I studied economics at college at a time when the two great questions of economics was: How Did Stagflation Happen? and How the Fuck Did Monetarism Manage To Fix It When Most of Us Still Believe that Strict Monetarism Was Just Mad Monkey Moon-Juice?
Stagflation is when you have rampant inflation, and low growth. It isn’t supposed to happen. Monetarism isn’t supposed to happen either. Britain and America tried it briefly in the early eighties, and it almost broke the economy, but when things recovered, the stagflation had gone away too.
In some significant ways, you can argue that inflation is a state of mind. Or at least, stagflation was. People had grown so used to inflation in the Seventies that they factored it into their future models of the economy, especially when asking for raises. People would envisage inflation being 10%, so they’d ask for 15% more money this year. Unfortunately, one of the key engines of inflation are wage increases. You can see where this is going: even if inflation was actually going down, the expectation of it caused workers to demand more money, which caused inflation to rise, which made it a self-fulfilling prophecy.
That inflation is largely generated by the belief that it already exists is not a shocking statement for economists to make. Still, it’s surprising to me how rarely they say it out loud. Instead, economists (especially those employed by central banks) spend a lot of time really loudly declaring how inflation is their number one enemy, and that they will do anything to reduce it. The monetarists were particularly emphatic about that. I hope you can see why doing this plays a key part in reducing inflation; why it worked for the monetarists, and why it works now. If you tell everyone you’re going to do everything to reduce inflation, and people believe you, you’ll reduce one of the key engines of inflation. (Especially if you also wipe out the unions and hitch up unemployment so no-one dares to ask for better wages, but that’s another story)
It was the great trick of Reagan and Thatcher to use their ideological fixation to convince the markets that, by gum, they were going to reduce inflation, even doing so meant riots, mass unemployment, and destroying their industrial base. It’s sort of like proving you’re serious by carving “FOR REAL” on your arm in blood.
What I’m trying to get to here, is an explanation for this line from Forbes that has been banded around so much recently:
In fact, some of the most basic details, including the $700 billion figure Treasury would use to buy up bad debt, are fuzzy.
“It’s not based on any particular data point,” a Treasury spokeswoman told Forbes.com Tuesday. “We just wanted to choose a really large number.”
That sounds incredibly, upsettingly, vague, doesn’t it? But here’s the thing: the main job of the bailout package is to convince the markets that everything is going to be okay, and that if the foreclosures go on, the US government will pick up the tab. If the markets believe that, there’s a vague chance that they’ll stop panicking about the foreclosures, and the economy will unfreeze. If it does that, there’s a chance that the foreclosures won’t happen, because the economy won’t suck as much as it might have done, people won’t lose their jobs, and they can keep up the payments.
In the same way as inflation only goes away if a government can convince everyone that it really is going to do everything to diminish it, so a bailout of this size only works if the government can convince everyone that it’s willing to do anything to save the market.
If the markets don’t believe the bailout is sufficient (or there’s no bailout at all), the markets could collapse in neurotic self-pity, the economy will tank, and the foreclosures will happen. And if the half-baked bailout is around, then the government will have to pay for all those foreclosed mortgage risks.
It is therefore really important that the number be very very big. Insanely big. Far bigger than will actually be necessary. If it’s any smaller than that, then no-one will believe it will be enough to save them, so the market will collapse, and whatever amount it is, it will be necessary, because we’ll have foreclosures up the wazoo. Better to say “Don’t worry, capitalism, my darling, I will save you, even if I have to pay you a quadrillion gazillion dollars”, and successfully reassure the current neurotic marketplace, than say “My darling capitalism, I will save you, but the taxpayers say I can only lend you a fiver.” Chances are in the second case, you will lose your lovely capitalism and your fiver.
No-one says from the administration or Congress, because they can’t, just as no-one could have said at the time “Look, just between you and me, the only thing holding up the Eighties deflation is everyone’s believe that Reagan and Thatcher’s would eat a baby on live TV rather than see inflation go up again”.
That lone Treasury spokeswoman was speaking the truth, but she wasn’t supposed to.
Now, say what you like about Bush, he is capable of displaying Thatcher/Reagan-like pigheadedness when needed, and that’s exactly what is needed right now.
Unfortunately, Bush is the President that cried Wolf. As the Daily Show pointed out perfectly, Bush has already managed to convince the American people to trust him to do something radical, without him really spelling out the reasons why — in Iraq. Now, no-one trusts him, which means that no-one really trusts his bailout package, which means there is no party unity, which means that the bailout plan can’t weave its magical confidence spell.
There’s a reason FDR said that the country had nothing to fear but fear himself. And there’s a reason why FDR refused to help the lame duck Hoover in the months leading up to his inauguration. To truly pull off a return to confidence when the country has lost confidence in almost everything, you need to have a sharp break, a clean pair of hands, with a message of hope, and a figurehead whose job is largely just to calm everyone down.
I have to say that America may be fairly screwed right now, but if it votes the right way this election, I think it may be in with a chance. Looking at the polls and the current choice, I can see why Bismarck once said that “a special Providence protects fools, drunkards, small children and the United States of America.”
Or at least, I hope I can.
September 30th, 2008 at 2:53 am
I can see your point about why we might need Obama in order to get people to be confident in the markets again.
Now here is what still gets me confused about the housing crisis:
House prices have been going up and up and up and up, to the point that nobody can afford them but it’s OK since you can just get in debt for decades and you know the prices will keep going up so what could possibly go wrong ? And now that bubble has grown large enough that it’s threatening the whole economy and we can’t afford to let it burst. Fine, I think I get that.
What I don’t understand is, what is supposed to happen after the bailout ?
Supposedly house prices won’t come down, as this is basically what the bailout seems to be intended to prevent.
