09 Feb 2010

The Recession Isn’t Over

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[UPDATE below.]

For the documentary on the Fed, I spent about 5 hours under the hot lights today with the cameras rolling. I will never criticize a politician for saying something dumb on the campaign trail; I’m not sure I could have recited my date of birth by the end of this ordeal. Hopefully the filmmaker can edit out the nonsense and make me look sharp in the final cut.

On the flight here, I reread my Depression book. (This wasn’t pure narcissism; the interview was going to be based on my book.) I ended up scaring myself all over again, and remembered why I was so sure the US economy was done for after I finished writing the book. The Fed and the government enacted similar policies back then to “fight” the downturn after the stock bubble burst, and we all know how that turned off.

One of the things that really interested me was a point Garet Garrett made on the 5th anniversary of the New Deal. Garrett pointed out that the surge in official output figures from 1933-37 notwithstanding, businesses were not replenishing their equipment through investment. In effect the US economy was consuming its capital even during the alleged Roosevelt recovery (which Krugman et al. say was aborted through premature deficit hawkishness in 1937).

So regardless of what the government and Fed did in 1937, there had to be a “depression within the Depression” or a “double dip” as we euphemistically will call it nowadays. Bernanke’s insane 0-interest rate policy has ensured that the US (and indeed world) capital structure has gotten progressively more screwed up in the last two years. It doesn’t matter what they do with quantitative easing, targeting NGDP futures, raising interest payments on excess reserves, or pinning the tail on a donkey… There will be another collapse. It might not be a sudden “crash”; it could be a slow-motion train wreck. But if you think interest rates serve a function, then you must concede that that function has not been fulfilled for a good two years.

Many commentators, not just Austrians, would now agree that in retrospect, it would have been fantastic if Greenspan had sat back and done nothing after the dot-com crash. Yes there would have been a painful recession from (say) 2001-2003, but it would be ancient history at this point. Moreover, that painful recession would have been child’s play compared to what we have already been through and will continue to suffer over the next few years.

What we need to realize is that right now we are in the analog of the housing boom years. This is the “soft landing” that Bernanke has provided us. The bubble isn’t in houses, it’s in US Treasurys.

And the coming collapse will make the housing bust look as easy to cope with as the dot-com crash looks to us right now.

UPDATE: I was watching a very interesting documentary on–what else?–World War II in the hotel room. One of the historians explained that the Americans (under the command of the guy preceding Doolittle) tried precision bombing of German targets without fighter escorts. In one raid, the US lost 60 bombers–about 600 men–trying to take out a ball bearing factory. But as crazy as that is, I loved the understanding of capital structure behind it. The historian explained, saying something like, “You use ball bearings in everything. Taking out this factory would strike a crushing blow to the German war machine.”

And yet a mainstream economist wouldn’t be able to capture this in his or her description of the current recession. “Huh, a ball bearing factory got taken out? Well how many marks did those things fetch? Just have the German central bank print up some more, and go buy sauerkraut with the new paper. We have to boost aggregate demand back up if we want to beat the Yanks.”

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