The economic pundits have stressed
more and more that this crisis is special because it involves
"deleveraging," and for that reason isn't a run-of-the-mill
recession. Because households and corporations are collectively trying to
reduce their net indebtedness, it is allegedly up to the government to run
massive budget deficits in order to prop up aggregate spending.
In the Austrian view, such analyses
are nonsense. According to canonical
Austrian business-cycle theory (which can easily explain the housing boom
and our current mess),
people engaged in misdirected investments and overconsumption during
the boom years. The proper remedy, therefore, is for the community to live below
its means during the recession — to save more and heal the
mistakes made during the boom. By piling up massive debts for the taxpayers,
governments simply thwart this corrective process and make the recession last
longer.
The Mainstream Analysis of Deleveraging
A recent article
from Time/CNN, relying on a research paper
put out by McKinsey, lays out the standard (Keynesian) analysis of our
current situation:
The U.S. appears to be the only
developed country where the overall debt level is falling.…
Of course, the reason our overall
level of debt has been falling is because of individuals and not government.
Government debt is continuing to rise. Private household debt has been
falling, in large part because people have been losing those households, and
the debt that goes with them. Consumers have also reined in spending and are
now saving at the highest level in years. And that is one of the reasons that
the economic recovery has been slower than expected.
Darn those self-centered
households! If people would just go to the mall and blow their paychecks
already, we could get this economy back on its feet.
This type of analysis is so
pervasive that the people in the financial press probably don't even realize
they are siding with the Keynesians as opposed to (say) the Austrians.
"If
people would just go to the mall and blow their paychecks already, we could
get this economy back on its feet."
This preoccupation
with consumer spending as the key to economic growth is why
forecasters cheer when households spend more on consumption and when they
increase their credit-card debt, even though on the face of it these would
hardly seem to be responsible things to do in the middle of an awful
recession. The Keynesian mindset also explains why, during debates over
government "stimulus," analysts worry that tax cuts would simply be
saved (and therefore would be a complete waste in terms of helping the
economy).
Alas, even though the Keynesians
tell us that all would be fine if people would just stop saving so much, this
is a free country after all. Thus far, nobody has proposed forcing
people to go out and buy new plasma-screen TVs. Instead, the pundits call for
governments to spend the (borrowed) money in order to maintain
aggregate demand. They think this prescription is a matter of simple
arithmetic: if the private sector is (on net) reducing its
indebtedness, then the only way to keep total incomes from falling is for the
government to step in and increase its indebtedness.
Saving Is Good in a Recession
It is certainly true that
households have been reducing their indebtedness since the crisis began, as
the following chart shows:
In the above chart, we see that the
personal saving rate (red line, right axis) steadily fell from 1980 through
the depth of the housing bubble, from about the double-digits down to a
measly 1 percent. But now, as Americans realize just how recklessly they have
been living for years, the personal saving rate has jumped back up to above 5
percent.
Another way of gauging the shift is
to look at household financial obligations as a percentage of personal
disposable income (blue line, left axis). That rose during the housing bubble
years and has fallen like a rock since the bust set in.
Contrary to Keynesian warnings
about the fallacy of
composition, in this situation what is good for the individual
household is also good for the economy as a whole. When a family has
lived beyond its means for years, running up credit-card and other debt, then
the solution is to cut discretionary spending and pay down the debt.
(Selling off assets and seeking other forms of income are also great ideas.)
According to Austrian
business-cycle theory, the boom period is unsustainable because artificially
low interest rates (fueled by Fed inflation) lead entrepreneurs to invest in
long-term production processes even though there aren't sufficient real
savings to complete them. In other words, when Alan Greenspan cut the federal-funds
rate from 6.5 percent in 2000 down to 1 percent by 2003, people
responded as if there had been more saving on the part of households. This
partially explains the huge upswing in the housing boom.
