff' lining up for free meals.<
Right -- even the Great Depression of the 1930s didn't hurt _everyone_. One of grandfathers did very well financially in the early 1930s and was still rich when I knew him. The other one did not do well at all, even though he was pretty rich (a small-town newspaper publisher) in 1929.
Jim Devine
Ay, what a horrible article. On the other hand...
ReplyDelete"crises are inherent to capitalism"
as opposed to socialism which apparently avoids them all together.
Re: energy price increases being permanent. Jim Devine said "This is true in nominal terms, but not in real terms. The real price of oil fell drastically during the mid 1980s, for example.
ReplyDeleteIt appears that the lowering of oil prices in the mid 1980s and 1990s was due to the weakening of OPEC control of world oil due to non-OPEC production in the North Sea, Africa and Latin America. These resources have dwindled in the meantime.
The world as a whole has been finding less oil than it used since 1981.
Peak oil, according to many sources, was reached last year.
http://www.planetark.com/dailynewsstory.cfm/newsid/44955/newsDate/23-Oct-2007/story.htm
So it's not apparent that oil supplies can be ramped up to cater for the steadily increasing global demand. I expect that, though there may be drops in the real price of oil for short periods of time (in response to drops in demand/economic recessions etc) that overall there will be ongoing increases in oil's real cost. Some observers say that the price of oil will probably be very large and over a short period of time.
Jim,
ReplyDeleteThanks. You said: 'over the long haul, capitalist crises can be fixed -- by dumping the costs on the working class and others -- until capitalism is overthrown.'
Which has certainly been true and might also be considered 'moving crisis around' or displacing it while failing to resolve those conditions from which crisis arose. A different type of accumulation-overaccumulating until all attempts to move, displace, mitigate, are quickly overwhelmed by their negative consequences and the immediate choice becomes the old choice between socialism or the barbarism of still more deeply decayed capitalism. But then, choice is an odd word to use isn't it as it assumes awareness that there could even be such a choice muchless organization.
I'm not great with 'Marxology' but my recollection is, yes, Marx did not expect capitalism to survive so long as it has and, no, he never understood its ending to be predetermined but that it had and would transform/adjust in order to survive.
YNS,
Crises inherent to socialism depends on what is meant by socialism