It’s easy, do exactly what Martin Wolf and George Soros are suggesting
Martin Wolf and George Soros, regular commentators in the Financial Times have both released pieces in the last few days calling for an avalanche of money to be unleashed on the economies of Europe and Britain in order to mitigate the negative effects of what is a second great depression in my view. Wolf doesn’t mince words, writing:
It is the policy that dare not speak its name: the printing press. The time has come to employ this nuclear option on a grand scale. The alternative is likely to be a lost decade. The waste is more than unnecessary; it is cruel. Sadists seem to revel in that cruelty. Sane people should reject it. It is wrong, intellectually and morally. A recession looms close in the UK and other high-income countries, less than four years after the start of the last one. This would be a disaster for those who would lose their jobs or the young, who would find their hopes of work further postponed.
Right from the off he’s branded anyone daring to rebut ‘wrong, intellectually and morally,’ as well as cruel and guilty of sadism, to give his argument an air of correctness and sanity. What he calls for, however is the opposite of correct, and will do far more harm than good in the long term. That he thinks that a recession is only ‘looming’ over the UK and the rest of the West is interesting. Most economists when asked are relatively sanguine about the prospects for growth in the future, with the idea that the slow down in the global economy is characteristic of postwar recessions and, while problematic, can be overcome with the right policy prescriptions. That aspect is what worries many, with most fearful that policymakers will drag their heels and fail to ‘do the right thing,’ due to pressure from evil sadists such as myself who revel in the pain and suffering of others as Wolf would have you believe.
The truth is that people such as myself feel the way we do because we recognize that the solution Wolf (and Soros) submit is more of the same – they seek to preserve and restore the economic structure that existed prior to the start of the downturn. However that structure (debt driven consumer spending) is fundamentally broken and unsustainable, which is what the events in Fall 2008 told us, or tried to. Western governments did not take the message, or perhaps ignored it, and ran the printing presses in the immediate aftermath. After some effort, the situation stabilized from the vantage point of capital markets. Economic data points turned up, creating the illusion of recovery.
In reality, the efforts of Western governments and central banks did nothing but increase the price level to combat the falling prices that characterized the Fall 2008 period. For anyone caught out by that price drop (firms and individuals primarily dependent on continued paper wealth creation), those actions provided an opportunity to cut losses and attempt to remain in business. For the average citizen who had already begun to find things difficult towards the end of the boom period thanks to the skyrocketing price of energy and to a lesser extent food, the restoration of those trends after 2008 has become problematic. The CRB index, a widely referenced commodity index is once again at 2007 levels. These increased costs of commodities mean that firms must either pass on these increased costs of doing business to the consumer, or slash ‘internal costs’ (reduce headcount or wage rates). This phenomenon has seen the living standards of the average earner decline since 2008, as the wages one used to earn have either declined nominally, or bought less goods and services than before. In the last year alone, the real wage has declined by 1.9%. This is why for most, the feeling is that the recession never ended. So Wolf, who only focuses on the figures and data points looks off base by declaring that recession is only just ‘looming’ once again. He feels that way precisely because the phenomenon that will make life easier for the average earner – falling prices – seems to be around the corner, thanks to the relative tight behavior from central banks and governments. Wolf continues:
A big danger for the UK is a sharp fall in house prices, which would threaten the finances of households and banks. A new recession would also shatter fragile business confidence, which would reduce real business investment, still 20 per cent lower in early 2011 than before the crisis. That would further delay the structural shifts on which sustained recovery depend. With UK gross domestic product still 4 per cent below its pre-crisis peak, this depression would be longer and costlier, in terms of lost output, than the Great Depression of the 1930s, as I noted four weeks ago.
Far from being a ‘big danger,’ a sharp fall in prices is exactly what the UK economy needs to get going again. The UK (and Western) economy was thrown into recession/depression exactly because prices continued to rise for years without abatement. Even the slightest rise in general prices causes problems, because the price rise is not equitable; some prices rise faster than others. Thus, some incomes rise faster than others. At the end of the episode, some are made to be worse off than before. These people must make changes to their lifestyle, or take on debt to maintain a prior standard of living. Rinse and repeat for each new round of inflation.
Over a period of decades, millions fell behind in such a manner as their real wage stagnated. This was mitigated somewhat by the ability to take on debt, increasingly in the shape of home equity for much of the middle class. All of this debt fueled spending and drove prices higher still, in the process leaving behind a new group of people who would soon undertake more debt to keep pace. The fall of 2008 was when this unsustainable model for growth fell apart, although the warning signs had been evident some time before. Ultimately, the increased debt burdens could not be supported by incomes, and the financial institutions that issued this debt became compromised as the nonperforming nature of these loans blew significant holes in balance sheets.
The increase in home values that Wolf seems to want will not change the fact that incomes cannot support those prices, and the debt burdens needed to obtain them. If prices are to rise in this environment, debt accumulation must increase given that prices are still at bubble levels, still not in line with incomes. If by some miracle people do take on more debt and home prices rise again, at some point we will end up right back at square one. When the demand (increased debt issuance) ultimately drives the price to a level that is beyond the reach of that last marginal buyer, the subsequent lack of demand will lead to home prices stabilizing and ultimately heading lower again for the same reasons they did in 2006-7.
The effects of 2008 will repeat themselves, and people like Wolf will call for yet more money printing to mitigate the effects of that downturn. I must stress that this logical exercise has almost no chance of happening. Bubbles, when popped, do not reflate. They often take on the order of decades to reach their pre bubble level. The debt and housing bubble is no different. In short, we have reached a point at which the effects of deleveraging and debt reduction cannot be avoided. When it occurs it will result in lower prices, which absolutely will destroy the structure of the pre 2008 economy, which governments are still trying to preserve. However this destruction is the only way by which the ‘structural shifts’ Wolf refers to will happen. Kicking the can down the road as Wolf prescribes is exactly what will delay those shifts as he fears. To continue to increase the debt and price level, is to increase the percentage of people who will be paying an increasing percentage of their incomes to pay for food, energy, shelter, education and healthcare. The logical conclusion of all of that is hyperinflation and social unrest.
Soros presents a more nuanced version of Wolfs argument, with a focus on the European debt crisis. The premise is the same, and therefore will be equally as destructive in the long term. His call for the EFSF to be expanded, the ECB to capitalize banks, and to provide liquidity to countries like Italy and Spain is analogous to Wolf calling for the cessation of UK home price declines. Soros says that these measures would
calm markets and give Europe time to develop a growth strategy, without which the debt problem cannot be solved.
In other words, the problem of governments being too indebted is to be solved by further increasing the debt burdens of these countries. The entire crisis has developed as a consequence of countries faced with the prospect of defaulting on existing levels of debt. Further increasing those levels of debt will only increase the likelihood of default. In the interim the ‘growth strategy’ (read: continued price inflation) will make things far worse for both the citizenry, as wages will not rise, and the banks and institutions, that will be squeezed by increased business costs.
All of these efforts are borne from the instincts of politicians and those deeply entrenched in the preservation of the status quo to keep that status quo in tact. The longer the pain can be deferred to the future, the better it will be for the politicians and those in power, as they will find it easier to retain their positions. The problem is that the status quo is an utterly broken model that cannot be preserved without the complete destruction of what little wealth the average person has left via inflation. Martin Wolf and George Soros are misguided in their belief that these preservation efforts will work, and should they be enacted, the second Great Depression that has already begun will be far, far worse in the end.