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Burning Down the House / Interess. Artikel mit Grafilken (im Link des Textes)

verfasst von - ELLI -, 05.12.2002, 18:14

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Burning Down the House
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by Sean Corrigan

[Posted December 5, 2002]

Corrigan heads Capital
Insight, a financial consultancy. He was interviewed at the Mises
Institute prior to his lecture on the"What Happened to Recovery?"
You can listen to the audio of his speech here,
and follow his charts and research here.

[img][/img] MISES.ORG:
It seems like the Austrian story of the boom is getting out there.

CORRIGAN: My sense is that many Austrians have described the
process of the boom very well. The literature deals very elegantly with how
unwarranted credit expansion leads people en masse to misjudge the
capabilities of an economy. The result is malinvestment which leads to
overbuilding in capital-intensive industries. In today's modern institutions,
this leads to a share price boom, company floatation, and all the symptoms we
saw in the upswing of the late 1990s.

In retrospect, this process has become better understood by
the masses. Even the Wall Street Journal has picked up on this. They
still miss the key element, namely that it has to be the elastic credit which
fuels this process. It is this elasticity that brings about an
asset-credit spiral that sucks more and more people in. It becomes effectively
a firestorm in the end. More credit is available, prices go up, that makes
more collateral available, that makes the asset look more attractive, the
banks lend more money, and round and round we go.

MISES.ORG: To think that the Austrian cycle theory was only
recently considered outmoded.

CORRIGAN: When, in fact, in today's extremely fast and
liquid markets, the credit-creation process of the Austrian cycle becomes more
and more exacerbated. Nowadays it is not just narrow money but nearly
everything these days in financial markets is a money substitute of some form
or other. We have clearing mechanism, netting mechanisms, we have derivatives,
and great deal of leverage. So now, a small amount of money, however narrowly
defined, can exert an enormous impact on asset prices.

As we know, once prices go up, everyone wants to buy because
things are going up. We might even know that there is no underlying income in
these companies. We just buy them because prices are going up.

So it is true that the process of the boom, and what went
wrong—the symptoms, if you will—are much better understood. The link to
credit creation is not as widely understood, but we are getting there.
Greenspan, for instance, has been coming in for some unwanted criticism. This
is not something he is used to.

MISES.ORG: But also, in your work, you have closely tracked
the unfolding of the bust.

CORRIGAN: Austrians have given far less attention to the
process of the bust. For ordinary people looking after savings, and for people
in financial markets trying to make decisions, the critical thing is not the
pathology of what happened. It is the prognosis of what might happen in the
future, as the bust unfolds. This is very unclear, and the Austrian literature
is somewhat lacking in this respect.

In the main literature, we get the boom and the collapse,
and then most authors try to glibly say that in the hopeful case when
government does nothing, prices and costs become more equilibrated, wages have
adjusted, financial capital is written off, and therefore physical capital
which still persists can be better used. Therefore, we have come down so far
that the only place we can go is up again. All of this is clearly stated.

But in today's world, the liquidation is never allowed to
take place. Every single fiber of government and central bank policy is
designed to avoid the liquidation. The literature is quite unclear about what
will happen in this case. Rothbard, I think, said that new credit creates
another boom on the back of the ruins of the old boom. But there is no clear
guiding path. Richard
Strigl deals with it a little bit. He says that we never quite liquidate
the previous boom, and that seeds of another boom are always coming through.
Some of Hayek's work deals with the concept of capital consumption, which is
very relevant to where we are today.

MISES.ORG: You find his triangle of production stages to be
useful, then.

CORRIGAN: Yes, but I tend to think of it as a cone, because
we have a flux of goods and services moving through these cones and they have
to go through each successive stage. The cone gets over- lengthened in the
boom. We put too many resources in capital intensive industries, far way from
the end point of consumption. There are not enough resources to see these
profitably all the way from their inception through to their consummation in
individual consumption. We then have a shortening process as this boom is
being eradicated and collapsing in on itself.

