Saturday, March 17, 2012

Two kinds of deleveraging, and MMT rebalancing

Dalio's article, "An In-Depth Look at Deleveragings" is apparently authored by him. It concludes that the best way to "deleverage" is a "proper" combination of debt reduction (defaults and restructurings) and debt monetization (monetary inflation). This is what he considers to be a "beautiful" deleveraging whereas deleveraging by debt reduction and austerity are "ugly." The ugly ones cause recessions/depressions and deflation which is bad. Beautiful deleveragings minimize debt reduction and revive economies with monetary stimulation....
Dalio defines a beautiful deleveraging as one "in which enough 'printing' occurred to balance the deflationary forces of debt reduction and austerity in a manner in which there is positive growth, a falling debt/income ratio and nominal GDP growth above nominal interest rates....
What he calls "ugly", an austerity and debt reduction, is actually "beautiful". While it is painful, it is painful for a much shorter period of time and enables the "economy", i.e., people, to go bankrupt, repair their finances, start saving again, create new capital, and then create new economic growth and jobs. By preventing or delaying this process the policy makers only doom us to economic stagnation, inflation, and permanent high unemployment. And I fear that is exactly where we are headed.
Read it at Zero Hedge
Ugly = Beautiful; Beautiful = Ugly: Ray Dalio On Deleveraging
by Econophile

What Austrians don't seem to get is that the art of deleveraging, should it become necessary due to Ponzi finance as Fisher and Minsky describe, is to reduce debt overhang with minimal capital destruction. Austrians want to "liquidate malinvestment due to credit excess and don't seem to get that in a debt-deflation this involves massive capital destruction in an indiscriminate fashion. So recovery begins from a quashed capital base. That's ugly to me.

Monetarist solutions involve high unemployment and significant idle resources for some time. Hardly "beautiful."

The MMT solution for rebalancing is to provide the necessary net financial assets to non-government in order to offset increased saving desire and make space for deleveraging, while maintaining output and employment. Now that's elegant.


Ralph Musgrave said...

Agreed. There is more nonsense on deleveraging from the suits at McKinsey:

It’s reviewed with approval by Martin Wolf in the Financial Times here:

Given that Europe as a whole has a balance of payments surplus, I’d don’t see how Europe as a whole can export its way out of trouble. Perhaps McKinsey have not worked out that world exports and imports must net to nothing.

As to investment, if we just increase demand, businesses can work out for themselves how much of that demand to meet via more investment, and without any advice from McKinsey.

Ralph Musgrave said...

I should have mentioned above that "exports" and "investment" are claimed by McKinsey to be the key to escaping an over-leverage situation. What's wrong with plain old consumer demand? Oh I know: the suits don't want to see the peasants having a good time.

Bob Roddis said...

Mr. Hickey:

When you say “in a debt-deflation this involves massive capital destruction in an indiscriminate fashion. So recovery begins from a quashed capital base”, we Austrians have NO IDEA what you mean and submit that you are completely wrong. In the hope of creating some form of dialogue, what exactly do you mean?

Our position is that value is subjective, people make exchanges based upon their subjective values, those exchanges produce objective prices which are then the only substantial form of information available for people to make informed economic choices. Bureaucrats backed up by SWAT teams do not and cannot have superior information.

Fiat money distorts prices and thus distorts this essential process of economic calculation. It may and does cause people to take on too much debt. Fiat money will generally cause a serious distortion in the price, investment and capital structure.

People create capital goods in order to use them to make stuff that people hopefully would like to consume with the goal of eventually selling them at a profit. Since busts are caused by massive mis-pricing of everything, what’s the advantage of prolonging the time at which everything will be properly priced, especially the capital goods. Further, how can there possibly be “massive capital destruction” of capital goods whose mis-pricing is corrected? The goods do not go anywhere. They are not vaporized by space aliens.

