Wednesday, March 18, 2009

Getting Credit Moving Again?

Anyone reading the policy pronouncements of the masters of the banker-verse will hear that the solution to the current economic crisis is to get "credit moving again." Alternatively, to make more credit available to consumers in the form of auto loans, consumer credit cards, etc. Yet, try as they might, all of the efforts in this direction over the past 18 months has not really worked. Credit continues to contract or stagnate as the graph above shows. And, as near as I can tell, this does not include credit created in the myriad off-books, off-shore vehicles that our financial wizards cooked up over the past few decades, so the decline in total credit may be much, much steeper than the image above implies.

Why isn't policy working? The reason, seems to me, to be that policy makers are playing with the standard recessionary handbook. An ordinary recession is described by Edward Harrison as

In a normal recession, credit becomes tight, but it is not central to the downturn. In fact, 80% of the decline in GDP is due to a de-stocking of inventory. Basically, businesses get ahead of themselves and forecast future demand that turns out not to exist. They are forced to ratchet back production and sell off inventories. In this case, policy makers can step in with fiscal and monetary stimulus and re-kindle domestic demand with a bit of a lag. Bing, presto, we are off to the races again. That's why recessions are over in 12-18 months tops.
In this context, one can easily understand just what Helicopter Ben and Tiny Tim Geithner think they are up to. But, their efforts are certainly not being rewarded with any significant expansion of cheap consumer credit. So, what's up? The answer seems to be that they have misdiagnosed the problem. We are dealing with a depression process not an ordinary recession process. Harrison continues,
That's not what happens in a depression - and this is a depression. In a depression, what happens is macro disequilibria build up so much and become so unsustainable that when the break in demand happens, there is no bing, presto from traditional policy responses. The leverage and debt in the system is just too large. The debt cannot be worked off without de-leveraging (See my post "De-leveraging").
The failure by team fed to define the problem correctly will now doubt result in a massive waste of taxpayer resources. The failure to define the problem correctly means that attempts to stoke consumer demand is not going to work to end the current economic malaise. Until we begin to hear the shift in the view of what is going on, we cannot expect much from the president's men on the scene.

Harrison's post on Naked Capitalism is a must read.

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