Monday, August 24, 2009

Seeing It Coming

In "No-one saw this coming?" Balderdash!, the maverick Australian economist Steve Keen reviews the common thread amongst the few prominent economists who predicted the Great Financial Crisis of 2007-9, referring to research performed by the Dutch economist Dirk Bezemer.

Aside from Dr. Keen there are 11 economists, including Nouriel Roubini and Robert Shiller. While there is much more, the conclusion is easy reading.

Firstly, unlike a tsunami, this crisis was predictable by economists who take what Bezemer characterized as a “Flow-of-fund or accounting” approach. Secondly, a tsunami is actually caused by a huge shift in the planet’s tectonic plates, and the shift itself relieves the tension that caused the tsunami in the first place: in a sense, the tsunami resets the system to a tranquil state.

This financial tsunami was caused by the bursting of asset price bubbles driven by excessive levels of debt, but the bursting of those asset bubbles hasn’t eliminated the debt—far from it. Instead, economic performance for the next decade or more will be driven by the private sector’s attempts to reduce its debt levels, and this will depress economic activity for years. Unlike a tsunami, a debt crisis is a wave of destruction that keeps on rolling unless the debt is deliberately eliminated.

Everything that is being done by policy makers around the world is instead trying to restart private borrowing. A better analogy is therefore not a tsunami but a drug overdose—and our “neoclassical” economic doctors are attempting to bring the patient back to health by administering more of the same drug.

Econblog Review has several times referred to the strategy of the Fed and the Feds as an alcoholic's strategy of feeding more of the addicting substance to the addict. It did not work in Japan and is unlikely to work here.

One detail of the above post is incorrect. It is clearly not true that "everything" that policy makers in the U. S. are doing is directed to private borrowing. Actually, in true statist fashion, the Obama administration's "stimulus" program is heavy on Government borrowing and Government-directed investment into paving roads and high-speed rail projects. This strategy has a name: central planning.

Copyright (C) Long Lake LLC 2009

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