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Tuesday, October 21, 2008 7:28 AM


Keynesian Claptrap From PIMCO


The amount of total nonsense currently circulating on the so called Paradox of Thrift is staggering.

The paradox: An increase in saving, which is generally good advice for an individual during bad economic times, can actually worsen the macroeconomy causing a reduction in aggregate income, production, and paradoxically a decrease in saving.

BusinessWeek briefly referred to the paradox in an article on the New Age of Frugality. John Mauldin referred to the paradox in an otherwise excellent and well worth reading article called The Economic Blue Screen of Death.

The blue ribbon for complete economic silliness however, comes from Paul McCulley at PIMCO in The Paradox of Deleveraging.

The Paradox of Deleveraging

Once the double bubbles in housing valuation and housing debt burst a little over a year ago, everybody, and in particular, every levered financial institution – banks and shadow banks alike – decided individually that it was time to delever their balance sheets. At the individual level, that made perfect sense.

At the collective level, however, it has given us the paradox of deleveraging: when we all try to do it at the same time, we actually do less of it, because we collectively create deflation in the assets from which leverage is being removed. Put differently, not all levered lenders can shed assets and the associated debt at the same time without driving down asset prices, which has the paradoxical impact of increasing leverage by driving down lenders’ net worth.

This process is sometimes called, especially by Fed officials, a negative feedback loop. And it is, though I prefer calling it the paradox of deleveraging, because the very term cries out for both a monetary and fiscal policy response, not just a monetary one.

But monetary easing is of limited value in breaking the paradox of deleveraging if levered lenders are collectively destroying their collective net worth. What is needed instead is for somebody to lever up and take on the assets being shed by those deleveraging. It really is that simple.

As Keynes taught us long ago, that somebody is the same somebody that needs to step up spending to break the paradox of thrift: the federal government, which needs to lever up its balance sheet to absorb assets being shed through private sector delevering, so as to avoid pernicious asset deflation.

Conventional wisdom holds that when an economy faces a paradox of private thrift, it is appropriate for the sovereign to go the other way, borrowing money to spend directly or to cut taxes, taking up the aggregate demand slack. Indeed, that is precisely what Congress did earlier this year, sending out $100+ billion of rebate checks, funded with increased issuance of Treasury debt. Good ole fashioned Keynesian stuff!

Fortunately, Congress is finally grappling with this reality, as it moves towards passage of Mr. Paulson’s plan for backstopping Fannie and Freddie with taxpayer funds. It’s not a fun thing to do, particularly following the use of $29 billion of taxpayer funds to facilitate the merger of Bear Stearns into JPMorgan. But it is the right thing to do. And it is further the right thing that Congress is doing it, not the Fed under Section 13(3), except as a possible bridge to Treasury authority.
I actually recommend everyone read the entire article because you will not find a better example of complete Keynesian silliness anywhere. The article is a true classic. And it is because of such absurd thinking the world is in the economic mess it is in.

Flashback 2001-2002

In the wake of the Nasdaq crash, Greenspan slashed interest rates to 1% to bail out his banking buddies who were then at the time deep in hock loans to dotcom companies and also to countries like Argentina, neither of which had any chance to pay back those debts.

In other words, Greenspan attempted the Keynesian ploy of blowing a bigger bubble. The result was a worldwide credit boom of epic proportion. Nearly every country on the planet had a housing bubble. Now that homer prices (and asset prices in general) are crashing, those loans cannot be paid back. What cannot happen will not happen and indeed foreclosures and personal bankruptcies are both massive and increasing.

Failed Policy Repeated

We are now bearing the fruits of past Keynesian idiocy right now, so what does Paul McCulley want to do? The same thing every Keynesian wants to do: spend money and force banks to lend. "Indeed, that is precisely what Congress did earlier this year, sending out $100+ billion of rebate checks, funded with increased issuance of Treasury debt. Good ole fashioned Keynesian stuff!"

Good ole fashioned idiocy is more like it. The $100+ billion is stimulus did not do a thing, so McCulley wants to throw another $100 billion from now until doomsday until it "works". Never mind, all the problems such a policy might have with long term interest rates or problems down the road with the US dollar, interest on the national debt, or anything else. Keynesians ignore all of those problems and a half dozen more.

Simple Logic vs. Paradox of Thrift

Simple logic would dictate that excessive spending and loose lending standards caused this crash so excessive spending and loose lending standards cannot possibly cure it. Indeed it is axiomatic that the problem cannot be the solution. The concept is so simple that Keynesian demagogues cannot see it.

Compelling Banks To Lend At Bazooka Point

Let's revisit Compelling Banks To Lend At Bazooka Point
We are in this mess because banks lent money to anyone and everyone including those with no possible means of paying the money back.