Today's economy tries to overcome this by fostering
consumption at any expense. Debt-led consumption, credit-created consumption,
spending consumption: these stretch the cone the other way, shortening it as
fast as the higher industries try to keep up and find a foothold. It's as if
the cone is closing up even as business is trying to get back on the surface.

In this process, we therefore must be eating what we did not
cook and burning what we did not plant in the forest. We must be consuming
capital. We are taking the assets that remain to us today and monetizing and
spending them, or we must be borrowing against tomorrow's income and thereby
alienating what may come in the future, but which may never come because this
process is so destructive.

As business tries to reorganize itself, the structure of
production is changing faster than they can adapt. To move people and skills
and fixed capital, some of which may be very specific, to the industry in
which it is best employed can be problematic. This whole instability of credit
and interest rates and foreign currency parities is hugely detrimental to the
process. We are at the stage here in which it is clear from the financial
market evidence that while nonfinancial corporate profits have stabilized in
the last four to five months, they stabilized at levels which are in current
dollars where they were before the boom started.

But this new stability is an uneasy one. It does look,
insofar as we can judge aggregate statistics, like these companies are not
replacing old capital and they are not investing new capital. The depreciation
levels against the fixed-investment levels are at the narrowest margin that
we've seen in fifty years. In addition, where companies have reported profits
recently, when we strip out the one-off gains that they are still trying to
book, any profitability has come at the expense of cost cutting, both on
capital expenditure and on the payroll. So clearly, these companies are trying
to adjust to the fact that the useful capital stock has shrunk.

At the same time, we're encouraging everyone to go out and
buy cars at zero percent and houses with the lowest mortgage rates in 40-odd
years. We are encouraging people to consume ever-more capital, today's and
tomorrow's. The debt will have to be paid for at some point.

MISES.ORG: In real estate in particular, Freddie and Fannie
were just approved to accept higher-end mortgages.

CORRIGAN: Yes, Fannie is particularly bad in this way. But
both Freddie and Fannie are doing everything possible to encourage more debt.
They have online mortgage applications. You can even get an online appraisal
of your house.

There is a subterranean literature on the fringes of the
mainstream press about how the appraisal process in home loans has been
corrupted in this boom. The appraiser is paid if the loan goes through.
Therefore, the potential borrower or purchaser or even the vendor can prod the
appraiser to give a higher evaluation, just to get the deal done. Even with
the inflation in prices that we've seen, it's worse than it looks because the
house values aren't there in the first place.

MISES.ORG: Sounds a bit like the relationship between
auditors and corporations.

CORRIGAN: Inflations corrupt people, one way or another.
Whether it is through peer pressure or the pressure of commercial business,
people are pushed to cut corners.

MISES.ORG: Does anyone really believe that all this
credit-fueled consumption will help?

CORRIGAN: We have this curious cognitive dissonance at work.
People are borrowing hand over fist to buy houses and re-mortgage their houses
to maintain their standard of living. This means that they must, somehow, have
adopted an inflationary psychology. On the other hand, everybody is terrified
that the Fed is going to allow the economy to lapse into deflation, that is,
allow prices to go down. This schizophrenia pervades the whole of the economic
debate, from the man in the street to the top traders on Wall Street. And
nobody seems to be able to rationalize, clearly, what the differences are.

At the Fed and the Treasury, you have this Keynesian view
that the economy operates like a toilet. You pull the handle and it empties,
and then the water automatically fills back up. The view is that if consumers
empty the stores of stuff, the stores will fill up again, and everyone will
make money. So they don't understand the intricacies and complexities of what
goes into a modern economy. To use another analogy, they believe that so long
as the fire is burning in the house, the logs will be put on it. They don't
seem to consider the possibility that you can be burning the furniture and,
indeed, the house!

MISES.ORG: What are the prospects for deflation?

CORRIGAN: It's true that we have such an unsupportable
pyramid of credit on such a miniscule base of real income. The idea that there
could be a cascade of debt default and asset fire sales is a real possibility.
And yet the Fed and central banks around the world—excluding somewhat the
European central bank—have clearly said that they will do anything to
prevent deflation.

