Why the Right Will Oppose Getting Us Out of Recession

by: Matt Stoller

Thu Dec 04, 2008 at 10:41

In a post about Depression Economics, Paul Krugman discusses deflation, or dropping price levels.  I'm seeing deflation in the local real estate market, as buyers are holding back because they think prices will keep dropping.  One theory is that deflation raises the value of money, which is true.  If one dollar buys more real estate tomorrow than today, the value of money goes up.  Presumably, this is expansionary since it is increasing the total monetary base in the economy, and has what's known as a 'real balance effect'.

But here's the rub.

Then add in the debt deflation issue: deflation redistributes wealth from debtors to creditors. If the debtors have a higher marginal propensity to spend out of wealth than the creditors, which is what Irving Fisher thought, then this could easily swamp the tiny real balance effect.

Deflation transfers wealth from debtors to creditors, which is another way of saying from people who are cash poor (the poor, the middle class, entrepreneurs, risk-takers) to people who have cash (the risk-averse rich).  Unfortunately, the risk-averse rich don't spend very much of their wealth relative to everyone else, which is why they are risk-averse.  There also aren't that many of them, and they have probably become more risk-averse in this environment because of expected deflation and financial losses from substantial asset value declines.  

In order to restart the economy, the distribution has to work in reverse, part of the monetary base has to move to people who will spend from those who hoard through various monetary and fiscal arrangements (ie. government).  And here you see the political problem; people that have money would prefer that they remain on top, and will oppose attempts to restart spending from a broad base.  These people are known as 'conservatives', and they have their Beltway facing servants writing screeds about how the New Deal failed in the 1930s.  Economics is very dry and technical, but it is inherently political.  

It's useful to keep that in mind when considering how 'experts' frame seemingly apolitical arguments.  

Matt Stoller :: Why the Right Will Oppose Getting Us Out of Recession

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Excellent, Matt. (4.00 / 1)
It's useful to keep that in mind when considering how 'experts' frame seemingly apolitical arguments

Always critcially analyze so-called "experts" and non-politicl solutions.  Determine who's interest they serve.  

That is not anti-intellectualism, either.  Critical analysis is key to any politics.  We must be self critcial also.

Too many now simply what to believe in Obama, yet even Obama will admit he is but a man, fallible, and needing input and criticism.

There are winners and losers in deflation.  

The key to understanding economics (4.00 / 4)
is understanding the assumptions that are behind the various economic models.  For example, everything in Neo-Classical economics is perfrectly logical IF you accept the assumptions on which it is based.

Many economists are fond of paraphrasing Oscar Wiide's line about cycnics: an economist is someone who knows the price of everything and the value of nothing.  

[ Parent ]
It's a disaster (4.00 / 2)
You're exactly right (though I think you inadvertently inverted debtors and creditors in "which is another way of saying from people who have cash (the risk-averse rich) to people who don't (the poor, the middle class, entrepreneurs, risk-takers)."

But the other problem is that deflation in the bubbled parts of the economy is necessary. Home prices grew way out of scale with incomes, and they have to come down. Either that, or we prop up home prices artificially forever, which is obviously both bad and impossible.

Conduct your own interview of Sarah Palin!

yup (0.00 / 0)
Thanks, that mistake is fixed.

[ Parent ]
Alternet cross-post (0.00 / 0)
needs to be fixed as well - I just got done posting a comment criticizing the fact that you had it backwards and then found you had fixed it here.  Sorry about that.  We are actually in agreement

[ Parent ]
I bought a house for $450 (4.00 / 4)
yes, you read that correctly, and entire house with walls, doors, windows, a roof.  Ok, it comes with a $5000 water bill lien that I'm working to get lifted.  But it also comes with a new roof, new siding and new exterior doors.  Welcome to Pontiac, MI.  A predatory lending A-bomb hit this area, the people are gone but the houses are still standing.  You can check the MLS today and find over 250 houses selling for under $25,000.  Dozens went unsold during the tax foreclosure auction I attended in October, those will revert to the city of Pontiac.  I bought this one because it was the safest bet.