The US is in a recession, consumers are cutting back discretionary spending, there is rampant overcapacity in every sector but energy, and there is no reason to go on a lending spree. Furthermore, there is no reason for any qualified buyer to want to borrow. Why would any responsible party want to expand in this environment? The only people who want to borrow significant sums of money now are the very people banks should not want to lend to.

Thus the best thing banks can do with that money is sit on it. Yet the penalty for sitting on it is the difference between what the Fed will pay on bank reserves and the 5% interest banks have to pay at bazooka point for borrowing money they did not want in the first place. If banks do start lending like Paulson wants, defaults are guaranteed to increase dramatically.
The backdrop for that snip is that Paulson gathered 9 top banks and forced them to take $125 billion that some did not even want and is going to charge them 5% interest on it. Another $125 billion is in the works. In other words, Paulson is trying to force banks to lend. But banks are reluctant to lends as well they should be.

Banks Are Likely to Hold Tight to Bailout Money

The New York Times is reporting Banks Are Likely to Hold Tight to Bailout Money.
Even as the government moves to plug holes in the nation’s banks, new gaps keep appearing. As two financial giants, Citigroup and Merrill Lynch, reported fresh multibillion-dollar losses on Thursday, the industry passed a grim milestone: All of the combined profits that major banks earned in recent years have vanished.

Since mid-2007, when the credit crisis erupted, the country’s nine largest banks have written down the value of their troubled assets by a combined $323 billion.

The deepening red ink underscores a crucial question about the government’s plan: Will lenders deploy their new-found capital quickly, as the Treasury hopes, and unlock the flow of credit through the economy? Or will they hoard the money to protect themselves?

John A. Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view.

“We will have the opportunity to redeploy that,” Mr. Thain said of the new capital on a telephone call with analysts. “But at least for the next quarter, it’s just going to be a cushion."
Banks Need Cushion

Banks have no reason to lend. What they do need however, is more reserves against future losses. And those losses are going to be staggering. Unemployment is poised to rise to 8% or so by my estimation, consumers are retrenching, and home prices are still falling. Any bank going on a lending spree in this environment would be acting incredibly foolish.

Is there a Keynesian on the planet who can think more than one second ahead?

Paulson and the Keynesian fools want banks to lend. For what? What is it we need more of? Houses? Condos? Pizza Huts? Home Depots? Lowes? Nail salons? Strip Malls? Walmarts? And if by some miracle banks did lend that money and new stores were built, who is there to buy? What would happen then? Is the amount of money that can be thrown at problem unlimited? What about the problems that will create? Can problems be postponed forever? Is there a Keynesian on the planet who can think more than one second ahead?

Fed Chairman Ben Bernanke supports stimulus plan

The Los Angeles Times is reporting Fed Chairman Ben Bernanke supports stimulus plan.
The last major obstacles to another government stimulus package began crumbling Monday, shifting the debate from whether the fading economy needs a jolt to the best way of providing it.

Federal Reserve Chairman Ben S. Bernanke endorsed the idea of further stimulus for the first time in congressional testimony Monday. Soon after that, the White House said President Bush was "open to ideas" as long as they were "targeted, temporary and timely."

Bernanke did not endorse specific ideas and declined to offer an estimate for the scale of a stimulus package. But his support earlier this year helped pave the way for a $168-billion package that included tax rebate checks for millions of Americans.

"With the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by Congress at this juncture seems appropriate," Bernanke told the House Budget Committee.

House Speaker Nancy Pelosi (D-San Francisco) urged Bush and congressional Republicans "to once again heed Chairman Bernanke's advice" and work with Democrats "to enact a targeted, timely and fiscally responsible economic recovery and job creation package."
Plea To Save

If Congress is dumb enough to pass another "stimulus" package that results in checks being sent out, here is my recommendation: Put 100% of it on credit card debt and if you have no credit card debt, save 100% of it. We are in this mess because the pool of real savings has been depleted and it is time to stop spending and replenish savings.

Why Doing Nothing Is the Best Policy to Revive the Economy

Austrian Economist Frank Shostak discusses the pool of real savings and a "do nothing" policy proposal in Good and Bad Credit.
Neither the Fed nor the Treasury is a wealth generator: they cannot generate real savings. This in turn means that all the pumping that the Fed has been doing recently cannot increase lending unless the pool of real savings is expanding. On the contrary, the more money the Fed and other central banks are pushing, the more they are diluting the pool of real savings.

We suggest that decades of reckless monetary policies by the Fed have severely depleted the pool of real savings. More of these same loose policies cannot make the current situation better. On the contrary, such policies only further delay the economic recovery.

By impoverishing wealth generators, the current policies of the government and the Fed run the risk of converting a short recession into a prolonged and severe slump.
Those short snips do not do Shostak's article justice. Inquiring minds, especially those unfamiliar with Austrian economics would be well advised to study that article.

It's a sad state of affairs that Bernanke who fashions himself an "expert" on the great depression knows less about the cause and cure of it than anyone who reads and understands the above article.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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