If prices are to keep going up and up and up and up, and prospective home owners are to keep taking longer and longer mortgages because they know the prices will go and and nothing could possibly go wrong, does that not imply that the bailout would just be setting up the scene for the next bubble burst ?
If prices could be maintained near their current level, this could possibly be the best outcome so current home owners don’t get burnt too badly and they don’t get rewarded for buying things they can’t afford either. But, is it even possible for prices to stay at their current level if new prospective buyers don’t think that prices will go up ? I.e. people might think twice about getting a 30-year mortgage if they don’t think the house will appreciate during that time. And if they don’t, nobody will be able to buy at current prices and I don’t see how the prices could be maintained without constant intervention.
I’m all for saving everybody’s butt, but I don’t see how this works unless this becomes a recurring expense, in which case I’m clearly not for it anymore…
September 30th, 2008 at 3:22 am
No, the bailout is prevent the damage caused by mortgage payers not being able to pay back their loans percolating through the rest of the financial system. It doesn’t have anything to do with shoring up house prices. Certainly, some people bought houses speculatively and assumed they could resell to pay off their debts and make some profit, but their motivation has no effect on the key fact, which is that they now can’t keep up their payments. And whether a mortgage company can do something to regain the money by selling the house at a certain price-level is almost a side-issue to preserving the wider financial system.
Having ‘negative equity’ in your house just means you’re stuck with a debt you’ve already agreed to pay. It’s the self-reinforcing collapse of borrowers who cannot pay back that debt which is significant.
September 30th, 2008 at 3:26 am
so now might be a good time for Sharehold?
(cast your mind back to a train journey to Brighton in 2000…)
September 30th, 2008 at 3:58 am
So sometime between 2000 and now I realised that the real world equivalent of sharehold (Gavin and I trying to out what a secondary market in housing equity could/would look like) was real estate property derivatives. But I’m not sure how popular derivatives are going to be after this all shakes out…
http://findarticles.com/p/articles/mi_m0EIN/is_/ai_n24387417
September 30th, 2008 at 4:50 am
So we can have the economy back without paying lots of bankers shitloads of tax-dollars and tax-pounds to prop up their obscene bonuses, just so long as we sound like we will do? And house prices *can* tank so that property is actually affordable by anyone?
I don’t pretend to understand economics, but I’m more concerned by the idea that lots of taxpayers’ money is gonna go and ensure that lots of people who are already filthy rich remain so, whilst doing fuck all to help people who were already struggling to afford to put food on the table.
I’m still not sure I see why it’s a bad idea to allow the construct of global capitalism — which seems to do an awful lot that is in outright opposition to social justice — to collapse around itself and partly-ruin a lot of people who became filthy rich from stupid gambles with fictional money in the process.
I don’t get why moving bits around that pretend to represent real money and have no effect on the real world apart from to destroy small economies, such as the Asian Tigers before the IMF and World Bank enforced more Friedmanite neoliberalism and impoverished already-poor peoples, is in any way a good thing.
So why do we need to throw trillions of dollars and pounds at the money markets? Why can’t we just do all the good socialist things we bloody should have done in the first place — like creating affordable social housing — and allow to go ahead the foreclosures on loans that should never have been offered in the first place but only were in order to sate the ridiculous idiocy that was Reaganomics and Thatcherite bullshit, based on mercenary (and, frankly, evil) bullshit theories like Chicago School Economics?
Sorry, Danny, I still don’t get it…
September 30th, 2008 at 4:51 am
Jeez, and I can’t even type my name right! :o)
September 30th, 2008 at 8:15 am
“Unfortunately, one of the key engines of inflation are wage increases.”
I can see that you’re not worth listening to. When you start from Wrong, you can only get to More Wrong, Wronger, and Wrongest.
September 30th, 2008 at 9:31 am
So the problem I have with the theory of “it’s all just a con to get the market to be more confident” is that if that’s the case, $700 billion is WAY TOO SMALL A NUMBER. When $700 billion in money dumped into the market fails to restore enough confidence, and the $n trillion of vaporized derivatives’ value is still weighing things down, then what? You’ve just made things so much worse by adding to the market mindset the notion that even the Federal Government’s most ambitious bailout plan, a whole whacking $700 billion, was not enough. If they can’t do it, then we’re truly all fucked. There was actually another argument for the $700 billion number, which came up in congressional testimony. It was stated that they reckoned on needing $50 billion per month for about a year (and I guess they rounded up). To which, of course, the Dem committee wondered why they should saddle the next administration with this one’s massive plan, rather than just giving them $50 billion per month until the plan changed. Either way, it’s not very confidence inspiring for me. The rest of the market seems to be thinking similarly, given its performance the last week or two.
September 30th, 2008 at 3:33 pm
Craig, I think that’s an entirely valid concern.
Russell, OMG drive-by Austrian Economist! For those of you who want here you go — and also Russell’s own take on the current mess, see his own blog. Remember: Russ may be right, and I may be wrong: opinions can go up as well as down. The sad thing is that I think if Russ had read on, the his disagreement with that anecdote wouldn’t have meant that he’d disagree with the rest of the entry, but hey!
Owen, I’d be interested to know what the difference is between Thatcher destroying the economy to pursue her economic idealism, and you destroying the economy to pursue yours.
October 1st, 2008 at 2:30 am
Danny: Fair point, and I’m well aware that I Just Don’t Get It™. Maybe we should discuss it over beer next time you’re on this side of The Pond? :o)
October 1st, 2008 at 3:49 am
So what do you think about the Soros plan ? (http://thehill.com/leading-the-news/soros-floats-alternative-bailout-plan-with-dems-2008-09-30.html)
I don’t know enough to really judge it, but to me it seems much simpler.