Further, how is this process “indiscriminate”. Because it's carried on without strict regulation by a SWAT team? The people who buy the capital goods at the corrected price have plans for them which you could never know. People may need to file bankruptcy to discharge or restructure their debts. It is indiscriminate to dilute the value of the entire currency and further distort the price structure which will lead to nothing more than further distortions of the investment and capital structure which will need to be corrected once more in the future.

And just to be clear, we believe that almost everything proposed by MMTers leads to catastrophic price, investment and capital distortions and that the advocates of MMT are oblivious to even the existence of this type of analysis.

Tom Hickey said...

Bob, you need to study up on debt-deflation depression. As bad debts are forcibly liquidated when companies cannot meet cash flow and cannot sell assets quickly enough due to lack of demand and plunging prices, a lot of firms and households go belly up that able to meet their obligations in normal times.

One can say that these are "marginal" entities, but liquidating marginal firms and households is much different from liquidating malinvestment in my view. Marginal capital is destroyed needlessly and many marginal individuals are wiped out and their livelihood is destroyed through no fault of their own.

What happens also is that the largest firms are still able to obtain liquidity, and the largest banks are accorded liquidity by the central bank into order to prevent a total breakdown of the economy and society. But it was precisely in these very large institutions that the malinvestment was rooted and it remains and gets more to boot.

As Randy Wray note, the TBTF banks have received 30T in liquidity provision and the auto industry got bridge loans while millions of homeowners were thrown out on the street for lack of cash flow to meet obligation. No liquidity for them. Were they the "malinvestors"?

In a debt-deflationary liquidation, the wrong people are punished economically and socially, and the situation actually becomes worse as the people that actually caused the event become even more entrenched.

Moreover, a policy of liquidation in a debt-deflationary environment can result in political instability and social unrest if a deflationary spiral develops.

See Irving Fisher, "The Debt Deflation Theory of Depression."

Septeus7 said...

Quote: "Bureaucrats backed up by SWAT teams do not and cannot have superior information."

Yes they can and they do. You are assuming that most economic choices are informed. That is false. Most economic choices are not informed but systematically biased and this is a physical reality. We have entire industries based on helping people make uninformed economic choices and even denying them choices entirely.

Real Science knows about cognitive biasing but the Austrian school denies the existence of this physical reality.

The case Tom Hickey pointed out is a great example of how the government can know that people who are the victims of frauds shouldn't have their houses liquidated tossed out on the street something the markets can't seem to figure out.

Most people who are defrauded aren't even don't even know what has happened on a good con. They usually blame themselves.

A highly trained regulator is much better judge of value than the typical mark err "consumer."

You see in the real world Bob, Fraud exist and will always occur given certain kinds of environments because humans are systemically programmed for cheating and herding behavior around leaders.

You can know which arrangements will result in large scale fraud and regulate against such arrangements. The "free market" can't do that but human intelligence can and use the power of our minds to predict such events and legislate laws guiding markets away creating destructive environments.

Remember folks. Where's there's gambling there's cheating. Trying build a "free market" is building a economy on a casino on the principle that it should have no security systems because that kind of regulation would discourage potential customers.

The Austrian school would have us deny the very thing that make us human. The ability to creativity imagine the future and plan a reasonable response based on scientific principles.

All of the arguments about how we can't know that individual particles err "people" should behave given lack of knowledge of the precise position so we can't any thing about the general results have been dealt with in real science even since Gauss.

The Austrian arguments about incomplete information have long since been rejected by real physical science. You probably don't even know what the applications of meromorphic functions are.

Ralph Musgrave said...

Bob Roddis,

In your first paragraph, you say that “we Austrians have NO IDEA what you mean and submit that you are completely wrong”. If you don’t understand what someone is saying, you cannot accuse them of being wrong.

