Bokonist: I’ve read [America’s Great Depression]**. Rothbard is dead right about the dangers of fractional reserve and the need to avoid inflation in the first place. But he’s dead wrong about what to do once the crisis hits. I do not buy his arguments that Hoover’s actions after the crisis caused the severity of the downturn. It’s very unlikely that Hoover’s cajoling was the cause of sticky wages. Right now we are seeing businesses across the economy choose layoffs rather than wage cuts, even in non-union, non-regulated sectors like tech. Furthermore, the major cause of the unemployment was businesses going bankrupt. Businesses went bankrupt because when the money supply shrank they could no longer payoff their debts. The debts were all nominated assuming a much greater money supply. Deflation caused the unemployment.
nazgulnarsil: I would argue that debts nominated during a time of a much larger money supply led to businesses that were predicated on artificial demand. when the demand shrunk these businesses went bottom up. The great depression is an almost perfect example of economic latency. Those workers did eventually get assimilated back into productive industry, it just took a long time.
Bokonist: The demand was not artificial. For example, before the crash people bought a lot of cars. After the recovery, people bought even more cars. So why was it necessary to go through 5-10 years where nobody made or bought cars, factories sat idle, and laid off autoworkers went hungry? There are cases in recessions where the unemployment is beneficial. For instance, “financial instruments” have been overproduced, and it would be beneficial for Wall St. workers to be laid off and then find more useful jobs. But a depression is marked by lots of collateral damage - people get laid off in industries simply because of instability in the banking and moneterary system, not because they were not being productive.
Let me ask this question: Imagine a gang of thieves slowly slipped counterfeit bills into the money supply for a long period of time. Eventually, half the money supply was counterfeit bills. The thieves had long traded their counterfeit bills for wine and women. The bills were now evenly distributed across the economy, in every home and business. Suddenly, the crime is discovered. Now no one will except the counterfeit bills. The money supply drops in half. Businesses with debt and wage contracts created before the counterfeit money was discovered start to bleed red ink.
What is the proper policy response to this scenario?
nazgulnarsil: the greater consumption of cars in the years following the great depression were due to having suppressed demand for all those years. as for the scenario you seem to be saying that the government needs to step in and take up the role of the counterfeiters. Why should the supply and demand structure from the time of counterfeiting continue on? those demands were artificial and the market met those demands with artificially inflated supply.
Bokonist: Let’s say that in the counterfeiting example, the counterfeiters pumped $300 billion a year of counterfeit bills into the economy. The counterfeiters spend all this money on wine and women.
When the counterfeiters are found out, this $300 billion dollars of demand for the vineyard and brothel industry evaporates. That will cause much unemployment. I agree with you that this should be allowed to happen. The workers in those industries must find new jobs that are economically productive. The government should not step in and start printing money to prop the brothels up, as this will simply create zombie industries as Giles noted. (Nor can the Giles recover the lost wealth - the counterfeiters already spent the money, the resources that went into producing the wine and woman have been consumed).
But there is a second cause of unemployment, which is the unnecessary collateral damage caused by the deflation. When half of the money supply evaporates, people’s savings to expenses ratio are now at dangerously low levels. So they start reining in expenses. But all expenditures are another person’s income, so business revenues fall. In theory, the businesses could drop their wages and prices an equivalent amount, and eventually you would get a pigovian rebalancing effect. But the trouble is sticky labor and, more importantly, debt contracts. When revenues fall, the businesses cannot pay debts, they go bankrupt, people are unemployed, and you get a full fledged deflationary spiral. Millions go unemployed, not because they were not building something people wanted (they were), but simply because contracts rely on a steady money supply, and when money supply drops by 50%, all contracts get shot to hell.
There are two solutions: one, the government could announce that in light of the discovery of the counterfeit bills, all contracts will be redenominated at a 2:1 ratio - thus debt contracts will be cut in half, wage contracts cut in half, NFL salary cap cut in half, leases cut in half, etc. Or, the government could announce a one month window in which people can trade in their counterfeit bills for real ones. This will restore the money supply to the original levels. Either one of these solves the problem instantly and completely avoids the depression. There are no zombie industries, everyone just continues with their productive pursuits. The only unemployed people are at the vineyards and brothels, they must still find new jobs.
Of course, if the government decides to restore the money supply by printing money and giving it to government workers digging ditches, then you will still get massive frictional unemployment, and you’ll permanently reallocate resources into useless activities. This is the Keynesian/Obama solution and it’s a terrible one.
The problem you and the Austrians have is that you do not distinguish the unemployment caused by necessary restructuring ( the brothels and vineyards) from the unemployment caused by a fall in the money supply and the wrecking of contracts. The first cannot and should not be avoided. But you can, and should, prevent the collateral damage that creates a great depression. Until you see the difference between these two types of unemployment, you guys will get killed in debates with the Keynesians, and no one will listen to you. Which is too bad because the Austrians have a lot of great insights, and the Keynesians are awful on a lot of other points.
nazgulnarsil: you’re assuming that the government must step in to renominate those debt contracts. consider this: you’re an economic agent owed a debt when this happens. Your debtor gives you two options: 1) you hold them to their original contract, they default, you get nothing. OR 2) you renegotiate and at least get some of your money.
part of the problem with the current crisis is indeed “stickiness”. That is, people refusing to renegotiate. Why should we reward such behavior?
So what have I missed? how would you have responded to his points so far?
edit: not sure what’s up with the text fonts.