16 September 2008

The D-word

Hmm... so the price of housing and automobiles has been failing for awhile now. Now that another wave of the credit crisis is causing a commotion, the associated margin calls seem to have deflated the commodities bubble. So are we going to see a general fail in prices everywhere?

Are we now in a deflationary period? I was certainly one who believed that the USA would do anything it could to inflate its debt away. It was the logical strategy given the general level of in-indebtedness at all levels of US society. However, the destruction of rent-seeking capital seems to be pervasive and occurring in massive quantities. The Austrian school certainly says that deflation is exactly what we should expect at the end of a credit-driven bubble. The huge amount of leverage involved and the general cross-connectedness of the Credit Default Swaps (CDS) market seems to make the domino-effect of financial corporation failures unstoppable. In fact, the US Federal Reserve seems to have largely lost control over prevailing interest rates.

This isn't like the old inventory-driven recessions of the past thirty years. Structurally, it looks closest to the run-up to the Great Depression around 1924-29 when all the Austrian banks went down.

Fortunately I don't think we are likely to have another coincidental Dust Bowl event (and farming is not quite as important anymore) to match the horrible times of the Great Depression. However, if the financial sector were to shrink by half, bringing it back in line with historical norms, that would certainly result in a GDP shrinkage of > 10 %, meeting the technical definition for a depression.

Canada isn't going to side-step the fallout on this one. Any large scale demand destruction in the USA will hurt producers up here badly. Stephen Harper was bright to call an election when he did, but he would be well advised not to stick his head in the sand. The USA is inevitably going to become more mercantilist so let's move to get ahead of that, shall we?

I continue to believe that the way out of this mess is a drive to shift the developed economies of the world away from fossil fuels and into renewable sources of electricity. Any such drive would generate a lot of high-quality jobs, present many R&D opportunities for the productive employment of capital, and achieve some enormous environmental and security side benefits.


Anonymous said...

"Fortunately I don't think we are likely to have another coincidental Dust Bowl event (and farming is not quite as important anymore)"

Fuel shortages could easily break the fragile food production and distribution system. Shortages are already happening as a result of the recent hurricanes and inventories were already at low levels.

Robert McLeod said...

I really think Ike was a non-event. In any event people will slow their driving before they stop eating food.
We've already seen 5% oil demand destruction in the USA this year.

Anonymous said...

Heck, people will do a lot of things before they stop eating.

They might even car-pool (the horrors!).

Anonymous said...

If we do have shortages it will be because of informal price controls, in the form of state governors threatening prosecution of "price-gouging".

Price controls are always a bad idea. Without them, fuel will be allocated to those who need it most, like farmers and utilities.

Robert McLeod said...

Bye buy Washington Mutual. I'm trying to figure out which bank will fail next? Wachovia? It also seems that JP Morgan Chase and Bank of America have packed on so much crap that they might not be able to survive without a bailout either. Of course they're complex enough that they can probably keep the shell game of avoiding technical insolvency for a good while. Spreadsheet wars for the win!