The Fed has changed the rules under which they can inject
liquidity into the system. The Fed has made several overt statements of intent
that, if necessary, it will buy anything—corporate securities, mortgages,
physical assets—it will conduct a"money rain" if it has to.

MISES.ORG: You are thinking in particular of the statement
by Fed Governor Ben Bernanke.

CORRIGAN: Yes. He said: think of it this way. If we were
alchemists, we could create more gold and drive the price down as low as we
wanted. He continued on to say that the Fed has that alchemy in the printing
press. This is the central bank that is supposed to be the guardian of stable
money! It's unbelievable. But, in my view, it would take a real crisis for the
Fed to resort to unlimited money creation by whatever means necessary.

There's a statement in that egregious book of hagiography
called Maestro in which it is said that Greenspan is prepared to take
emergency measures, as when a fire-truck drives down the wrong way of a
one-way street in order to put out a fire. In other words, he'll do what it
takes. We saw this in Mexico, Asia, and the dealings with Long Term Capital
Management. We saw it on September 11, when it was strongly rumored that
mutual funds were offered credit lines by money-center banks and by the Fed,
so that the funds wouldn't have to sell all their stocks. Whether or not this
is true, I can't say. But senior people in financial markets give it credence.

As for the short term, the Fed does have a very serious
problem to deal with. Somehow or other, we need to get the monetary value of
our liabilities in line with the monetary value of the real income we can
produce. There is a huge disparity now. A great wedge has been driven between
the two. The problem can be addressed through inflation or deflation. We know
which the central bank will choose.

MISES.ORG: Many have compared the current state of the US
with that of Japan.

CORRIGAN: There are some differences. The Japanese banking
system got itself tied up with the land boom. It wasn't so much a share price
inflation as it was a land collateral inflation. Remember the tales of the day
when the real estate of the Emperor's garden was said to be worth more than
Canada. While we may not necessarily value Canada all that highly, this
is something of an unreality.

The Bank of Japan has been accused by the Fed of acting too
timorously in the aftermath. But the BoJ has disputed this vigorously. The
Bank points out that the collapse would have happened whether it had warned
people or not, and, in addition, there are rules and regulations and regimes
and constitutionality questions involved that might have prevented substantial
intervention. Of course in Japan, the crisis was entrenched not just by the
monetary policy but by the rigidities of the Japanese economic system.

The Japanese come in for some undue criticism now. They have
made great strides. The total of the debt involving corporate bankruptcies
over the last four years is $670 billion. That's about 4% of GDP every year
for four years. That is much higher than the US economy has managed, even with
the somewhat easy regime of Chapter 11. So the Japanese are tackling their
problems. It's just that the problems are so enormous and so entrenched.
Obviously, as in any country, politics intrudes to take short-term measures
that prove detrimental: witness the way the Bush administration has handled
this.

MISES.ORG: As one of the first to predict the bust, have you
been basking in glory?

CORRIGAN: Of course not. Immediately after the bust came, we
had a long period of denial. First we were told that technology had abolished
the business cycle. Then it was said to be merely a dot com bust, but then it
was a telecom bust as well. Then Greenspan was to give us a soft
landing. Then we were to have a V-shaped recovery. Then the recovery was to be
U-shaped. Suddenly it began to look W-shaped. And now, everyone is
consumed by the fear of deflation.

Remember that all the predictions come from the same people
who thought the boom could last forever. To know what's ahead, you are far
better off reading books on Austrian economics than listening to the latest
forecasts from economists, which are made with rulers and a couple of
debatable assumptions.

MISES.ORG: Thank you, Sean.

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Sean Corrigan is a principal of www.capital-insight.com,
a London-based economic consultancy. See his Mises.org Articles
Archive, or send him MAIL.
See also the Study
Guide on Business Cycles.

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Burning Down the House / Interess. Artikel mit Grafilken (im Link des Textes) - - ELLI -, 05.12.2002, 18:14