talkpolitics | Credit <=> crisis

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Credit <=> crisis

We often hear the assertion that economic crises occur as a result of personal incompetence, greed and bad credits. Never mind the structural inconsistencies in a society. Now, two economists (Michael Kumhof and Romain Ranciere) are proposing a different approach in explaining these phenomena. They've explored an aspect of the US market which is often overlooked, but which is closely related to bankruptcy. And that is the relative level of financial disparity between the various layers of society.

They investigated the economic data around the two biggest financial crises in modern history (1929 and 2008). In both cases they concluded that the crisis happened when the "scissor" between the rich and poor was opened too widely, until at some point it turned out that the top-5% layer was in possession of 34% of the wealth. That was coupled with a simultaneous increase of the share of private credits - in fact it doubled.

They argue that the logic is very simple. In order to sustain the tempo of consumption, people with weaker financial capabilities were compelled to take credits, which eventually they were unable to pay back. Meanwhile, the wealth of the rich (I'm sorry, did someone say "job creators"?) was increased to such an extent that they would invest significant amounts into presumably highly profitable (but also very volatile) credit deals. When the credits stopped being served by a significant number of debtors, the whole system would collapse.

The authors are also proposing some solution to the situation. They argue that workers and employees should be paid such a level of salaries as to allow them a minimum level of living standard without taking credits. Now, the objection is that with increasing their income their needs would automatically increase as well, and this does make sense, but only to some limited extent. The data shows that the usual consumption levels of the wealthy would rise at a slower rate compared to their income, and the remaining extra money they'd rather invest into speculative deals and luxurious items, as opposed to actually fueling the engine of the economy.

Sources:
http://www.smarterearth.org/content/inequality-leverage-and-crises

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Leave it to the witch doctors of socialist thinking to see the disease and yet attribute it to "evil spirits." More accurately, they see the germs and presume that the germs are the effect of the disease not the cause.

The fiat money system transfers wealth. When you print up currency or set the interest rate or availability of credit by political fiat, you allow the people to whom they are given to buy stuff with it. The people who get the new dollars first bid up the prices of goods and services. The people who get the dollars last find that their purchasing power is diluted because prices have risen — there are more dollars chasing the same quantity of actual goods and services. Who gets the new fiat currency first? The banks and financials (Wall Street) get the new dollars first, followed by their large customers. Do the math.

Of course, the new dollars or credit or both distort the market, making longer range projects look more profitable than they actually would otherwise be if the credit market and interest rates reflected the true average time preferences of people acting in the market. On top of this, the increased money supply induces people to consume instead of saving, lowering peoples' apparent time preferences. Eventually, the disparity is revealed when the prices of labor and resources are bid up by those investing in higher order production structures. The higher prices reveal that many of the projects are not actually profitable and the bubble pops and there is an unwinding.

So yes, what the article claims on the surface is true. Nevertheless, when it comes to cause and effect, Kumhof and Ranciere are reversing cause and effect. This is precisely the fundamental erroneous premise at work in socialist thinking — the idea that consumption precedes and causes production.

The idea put forward in the cited "Inequality Leverage" article is not new, and it has been refuted, over and over. See: Say's Law and the Austrian Theory of the Business Cycle. (http://mises.org/journals/qjae/pdf/qjae12_2_4.pdf) [PDF, 13 pages]

http://talk-politics.livejournal.com/1117122.html?thread=89196482#t89196482

You used too many words to say that socialism is here to kill us all.

picture credit to the_rukh

Ha, All I did was the caption and text, probably should credit Larson.

If I wanted to presume malice, I could indeed have stopped with your one-liner. I just don't attribute to malice what can safely be explained by ignorance, and that takes a few words to draw the distinction.

Having a thoroughly different opinion than you is not the same as ignorance, no matter how many times you repeat it.

Hypothetically, yes, but that is the matter we are debating. I'm doing more than just raising assertions; I am backing them with reference to logical argument, which itself can be debated. I don't have to take anyone's claims at face value and neither do you or anyone else. I'm offering my reasons for why I believe the socialist claims are rooted in fundamental ignorance and anyone can examine them and make their own judgment.

I'm sure everybody and their dog by now understand and are aware that you don't like macro economic stabilization plans, but what Kumhof and Romain are proposing doesn't necessarily equal fiat money (in fact, they don't go into specifics at all, when it comes to how lessening of the middle class debt through redistribution should happen). Their main claim is that it is preferable to bailouts and debt restructurings. And yes, I think people *get* that your line of thought is to leave it all alone come what may.