In your second paragraph you say that “our” position is to do with subjective values etc etc and that this results in a better allocation of resources than where prices are determined by bureaucrats. That is not “our”, i.e. a specifically Austrian claim. It’s what those basic simple supply / demand charts or graphs are all about which are set out in introductory economics text books. I.e. the idea is accepted by 99% of economists.

I’ve actually come across Austrians who quite clearly don’t understand the above charts / graphs because they claim the charts / graphs don’t take account of the different subject values placed on products by different consumers or people.

In your third paragraph you claim that fiat money DISTORTS prices. I can’t for the life of me see why. The big danger with fiat money is that the TOTAL money supply becomes excessive, which leads to inflation. But why fiat money should lead to apples being over-priced relative to bananas for example, I’ve no idea.

In your fourth para, you make the classic Austrian assumption that RELATIVE prices can only change given deflation or relatively high unemployment. Not true. The price of micro-chips has been falling relative to the price of other goods, and has been falling steadily over the last thirty years come boom or bust. The Dow Jones rises and falls, as does the price of oil, wheat, houses and everything else. And they rise and fall come boom or bust or periods that half way between boom and bust.

paul meli said...

So many thousands of internet man-hours are wasted every day trying to reason with an Austrian "thinker".

It is like arguing with a member of a cult. May as well argue to the wall.

Fortunately they are harmless as their ideas will never gain traction with more than relative handful of the population. It's a big boat, there's room for all of us so it's all good.

I do learn from the non-Austrians in the discussion so i suppose all is not wasted.

The people that scare me the most are the centrists - the definition of people without principles.

Tom Hickey said...

paulie 46, I agree in general. But now these ideas are gaining credence even among some progressives, it's time to address the assumptions. Same with neoliberalism. The assumptions are both unfounded and also anti-progressive, designed to favor accumulators rather than advance the goals of either individuals in aggregate or societies built on civilized institutions.The ideas are attractive as the myth of the frontier, but they don't hold water in an age of globalization and increasing interdependence.

Bob Roddis said...

I’ll address one topic at a time. There are so many.

1. If you don’t understand what someone is saying, you cannot accuse them of being wrong.

My statement might have been better stated as follows: "The assertion that the necessary repricing causes “massive capital destruction” with or without being accomplished “in an indiscriminate fashion” is baseless. Further, I cannot imagine how you came to that conclusion."

In fact, neither Mr. Hickey nor the other commenters explained how the repricing causes “massive capital destruction” at all. Mr. Hickey then pointed out that TBTF banks received bailouts (forbidden pursuant to our proposals) from the central bank (also forbidden pursuant to our proposals) suggesting that those banks might have bought up assets that they probably were not entitled to purchase. As I stated, those assets were not vaporized by space aliens. So, I still cannot imagine how they are destroyed during the necessary repricing.

I stand by my original statement.

Tom Hickey said...

Bob, when marginal businesses go belly up and are liquidated that capital investment is lost and the physical capital itself is often destroyed, or deteriorates while idle. Similarly with RE. A lot of financial capital is destroyed or diminished, and a great deal of real investment either deteriorates or is destroyed, both commercial and residential FE being booked as investment. For example, , entire subdivisions have been plowed under, and most of us have seen the derelict houses and building in our environs detracting from property values.

Then there is the cost of lost opportunity as economic resources either lie idle or underperform. This loss can never be recaptured. It is waste as inefficient use of resources.

In a great many cases, liquidity provision is all that is needed. Other cases can be resolved by restructuring. LIquidation through default is seldom a good solution.

BTW, Bill Black has shown how the TBTF should by law have been put into resolution, management sacked, equity holders wiped out, and bond holders made equity holders. Could have been done over the weekend, according to Black.

Financial Armageddon was BS. What would have happened is that a lot of powerful and influential people would have been out, and a lot of equity would have changed hands. That kind of malinvestment I agree should have been addressed, but liquidating the banks was not necessary under existing arrangements.

Bob Roddis said...

Mr. Hickey:

I agree with your last two paragraphs. We agree on something.