But when Greenspan added a bunch of
zeroes to commercial bank balances, he didn't actually create more roof
shingles, lumber, floor tiles, and so forth. As the economy adapted to the
artificially low interest rates, the structure of production evolved into an
unsustainable configuration. Because of capital consumption, Americans (and
others around the world) persisted in delusion for several years, thinking
they were enjoying prosperity. But in reality, they were eating the seed
corn. (In my "sushi
article" I give a simple fable to illustrate the process,
while Roger Garrison's PowerPoint
show on unsustainable growth provides a more technical explanation
of the Austrian theory.)
In this context, households can
partially justify some of the investments of the boom years by saving more. In
other words, if people had actually begun saving a much higher
fraction of their incomes starting in the year 2000, then (other things
equal) interest rates would have dropped due to market forces. Even in the
absence of any prodding from Alan Greenspan, resources would have been freed
up from making consumer goods (TVs, video games, steak dinners) and could
have been diverted into making producer goods (tractor trailers, tools and
equipment). The higher investment spending in various sectors would have been
sustainable because consumption (in the short term) would have gone
down.
"It saps the sweetness of paying
down your American Express balance by $5,000 if your portion of the federal
debt goes up by $3,000 during the same period."
To repeat, households can at least
mitigate the mistaken investments of the boom years by saving more now. The
economy will be brought closer to the configuration that it should have
had, to justify the low interest rates spawned by the Fed (under Greenspan
and now Bernanke).
None of this analysis implies that
households ought to "take one for the team" and save a higher
fraction of income than they individually consider desirable. The point is
that once we take seriously the Austrian conception of a long-term capital
structure of production — as opposed to Keynesian aggregates, which
reduce the entire economy to numbers labeled C and I —
then it becomes clear that increased saving helps during a recession.
It is the macro analog of the beneficial (long-term) effects that increased
saving has on a household at the micro level, when that household realizes it
has dug itself into a hole through reckless spending.
Government Just Prolongs the Adjustment
If households are trying to save
and pay down their debts — and we have seen that this is actually good
for the economic recovery — then it obviously follows that government
deficits only prolong the agony. For one thing, to the extent that each
household takes into account future tax obligations to service the government
debt, private efforts at saving are offset by government borrowing. In other
words, it saps the sweetness of paying down your American Express balance by
$5,000 if your portion of the federal debt goes up by $3,000 during the same
period. If Keynesians want households to stop saving so much and resume
"normal" consumer expenditures, they should tell the government to
stop piling more debt onto the backs of the taxpayers.
Another important consideration is
that government spending is not nearly as productive as private spending.
Government deficits allow more resources to be siphoned out of the private
sector and diverted to political channels. This is always a bad thing, but
particularly so during a recession when the economy is already
"sick" and trying to recover from previous malinvestments.
Finally, what of Paul Krugman's point that total incomes necessarily fall if
the economy as a whole (including private and government) saves? Well, so
what? There is nothing magical about the nominal level of income; what
matters is what people can buy with their paychecks. If massive
deleveraging causes total income — measured in absolute dollars —
to fall, then equilibrium will be restored only when product prices fall too.
The real problem isn't the
adjustment, but the preceding boom period in which wages and prices were bid
up to unrealistic heights. It's true that falling incomes will make it harder
for debtors to pay down their debts, but that observation doesn't negate the
need for paying down debts. It is foolish to prop up unsustainable prices
— whether of certain salaries or homes — for years on end, rather
than facing the necessary liquidation process.
Conclusion
Back in the fall of 2008, when the
extraordinary budget deficits and monetary expansions began in earnest,
policymakers warned the public of how awful the economy would become if they
"did nothing." Trillions of dollars later, the economy is still
pretty awful, especially from the perspective of lower- and middle-income
households.
Deleveraging — a fancy word
for paying down debt — is a painful process, but necessary given the
extravagant living of the boom period. Rather than fight it, the government
and Fed should get out of the way. They certainly shouldn't implement
policies — such as zero-percent interest rates and trillion-dollar
deficits — that will only build up the problem once again.
|