Let this time be not different

Please, let this time be not different.  Please let this recovery be the similar to all the previous recoveries.

I have just finished reading This time is different by Carmen M. Reinhart and Kenneth S. Rogoff.  They bring together statistical data on all the world’s known debt and banking crises and look for patterns that precede them.  Their title comes from people saying during each boom that there will not be another crisis because we now have knowledge and experience from previous crises and  “this time will be different.”

Following each crisis there has been recovery in which the economy has grown to a new high. For the sake of all the people who are suffering from the current crisis it would be good if this time is not different and we could have a full normal recovery.  It would be even better for the planet and our long-term well-being  if we could adapt our economy so that people would not suffer from zero or negative economic growth.

One of the things which is different for this recovery  is that the marginal cost of extracting energy, mineral and agriculture resources has increased.  We have used up the most easily available of these resources and those that are left take a lot more work to extract.  This is bound to limit the potential for further economic growth.  We should beware of believing economic growth can continue forever.

I think there is an element of truth in the Elliott Wave Theory which applies to economics as well as the stock market. This theory says ups and downs run in series of fives and after the fifth the overall trend reverses.  Within each up and down there are series within a series.  I don’t  know about the fives but I believe the economy is fractal in nature and that there can be major turning points.  We should not rule out the possibility that we have passed a major turning point and that for some time to come we will have a series of downs and ups with each down going even lower.

As I read this book I wondered how the crises impacted people’s lives.  How serious was the unemployment?  How did people cope with unemployment?  Who were the people who lost their savings from defaults or inflation and how did they cope?  Did some of the one percent find themselves joining the poor?

In the current crisis, the headlines indicate young people are being hit hard and are the lost generation.  Meanwhile the cruise ships are packed with older people planning their next cruise.

It could be that during an economic boom we have a psychological need for economists to be telling us the boom will not end in a crisis.  Then we can work hard to prepare for retirement and to provide short-term profits for people in the financial industry.   We want to hide from ourselves the possibility we will lose the benefits of our hard work to defaults, haircuts or inflation.

As I was reading about all the financial crises I was saying “why oh why oh why would anyone want to put effort into the financial industry when there is such a high probability we will lose a lot of our savings?”  But then I have never been much for ambition.

Solving the debt crisis with two coins in the bank. Probably not.

Two platinum coins worth $1 trillion each to solve the U.S. debt problem.  This proposal is reported in this article on the Huffington Post.  The coins would be made by the mint and deposited with the federal reserve to meet debt requirements.  Platinum would be used to get around legal requirements.

The good part of this proposal is that it would replace fractional reserve money with fiat money.  Fractional reserve money is created by the banks when they make loans.  Very little economic thought has gone into the effect of interest rates in this money creation.    This new fiat money would not involve interest charges and that is probably very good.

The problem would be what it does to the money supply.  Presumable  the $2 trillion would be used to pay off government debt.  Some of this debt would be held by the central bank and repaying this shouldn’t change the money supply.  The rest would be to repay bondholders and this would increase the money supply.  Further it would be what economists call high-powered money which is subject to a multiplier effect as it worked its way through the banking system.

The result would be the potential for a massive increase in money supply.  This is the opposite to a return to the gold standard which would force a decrease in the money supply.    The result would be deflation and a decrease in economic activity.

There are four variables in the equation that connects the financial system and the physical side of the economy: the amount of money, the quantity of goods and services produced,  the price index and the velocity or speed at which money circulates. The formula is MV=PQ.  If one of these changes at least one of the others has to change.

If we were to have an increase on the money supply then the velocity must decease or either the price index (inflation) will go up and/or the quantity of goods and services will go up(economic growth).

In an attempt to stimulate economic growth central banks have been trying to increase the money supply and called it quantitative easing.  So far there has been little indication of its working.  This leaves either inflation or a decrease in velocity.

There has been little inflation from quantitative easing so probably the velocity has fallen.

So the impact of the two little platinum coins is unclear but they would certainly be disruptive and have the potential for hyperinflation.

For a fuller explanation of fractional reserve money is created and some of its problems please see the essay “LETS go to market: dealing with the economic crisis” on this weblog.


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Credit crunch and the money supply

Mark Carney, the governor of the Bank of Canada, and recently appointed to the Financial Stability Board, to oversee international financial reform has made the news by pointing out there may be a new wave of credit tightening as a result of the European debt crisis.

When bankers and economist worry about a credit crisis they are talking about a decline in money supply.  This is because banks create money when they make loans.  If they don’t make loans there will be less money around.

In a declining economy there are two things to note.

First, as we feel the squeeze from an unsustainable use of resources, there will be need for less money in the economy. Otherwise there will be inflation.

Second, if the money supply declines more than is needed, then there will not be enough money for the exchange of the goods and services we are capable of producing.  This too could contribute to the recession.

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