My plan, fix the house up myself, and sell it back to one of the neighbors renting in the area.  Rent is currently about $600/month.  I should be able to sell to someone, with a fixed rate loan, for about $300/month.  The buyer would get an immediate $300 wage boost and be building equity in the neighborhood.  With my profits I plan to pay off my credit cards, clean up the adjacent empty lots with a small business owner that does this work, and buy the neighboring property which is also in tax foreclosure.  I am working with the local district councilman.  His mantra is let's lift all boats, mine is, there is the ways things are, and the way they should be.  Slowly but surely I hope to stabilize 2 square blocks in one year.

Microeconomics for Pontiac, MI.  Matt you make excellant points and you are spot on.  I just hope there are more liberals like me out there trying to do the right thing for these communities. But there aren't, another buyer at the auction was guy wearing a "remember 9/11" T-shirt.  I don't know what he's doing with his properties but I can find out since I eyed one of the properties he bought.  

One thing is that eventually prices get so low, like they there are here in Michigan, that you almost can't lose.  My risks are tremendous.  Vandalism(none yet), a stolen vehicle ended up in my backyard the other week, the electric company continues to jack me over so God knows when I'll have electricity(they are promising Jan 9th, like they are doing me a fucking favor or something), oh, and I mentioned the water company which cleverly shifted the deliquent water bill ($5000) onto MY tax bill two days after the auction.  The water company's attitude, Fuck you, pay me.  But I move forward.  Why? Because Pontiac and Detroit's fate is metro Detroit's fate. and the auto companies fate, is America's fate.  And conservatives feed on the chaos, disaster capitalism and smash mouth politics.  And I say, fuck them, I'm going to make money on these deals, recapitalize this communities, pour profits into the progressive infrastructure and shove our gains right up the conservatives asses!!

Even here in Germany, we get TV reports about houses for $1! (4.00 / 1)
This was in a report about Detroit just two days ago, and the real estate guy who bought it, living in that neighborhood, said there are about 180 houses under $1000 for sale now. Wow! An opportunity for bargain hunters? Well, homeless families care about job opportunities, too, and there are none in Detroit. And it isn't a real retiree paradise, either. So, it looks like even at those ridiculously low prices there is no demand.

Btw, that house for $1 had lost almost all of its aluminum facade and looked like a real mess. But still, the property alone shold be worth more than a buck. I guess the realtor will tear the house down and simply wait for better times. Wonder how much taxes he will have to pay for that "real estate", though.  

[ Parent ]
Well, you may pay $1 but it'll cost you thousands (4.00 / 2)
The house I got has a solid foundation and a new roof buuutttt all the plumbing has been stolen, I been replastering the walls because of age and humidity cracks, the windows are shot, I'm going to have to replace all the wiring or risk a fire.  But at least I have hardwood floors which I can resurface and stain myself for about $100.  It's tough, the electric company has been dicking me around for 5 weeks now.  The water company shoved a $5000 bill up my ass.  Thank God my district city councilman and his assistant are totally in tune with me, what I'm doing and are a giant bright spot in the abyss that is the real estate disaster known as the state of Michigan.  
I have to watch literally how I choose to spend every freaking penny.  I can't pour in $5000 and then come to find out there are still no buyers.  Houses in good shape are selling for $30-$40k or about $50/square foot but nothing is a lock.  The fate of the big 3 is inextricably linked to Pontiac.  Pontiac has several huge GM production and design facilities.  It may not be betting like at a casino but I have no guarantees that any of it will work out.  Just faith in my hard work, people and a community desperate to turn itself around.

[ Parent ]
deflation and class conflict (4.00 / 3)

One of your points doesn't make sense to me: the case of the indebted 'entrepreneur' under deflation.

If I own a business that is financed by debt (and lots of petty bourgeouis do, that's what makes them 'petty'!), deflation will destroy me because my cash flows will decline below my ability to service the debt. Let that go on long enough and I will become insolvent, and the creditor will seize the collateral put up for the loan. Hardly a transfer of wealth from the creditor to me (the debtor).

Am I missing something here?

yep (4.00 / 1)
you got it right. deflation kills everyone with debt. and if gets bad enough where you have defaults and massive asset deflation it kills the creditors too since the collateral is not nearly worth as much as when the loan was made.

thus comes the phrase - never a borrower or a lender be. the big banks and middle american spend thrifts are in the whole mess together.

~* the * Will * to go on *~

[ Parent ]
thanks, but (0.00 / 0)

Thanks for the confirmation and extension of the point I made.