So, the TBTF banks gets bailed out while homeowners are prohibited from modifying their mortgage notes in bankruptcy court. That’s not the Austrian proposal. 11 USC section 1322(b)(2) prohibits a Chapter 13 bankruptcy plan from modifying the rights of holders of secured claims in real property that is the debtor’s principal residence:

The plan may modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence

If the banks had been allowed to fail and people could have obtained by right mortgage modifications in bankruptcy court, the necessary re-pricing could have occurred quickly. It’s the long, drawn-out recession caused by the government’s desperate attempts to obstruct the re-pricing coupled with poverty-inducing deficit spending that is going to cause assets to gather dust in a permanent government-induced depression. Of course, it was the creation of artificial fiat loans that caused the artificial run up in prices in the first place.

Further, the fact that the current system grants the government plenary economic power (as requested by the elite, but which you wish the enhance) makes it almost inevitable that the elite is going to run that government. You MMTers are blind to the obvious.

Salsabob said...

What's missing in the discussions both at ZeroHedge and here is the impact of rapid debt depreciation and resulting "repricing" on ALL economic flows. As much as Austrians see the wished-for “repricing” as sterile, if not happy-go-lucky-gee-whiz-everything-is-cheaper, the real economy doesn't play that game. It gets freaked-out, if not catatonic, and takes a long time to recover (just in case no one has noticed). Just note GDP in Dalio's “ugly” examples (-17, 0.6, -5.4, -0.5) vs “beautiful” (9.5, 6.8, 3.5).
Monetary policy is not MMT’s “starting quarterback;” instead, that would be fiscal policy. While that can work miracles, MMT would prefer that it not start from even a deeper hole that the sterile Austrian viewpoint seems hell-bent to impose.

Bob Roddis said...


There is nothing "easy" about the realization that society has mis-priced most everything due to fiat money creation and there is nothing "sterile, if not happy-go-lucky-gee-whiz-everything-is-cheaper" about the inevitably painful and distressing bust/recession/depression. That is why the Austrians are relentless in their warnings so that the horrific boom/bust cycle need not occur.

Hayek is very clear that you wouldn't have to worry about a "deflationary depression" if interventionists hadn't caused the boom/bust in the first place. From "A Discussion With FRIEDRICH A. VON HAYEK" Held at the American Enterprise Institute on April 9, 1975, pages 8-9:

For forty years I have preached that the time to prevent a depression is during the preceding boom; and that, once a depression has started, there is little one can do about it. My advice was completely disregarded as long as the boom lasted. Now suddenly, when my prediction has come true and we have reached the stage where, in my opinion, little can be done about the inevitable reaction which has set in, people suddenly turn to me and ask for my opinion. I am very much tempted to answer, "Well, if you had listened to me before, you wouldn't be in that mess" Of course, I do not mean you—I mean the public in general.

What I want to discuss is policy in the long run—by which I mean not only the very long run in the Marshallian sense, but policy over the next few years. What we should absolutely avoid is any attempt to recreate employment, or diminish unemployment by a further does of inflation.

Tom Hickey said...

Bob, consult the voluminous work of people like Bill Black, Randy Wray, Janet Tavakoli, and Yves Smith, which documents how the majority of mortgages that were securitized were predatory or fraudulent, therefore, not binding contracts in the first place. Moreover, fraudulent conveyance has seriously polluted the title chain in the US.

Salsabob said...

Bob R -

We could argue Hayek or Minsky (i.e., public interventionists or private meatheads) for the next boom/bust cycle. However, I tend to agree with Keynes about where we'll be "in the long run" - and more than likely, that's where most on this forum will be before a boom, let alone hyper-inflation, shows up.

MMT takes inflation seriously; we just don't worship it as an angry god requiring the sacrificing of people at the altar of the unemployed - that’s what low marginal tax rates are for; to be sacrificed, if and when necessary.