THE BEAR'S
LAIR Drowning in
malinvestment By Martin
Hutchinson
Austrian economists'
explanation of the 2007-08 financial crisis, that
it resulted from a mountain of "malinvestment" in
housing and the debt related thereto, in the
United States, Britain, Spain and several other
countries, is now generally accepted as correct.
Unfortunately the actions, monetary,
fiscal and regulatory, taken to resolve that
crisis have had the effect of creating a new
tsunami of malinvestment, more widespread and far
larger than the original problem. We will be
paying the cost of working off the new mistakes
for a very long time indeed, probably for a
generation. Those awaiting a return of
satisfactory global economic growth
had better swallow the
Sleeping Beauty's potion, and set their alarm
clocks for 2035.
When I started writing
this column in October 2000 there was only one
glaring example of US policy mismanagement, Alan
Greenspan's Federal Reserve, which had already let
the money supply grow excessively for the previous
five years.
US fiscal policy was
impeccable; the country was running a substantial
budget surplus and although one knew that much of
that surplus was the effect of the dot-com bubble,
nevertheless even deflated to a reasonable
economic activity level the budget deficit was
minimal - only 1-2% of GDP. The trade deficit was
mildly worrying, but again it had obviously been
inflated by the bubble and seemed sure to shrink
back once the bubble burst, as it was apparently
in the process of doing.
International
trade policy seemed to have gone off track, with
the protests against the 1999 World Trade
Organization meeting in Seattle, but it seemed
likely that this was a minority enthusiasm that
would not prove lasting, whichever candidate won
the forthcoming election. As for global warming,
that was thankfully a distant problem; there was
no chance whatever of the US Senate ratifying the
Kyoto Protocol, whatever the wishes of even a
president Al Gore.
Austrian economists
would say that the 2001-03 recession was necessary
to remove the "malinvestment" - misguided
investment into entities that could never be
profitable - of the dot-com bubble, while the
2008-09 recession was necessary to remove the
malinvestment of the housing bubble. For those
generally subscribing to Austrian economic tenets,
that raises the question of why the latter
recession was so much worse than the former.
The housing bubble, apart from a fairly
limited amount of subprime mortgage debt, involved
the building of homes that almost all had value,
generally at least half of their building cost.
The dot-com bubble, on the other hand, not only
resulted in the Nasdaq share index rising to a
height that is still nearly double the current
(itself inflated) level, but also the construction
of telecom capacity sufficient for the next three
or four decades, as well as business enterprises
like Pets.com of no value whatever.
When I
started this column in 2000, I expected a deep,
lengthy recession to follow the collapse of the
1995-2000 bull market, but the recession turned
out to be one of the shortest and mildest on
record. Greenspan is popularly supposed to have
shortened it artificially by lowering interest
rates rapidly, but believing Greenspan's actions
alone shortened it requires monetary easing to
have had an efficacy maybe 10 times that exhibited
by the frantic exertions of his successor as
Federal Reserve chairman, Ben Bernanke.
The explanation, I think is that the good
policy of 2000 produced the mildness of the
2001-02 recession. The budget surplus swung into
only a modest deficit, so George W Bush's 2001 and
2003 tax cuts had a genuine stimulus effect
without producing pathological side-effects. (Tax
cuts generally have more "stimulus" effect than
spending increases, because the money is spent
optimally, at least for the recipients of the tax
cuts, rather than being wasted by bureaucrats and
politicians.)
Monetary policy was too
loose, but interest rates were still above the
inflation rate, so loosening it further also
produced stimulus without de-capitalizing the
economy. The international balance was only mildly
in deficit in spite of a strong dollar, so dollar
weakening after 2002 was also helpfully
stimulative.
By 2008, those good policy
elements had been removed, so a malinvestment
bubble that should have been no larger or more
damaging than that of 2000 proved much more
harmful. Monetary policy was more out of kilter,
with interest rates at a level that seriously
depressed saving. The balance of payments deficit
was much larger, and had built up destabilizing
overseas liabilities. Fiscal policy during the
2000s had been appalling, so the budget deficit
was completely out of control.