On your point regarding the postion of creditors under deflation, it is obvious that the Paulson bailout has been exclusively, massively devoted to making (portions of the FIRE sector of) capital whole by shifting the losses to the public sector.  

I agree with Matt that what is needed is redistribution of wealth down the social hierarchy. What we face is a crisis of over-accumulation.

What I personally dream of is taxing wealth, not income, at punitive levels at the upper reaches of the wealth distribution.

But Obama ain't gonna destroy capitalism in order to save it. I don't think he could even if he wanted to in any event. Just my guess.

[ Parent ]
i have no house, plenty of cash, no debt (0.00 / 0)
this puts me (and lots of middle class who are like me) in the camp which benefits greatly from deflation. inflation services those who lend money, barrow money, and who control assets ( the wealthy and every dolt who bought a house in the last 5 years and ran their credit cards up). now it will seem counter intuitive that inflation should benefit those who lend money, but for giant banks deflation is absolutely killing them, because it pushes people and companies who are over extended to default on their debt. which then means the banks have write downs to the tune of $300B bailouts for citibank.

now, if you want to help a lot of middle class, lower middle class, and poor people, and the responsible people who didn't buy homes in this bubble and who didn't max their credit cards at target on new plasma screens, then you let the market work as it should, and restore home prices and all assets to a reasonable level. home prices in general are still waaaaaay too expensive based on income.

what paulson and bernanke are trying to do is keep home prices propped up. bernanke said so as much the other day.

the reality is that America is way over leveraged, and those debts must be settled. we can do it slow and painful japanese like by 'bailing out' every thing that starts to fall 'too far' and stringing out debt payments, or quick and bloodly through debt defaults. but the quick way lets the market reconstitute everything to its true worth.

the reason the japanese way is so bad is that even if you throw tons of money into the economy through a stimulus plan that money will not recirculate into the economy until the debts are resolved. this is the fallacy of the stimulus idea in this depression. even if it holds the bar on job losses and company closures, earnings will go into servicing debt. growth will remain severely constrained until the debt has been serviced to a manageable level.

I'd like to believe a stimulus package will save use from a protracted depression. but I don't buy it. the circumstances of GD1 and GD2.0 are not comparable - the US then and now are completely different markets. I'm literally putting my money where my gut is, and that's on protracted contraction - despite a stimulus.  

~* the * Will * to go on *~

If it wasn't the economic stimulus (4.00 / 1)
why did the US economy take off when the nation entered WWII?

[ Parent ]
Stimulus or natural progression (0.00 / 0)
Correlation does not necessarily mean causation.

If one looks at the data employment was trending up since the mid-30s trough and so were many economic indicators such as GDP growth, velocity of money, hours worked, earnings growth, etc.

So there is a well founded argument that debt defaults and liquidation ran its course and both the financial system and the economy were already on the mend and on a growth path when the real war effort began in the early 40s.

[ Parent ]
But then there's 1930s Japan & Germany's track record (0.00 / 0)
In 1932 Japan became the first nation implement what would become 'Keynesian' economics. Japan's Minister of Finance (MoF) looked at the situation at the time, saw a lack of demand and implemented deficit spending.

By 1933 Japan was out of the Depression, and by 1940 had increased its industrial productivity by 100%.  

In Germany deficit spending was implemented almost immediately after Hitler came to power in 1933.  Germany was out of the depression by 1934 and had a labor shortage by 1936.  

The unfortunate side of this was that the deficit spending, in both cases went to munitions.  In fact, in Japan the MoF attempted to dial back the deficit spending in 1934 and was promptly assassinated by far right wing nationalist within the military.  This had a chilling affect on the civilian branches of the government, and slowly the Military took control.  

By 1939, Japan's GNP was nearly half that of the U.S.s (it had been a third of the U.S.s in 1929).  Given the rough parity and the U.S.'s preoccupation with the War in Europe and the Atlantic, the Japanese had reason to believe that they had an even chance against the U.S.  

However, after Pearl Harbor, the U.S. finally implemented 'real' 'Keynesian' economics - using deficit spending - and similar to Japan managed to double its industrial productivity in only 4 short years.  

The argument that Keynesian economics doesn't work is a weak one, if case history is not limited to just the United States.  The fact is, Roosevelt tried to implement deficit spending on the cheap, a 'milk toast' program and like a lot of things in life, he got a 'milk toast' outcome.  

