A different view on the Economy

I don’t pretend to be an expert on economics, either Austrian, Marxist, or Contemporary. Nor am I absolutely aware of every aspect of the current crisis. Other than watching perhaps a higher than average amount of news clips on youtube, and listening to both NPR Economy podcasts regularly, and reading the Globe and Mail, I havn’t done any specific research into current issues. However, it does seem that one problem we are seeing is over production leading to not only low prices but deflation – the continual lowering of prices over time, which discourages consumption and shrinks the amount of money changing hands.

Intuitively, it seems strange that low prices and over supply would be a problem – isn’t it better that we can produce more with less labour? Shouldn’t that mean we’d need to work less?

Maybe in a command economy we could just raise everyone’s hourly wage and ask them to work less. But in a market economy, France’s experiment of a legislated shorter workweek is generally considered a failure.

Two other depressing thoughts. First – Hegel. Hegel predicted that over-production is a problem that would plague industrialized economies, and believed it could only be solved through colonization and the creation of new markets for products. This is bad news because the world is already fully economically integrated.

Second – we don’t actually have a problem of “over production” – we hardly produce anything – Canada’s economy is 75% services. So, when we talk about over-production in our context, we’re talking about mostly over-services. I.e. too many jewlery stores, electronics stores – in other words firms that don’t actually produce anything of value. The fact that almost anything bought in a retail store could be ordered from a warehouse over the internet puts into question whether the retailer as a distributor adds any value whatsoever to the transaction.

One other thing – when we talk about our economy being in the duldrums we talk about the rate of consumption being on the decline. But, couldn’t that simply be because people are saving more? Why is saving rather than consuming bad for the economy?


2 thoughts on “A different view on the Economy

  1. The problem is not overproduction and is only indirectly deflation. The problem is that financial institutions were over-leveraged and that there was a poor estimation of risk. Leveraging is when you borrow to make an investment. The idea is that you achieve higher returns because you are putting the money to work for you. As long as you achieve higher returns than the interest you pay on the borrowed money, than the proposition makes sense. The downside is that you could lose many times more than your principle. The systemic risk comes from the fact that a contraction can trigger market calls, where you have to sell off other assets to meet your debt obligations, which starts a downward spiral of market contraction. If everyone in the market is leveraged, it only takes one initial downturn and/or the re-estimation of risk to start a chain reaction.

    Generally loans are secured by holding assets. The problem is that the value of the assets was inflated by the availability of cheap money. So the houses that were used as collateral on debts weren’t accurately valued. Or, if someone wants to take issue with that, they are prone to the same type of systemic risk. Because banks stopped hold mortgages for the duration of the loan they weren’t concerned about risk, and so made loans to people who did deserve them (pumping up housing prices, increasing the risk of defaults, etc). The banks packaged mortgages into CDO (collateral debt obligations) and sold them to other financial institutions. These were bought be other banks (representing institutions), and things like insurance and mutual funds (representing the average public). These were thought to be safe because they were backed by assets, (the assumption was – there is nothing safer than a mortgage, we can just take the house) but we failed to realize a significant portion of these were toxic.

    Deflation is only indirectly responsible, because the system could have kept going if prices went up. The crash in prices is symptom of the problem – the systemic risk of over-leverage leading to a severe market contraction. However, it represents itself as the problem, because the crunch wouldn’t have happened if everyone was still making money, could meet their loans, or sell their assets at a profit if they can’t meet their loans. A system of 35:1 leverage, and even the bubble mentality make sense if prices continue to go up, because no one gets pinched, the problem is that it couldn’t happen indefinitely, so now the entire system has to de-leverage, which will continue to contract the economy and reduce asset values.

    Next point: Savings is bad for the economy in the sense that it doesn’t create or sustain bubbles. As a matter of practicality, savings is very important to individuals and nations. Once again, refer to the mistaken assumption that they assumed house values would always go up. The people who say it is bad want to re-inflate the bubble.

  2. Buttonwood
    Taking von Mises to pieces
    Why is the Austrian explanation for the crisis so little discussed?

    Nov 18th 2010 | from PRINT EDITION

    JOHN MAYNARD KEYNES is back. The British economist has modern intellectual champions in Paul Krugman and Robert Skidelsky. For all today’s talk of austerity, a policy of Keynesian fiscal stimulus was adopted by most governments in the immediate aftermath of the credit crisis.

    In contrast policymakers seem to show a lot less interest in the economic ideas of the “Austrian school” led by Ludwig von Mises and Friedrich Hayek, who once battled Keynes for intellectual supremacy. Yet the more you think about recent events, the odder that neglect seems.

    A one-paragraph explanation of the Austrian theory of business cycles would run as follows. Interest rates are held at too low a level, creating a credit boom. Low financing costs persuade entrepreneurs to fund too many projects. Capital is misallocated into wasteful areas. When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up.

    Take that analysis piece by piece. Were interest rates held too low? The case seems self-evident for Ireland and Spain, where the European Central Bank was setting a one-size-fits-all monetary policy. Many people would also argue that the Federal Reserve kept rates too low. Some lay the housing boom of 2003-06 at the Fed’s door, others criticise the central bank’s tendency to slash rates whenever the financial markets wobbled.

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