Your analysis of the original post, further down is also disingenuous. Both authors are actually mentioning the bubble and the market manipulations that created it, they are in fact not saying that the cause was "Jane's inability to buy" but rather the market manipulators reactions to lack of accumulative force in Jane and the likes of her.

There are whole websites in response to the Austrian Business cycle, it could be like playing tennis, only with fancier words that would fool people in here that we actually know exactly the outcome of all our systems. The fact is that economics isn't that accurate a science, otherwise whole schools contradicting each other wouldn't arise.

It would be better if you

a) didn't assume that everyone that doesn't follow the Austrian school is ignorant, there are societies that don't follow it and have a working economy. There might even be more than one well working system in the world.

b) Didn't post links to Austrian economics as "proof". Just as it it's kind of moot for someone to send links to other schools as proof.

These are just my own very personal annoyances with you. You will of course carry on as you prefer in the end.

Edited 2011-08-07 22:37 (UTC)

There might even be more than one well working system in the world

No kidding :)

Is it okay for me to say that I love you?

That's some great prose!

Re: Socialist thinking is fundamentally a reversal of cause and effect

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Re: Socialist thinking is fundamentally a reversal of cause and effect

telemann.livejournal.com - 2011-08-08 20:57 (UTC) - Expand

*polite applause*

Re: Socialist thinking is fundamentally a reversal of cause and effect

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The Gold Standard would revert humankind to a way of existence that would make Planet of the Apes look like a utopia.

you shall not crucify mankind upon a cross of gold

But we will forbid discussion that the Beast Man could be descended from such noble forebears as the humble ape. :).

How funny to tie Planet of the Apes allusions to the Cross of Gold Speech, subsequently to Bryan, and then to the Scopes trial. I'm wondering if you or

caerfrli intended that or if it just happened by accident. If it was intent on either of your parts I salute your ingenuity, even if I disagree with your arguments.

I did intend that, yes. I was actually referencing one of the plots in the original 1968 film.

Do you actually know the source of that quote? I do. Interestingly enough, The Cross of Gold Speech (http://en.wikipedia.org/wiki/Cross_of_Gold_speech) was made by William Jennings Bryan (http://en.wikipedia.org/wiki/William_Jennings_Bryan), the same man who argued in favor of prosecuting John Scopes for teaching evolution. (http://en.wikipedia.org/wiki/Scopes_Trial) Bryan made the speech in favor of bimetalism (http://mises.org/daily/4112), an economic superstition more destructive than Creationism.

Here's one area where we both agree, Bryan's ideas were tom foolery with no serious place in politics.

I'll agree about the Tom Foolery part. Nevetheless, Bryan's ideas were supported by a substantial constituency who believed that they had something to be gained in the implementation of bimetalism. Politics is the natural homeland of Tom Foolery. People who cannot lick 'em with logic, nor baffle 'em with bullshit, almost always resort to pounding 'em with politics.

"The kind of man who demands that government enforce his ideas is always the kind whose ideas are idiotic."
— H. L. Mencken

Most of the Austrians who support a so-called "Gold Standard," do so on the belief that it would be a politically achievable lesser evil compromise than the fiat system which obtains now. (http://mises.org/daily/3560) I agree, it would be better, but it is not necessarilly what I would endorse. It still leaves the government in charge as an arbitrary setter of value. I endorse free banking. (http://wiki.mises.org/wiki/Free_banking) Money is a market phenomenon and the attempt to monopolize it through the political system is counterproductive.

The problem is that you could strip-mine the planet of gold and not come near handling the US debt, let alone that of Japan or the rich EU countries.

The erroneous premise behind what you said is the belief that gold has an intrinsic value. You are comparing this supposed objective, intrinsic value, with the dollar value of outstanding debt and finding that there is "not enough gold." The thing you are not considering is that there is not enough gold below a certain price. I agree that, for the government, reestablishing the dollar as a denomination for a certain quantity of redeemable gold would be a herculean task, but it would not be economically impossible. People are exchanging dollars for gold today at a rate of about $1750 per troy ounce. I'm not saying this to imply that this is THE "peg" at which the redeemability of the dollar should be set, rather I am pointing out that there is already an exchange ratio in dollars to gold that has not resulted in the strip mining of the planet. People are still willing to exchange gold for some quantity of dollars and vice versa.

'More accurately, they see the germs and presume that the germs are the effect of the disease not the cause.'

That's one way to put it.

The stratification and difference in pay isn't what's causing the problem but another symptom of the problem. Treating the symptoms doesn't stop the disease and if anything just lets it fester more.

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