I think you cold argue that the 'hooveresque' forces in American life worked to hamper Keynesian economics then, just as it is attempting to do now.  Just like then, people will see the President as their champion.  So Neo-Hooverism will only serve to create misery for millions of Americans.

[ Parent ]
Great point (4.00 / 2)
Misleading the public on economic issues goes all the way back to the days of the Gold Standard. Banks wanted to keep the gold standard because it was inherently deflationary, put greater value on money (rather than goods and services) and benefited creditors more than debtors.

In the book Tragedy and Hope, Carroll Quigley describes how bankers at the turn of the 19th-20th centuries routinely framed financial terms in ways that benefited their own interests:

The influence of financial capitalism and of the international bankers who created it was exercised both on business and on governments, but could have done neither if it had not been able to persuade both of these to accept two "axioms" of its own ideology. Both of these were based on the assumption that politicians were too weak and too subject to temporary popular pressures to be trusted with control of the money system; accordingly, the sanctity of all values and the soundness of money must be protected in two ways: by basing the value of money on gold and by allowing bankers to control the supply of money. To do this, it was necessary to conceal, or even to mislead, both governments and people about the nature of money and its methods of operation.

For example, bankers called the process of establishing a monetary system on gold "stabilization" .... It really achieved only a stabilization of exchanges, while its influence on prices ... might be unstabilizing. [...]

As a consequence, many persons ... were astonished to discover, in the twentieth century, that the gold standard gave stable exchanges and unstable prices.

yes and no (0.00 / 0)
I'm not sure I agree that the rich are "risk averse" so much as that they have enough money that they don't need to be highly leveraged.  A "smart" buyer would prefer to buy at the bottom, not while it is still going down, but the problem is that it is hard to identify that, so often people stay on the sidelines until the market goes up, then essentially a buying frenzy happens as everyone gets back in the market as they try to buy before the prices are high again, generating a fast rebound when it finally happens.  But given the dire predictions for the economy and real-estate markets to not see the bottom for 12 months (maybe longer, but it is just that no one has visibility farther out), the bulk of the money is not yet motivated to put their money back in play.

I think conservative desire to prevent stimulus spending is less based on preserving "on-topness" than preventing progressive successes that would rebuild faith in government working for the people and universal healthcare that will cement a generational political shift to progressives ... plus sudden new-found supposed fiscal prudence (really just prevent progressive spending instead of conservative spending).

not the rich (4.00 / 1)
The risk-averse rich.

[ Parent ]
Not true (0.00 / 0)
The risk averse rich have many options.  A favorite seems to be gold for example.

What deflation really helps are the middle class who manage to keep their jobs.  The ones that lose them lose big, but the rest are the only real group that has to keep a significant portion of their money in cash to deal with unexpected expenses.

There are plenty of risk averse options.  The rich don't have to choose cash.

Who deflation really hurts are creditors.  People who are risk averse will simply choose a different asset.


[ Parent ]
Real Balance effects (4.00 / 1)
Actually, I think it was Pigou who articulated the real balance or "wealth effect" from a deflation, though I'll give Fisher some credit as well (though Pigou was not opposed to public works or to a monetary expansion in the case of a Depression).

In order for the real balance effect to work, the drop in prices has to create enough increased wealth to stimulate increased spending. I'm not sure why you are referring to the "monetary base" when you should be talking about the monetary aggregate: Call the monetary aggregate M and the Price level P, so real wealth is M/P. If M is constant and P falls, "real balances" rise, thus allowing for increased spending. You don't have to shift money around or count on redistribution effects. An example of a real balance effect would be increased consumer spending that comes from the fall in gasoline prices.

Keynes directly addresses this argument and points out that even while a deflationary period may increase real balances, if people simultaneously lose their jobs, then the spending effect from the drop in Aggregate Demand swamps the real balance effect. Thus Keynes makes a two fold argument: there are forces in the economy that are likely to keep prices from falling far enough and fast enought to stimulate the economy, and even if prices and wages could fall fast enough to the bottom (as they might if the Depression is long enough and severe enough) the decrease in aggregate demand will swamp this and prevent recovery. So flexible wages and prices are not the answer.

The right (depending who you mean) will oppose a Keynesian strategy primarily because of ideology. As of right now, the financial sector and much of manufacturing wants some kind of keynesian strategy, while expressing concerns about future deficits.  