In this
area I agree with the Democrats in blaming
president Bush and the 2001-08 congresses of both
parties much more than I blame President Barack
Obama, though I would suggest that after 2010
Obama would have pursued much more damaging
policies if he could have, being restrained by a
Republican congress that repented of its
predecessors' misdeeds. Finally, the tendencies
towards protectionism in international trade were
much stronger after 2008 than in the 1990s,
further slowing economic recovery.
Currently, gold, oil and the world's stock
markets seem to have embarked on another bull run,
in spite of the anemic position of the US and
global economies. All three are closing in on full
malinvestment mode.
In the whole of its
history, the gold price has spent only a few
months in 1980 higher than its current
inflation-adjusted level. Oil is also well above
its likely long-term average cost, especially as
its supply has been increased by the discovery of
"fracking", which seems feasible at production
costs in the $70-80 range, well below the current
level. As for stocks, if they were at the solid
middle-of-the-road value in relation to GDP that
they were when Greenspan took the leash off
monetary policy in February 1995, the Dow Jones
index would today be at 8,800 instead of over
13,000.
However, the areas of
malinvestment stretch far beyond gold, oil and
stocks. Government bonds at today's levels
represent a pool of malinvestment unequalled in
global history. The problems this causes have
already begun to appear in southern Europe, where
Spain and Italy have gone from having an
excessively easy monetary policy to having an
unduly restrictive one, as lending costs in those
countries include a healthy allowance for the
national credit risk.
Last week's decision
by the European Central Bank to allow unlimited
purchases of southern European government bonds
has alleviated the problem for a time, and in the
case of Spain, where the problem was a housing
malinvestment similar to that in the United
States, may eventually allow the country to pull
through.
In Italy, however, there is no
evidence that the government is undertaking the
austerity needed to get government spending down
to a reasonable level and begin to pay off the
country's excessive debt. And then there's France,
where the government is determined to pursue
policies of soaking the rich and excessive public
spending that could be expressly designed to
worsen the country's fiscal position at the
maximum possible speed.
The European
Central Bank (ECB) may think it can prevent
default by the wayward France and Italy through
bond purchases, in the same way that Bernanke
thinks he has achieved miracles through his
quantitative easing purchases of Treasury bonds.
But in the short run this imposes enormous costs
on the economy.
A recent study by the
American Institute of Economic Research has
estimated the costs of Bernanke's current policies
as an annual US$347 billion in spending, 3.5
million jobs and 2.53% of GDP - in other words,
much of the difference between the current feeble
economic recovery and the robust one we could
reasonably have expected after the deep 2008-09
decline.
In the long run, once they have
embarked on their bond purchase policy and seen
their economies suffering the sluggish growth that
results, the ECB and the Fed are compelled to
repeat the bond-purchase treatment in successively
larger doses until the patient finally expires in
a burst of Weimarean hyper-inflation. At that
point, the malinvestment comes home to roost with
a vengeance - with a gigantic rise in interest
rates that causes even the government bonds that
remain solvent to trade at huge discounts, as in
1980-82.
In case the bond market
malinvestment in the US and Europe is not
sufficient, there's additional malinvestment
caused by misguided government policy in Japanese
government bonds, in the Chinese banking system,
in the gigantic pools of stagnant money (now more
than $10 trillion) in the world's central banks
and in the hopelessly badly designed Target-2 euro
payments system. That's before we have even
considered the foolish Facebooks of the world.
The
pool of malinvestment is a large multiple of those
in 2000 or 2008, and it is increasing in size at
an exponential pace. In comparison, that of 1929
was a benign puddle. Yet if the 1929 malinvestment
took more than a decade to overcome, surely the
current gigantic swamp will doom the global
economy for a generation. Yes, the misguided
policies of the 1930s were partly responsible for
the depth and length of that trauma. But do we
really think that government policy, on the
evidence of the last decade, has improved in any
significant way in the past 80 years? 2035, I tell you. I hope I
shall still be around to see the beginning of true
recovery. The only consolation is that it gives me
another couple of decades before this column
becomes obsolete.
Martin
Hutchinson is the author of Great
Conservatives (Academica Press, 2005) - details
can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished
with permission from PrudentBear.com.
Copyright 2005-12 David W Tice & Associates.)
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