Consensus conventional wisdom (4.00 / 1)
Its now accepted "fact" across all the pundits that we are facing deflation and the consensus answer across all political stripes is even more easy money and fiscal stimulus - i.e. - even more debt is the ONLY solution.

Those that have memories larger than the punditry remember the disinflation leading to deflation scare that Greenspan and the other pundits across both parties sold us in the wake of the dotcom crash. What was the response then? Easy money with Fed funds rate at 1%, more fiscal stimulus - tax cuts and deficit spending out of control. What did we get - a debt fueled credit binge around housing that is now collapsing under its own weight.

We always get more parabolic debt expansion with easy money and deficit spending each time. The problem and solution is always the same - more and more debt.

Lets also not forget the cast of characters that keep selling us the debt is best mantra - its both Democrats & Republicans.  They are Keynesians, Monetarists, Supply Siders and Objectivists. The A list includes luminaries such as Bob Rubin, Hank Paulson, Larry Summers, Alan Greenspan, Ben Bernanke, Tim Geithner, Jim Leach, Phil Gramm, Barney Frank, Chris Dodd. They span administrations from Ronald Reagan to Bill Clinton as well as George Bush and Barack Obama.

What American taxpayers may not know is that the current bailout generosity has the Fed, Treasury and other government agencies pledging their future incomes to the tune of $8 trillion that is more than half the GDP of the US. Total credit market debt as a percentage of GDP continues to skyrocket well past 350% in a parabolic fashion. It now takes $7 of debt to generate $1 of GDP growth. As recent as the mid-90s it only took $3 debt for the same dollar of GDP growth.

Paulson & Bernanke now want to prop up elevated home prices and provide mortgage relief to those that speculated on prosperity on the back of forever rising home prices with no money down credit. This after propping up Wall Street compensation packages. Maybe its too hard to increase peoples real incomes to make housing more affordable. How unAmerican that house prices should decline lest it becomes more affordable to the vast majority who have not seen real income growth in years. How "stupid" it would be to pay for homes from savings & income without having to borrow 100% of its value as the majority did in the 50s?

It seems there is no advocate in the halls of power or the economic punditry for the prudent. Those that did not gorge on debt fueled visions of grandeur. It seems that traditional values of thrift, savings, hard work and the entrepreneurial spirit of creating new businesses based on innovation and capital is no longer relevant. There are no policies on the horizon to incentivize savings and capital formation. Why bother when its so much easier to print money and paper over any problem.

Today from progressives to conservatives there has never been so many prostrate before the temple of debt. Will the debt God return the favor?

this is a very interesting point (4.00 / 2)
I have to wonder though: is there really no limit to the narrowness with which the economic elites conceive their self-interest? I mean, at some point the self-interest of the wealth class dictates that we need to have a strong overall economy, because without a strong economy, wealth cannot be created. They ought to make this rational calculation even if they don't have an empathetic or civically-oriented cell in their bodies.

On the other hand, I suppose it's possible that they're so clouded by free market ideology and the idea that wealth is created by the individual agent regardless of the broader social and economic context that they don't even perceive their own dependence on a healthy economy, strong job growth, etc. Which, really, I wouldn't put it past those fuckers to think that way.

Estate taxes, real estate (4.00 / 1)
For many years, wealth was taxed at high rates when transferred to another generation of a family through the estate tax.  Of course, the estate tax contained a generous allowance so that most homes or small businesses were not taxed when passed on.  When George W. Bush eliminated the estate tax, the benefit fell solely on the rich and the vewry rich ($600 K was exempt and good lawyers could improve that result; that was back in the day when the average home cost $150 or $200 K; $300 in expensive areas).

Now mega fortunes can be transferred tax free forever (see the Waltons of Walmart).  For the little guy, the way to tax free wealth was, briefly, real estate.  Single taxpayers were allowed to pocket $250,000 in real estate gain from a single transaction as long as the property was owned for two years; masrried couples gad a $500,000 exemption.  As long as properties kept going up, the path looked good.  Buy a $300,000 home, invest $50,000 in repairs and upgrades and sell it for $500,000 two years later.  All of a sudden, the $100 K down payment was tripled to $300,000.  Do it two or three times as you climb the ladder and suddenly you were rich and living in a mcmansion unless the market collapsed.  Oh, well.


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