"Is Greider's Economic Solution Correct?" (CITS Debt Watch)

**                                                              **
                    W. Curtiss Priest, Ph.D.
          Center for Information, Technology & Society
              466 Pleasant Street Melrose, MA  02176
  E-mail: BMSLIB@MIT.EDU, Voice: 781-662-4044, FAX: 781-662-6882


                           June 21, 2003

                        Public Issue #:105

                          CITS DEBT WATCH

               "Is Greider's Economic Solution Correct?"

             Commentary by Dr. W. Curtiss Priest, Director:


As most of you know, I passed along the article that Greider
wrote in "The Nation."

Busy with other work, respecting Greider's prior work, I
did not take the time to analyze his solution to deflation,
with a capital D.

As Kondratieff, the Russian, who suggested economies move
in "longwave cycles" noted, there are economic cycles of
boom and bust that occur in fifty year intervals, give or
take a few decades.

Mr. Greider believes that inflating the money supply, by
printing money, is the solution out of a giant boom.

This analyst emphatically disagrees.

As Germany learned, in trying to "print themselves" out
of a boom, by throwing ever worthless currency into the
market, they created hyperinflation.

Greider misses this point.  He thinks that a period of excess
can be "quietly" cured.

This analyst is skeptical.  Yes, if, we can "curb the fear"
of the panic, i.e., can get everyone to agree that debt is
at much too high a level; that house prices are at much too
high a level; that goods are much to expensive (except from
China) -- that we can slowly work our way out of the boom.

From a theoretical perspective, I admire Greider's tenacity
to such a solution.  Indeed, while any one of us who has
seen his/her neighbors spend with abandon, with ever increasing
debt, we think "Schadenfreude" -- those who over-borrowed,
committed sins of over-spending, will get their comeuppance.

Greider, thoughtfully, avoids this response.  He is one who
truly wishes that we can figure out a way to "pay for the
boom" without paying for it with a "bust."

This analyst, as described in several prior newsletters, believes
that the only solution to prevent booms, is to prevent busts.

For Greider to be right means two things:

    1.  Hyperinflation will not drown the U.S. economy
    2.  Everyone will behave more reasonably than in dozens
            of prior booms and busts

Of course, for this particular boom, which Greider so well
describes, it is uncertain to this analyst that we can plot
a course out of it, without panic.

Indeed, Dr. Kindleberger's book is entitled:

    Manias, Panics, and Crashes: A History of Financial Crises

There is the mania, there is the panic, there is the crash!

What Greider wishes simply may be impossible.  We must remember
the arrogance of Germany in the mid 30's.  They were going to
conquer, not only the mania, but the world.

Is this a harsh statement?  Only time will tell.

Regards,

W. Curtiss Priest
Editor

P.S.  the Greider article is provided below

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Previous issues of (all) the CITS DEBT WATCH:
    http://groups.google.com/groups?q=cits+debt+watch&hl=en&scoring=d

The entries appear in reverse chronological order, with the
most recent, first.

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http://www.thenation.com/doc.mhtml?i=20030630&s=greider

Deflation

by WILLIAM GREIDER

[from the June 30, 2003 issue]

At the risk of sounding like Chicken Little, I am going to describe
the economic situation in plain English. The United States is flirting
with a low-grade depression, one that may last for years unless the
government takes decisive action to overcome it. This would most
likely be depression with a small d, not the financial collapse and
"grapes of wrath" devastation Americans experienced during the Great
Depression of the 1930s. But the potential consequences, especially
for the less affluent and the young, would be severe enough--a long
interlude of sputtering stagnation, years of tepid growth and
stubbornly high unemployment, punctuated occasionally with a renewed
recession. Depression means an economy that is stuck in a ditch and
cannot get out, unable to regain its normal energies for expansion.
Japan, second-largest economy in the world, has been in this condition
for roughly twelve years, following the collapse of its own financial
bubble. If the same fate has befallen the United States, the
globalized economy is imperiled, too, since America's market for
imports and its huge trade deficits keep the global trading system
afloat.

Most authorities, I should add, do not regard any of this as likely.
The great difficulty for policy-makers is that this doesn't much feel
like a crisis--not yet anyway, for most Americans. So where's the
urgency to undertake radical remedies? Some of Wall Street's best
forecasters, for instance, are predicting 4 percent US growth in the
second half of 2003. But Japan experienced false recoveries, too.
Nobody knows what will unfold if nothing is done, but the consequences
of waiting to find out could be horrendous for the broad ranks of
Americans. When the US economy corrects for its excesses, it is always
the innocents who are led to the slaughter first. Even if the odds are
only one in four that the worst will happen (as the Dallas Federal
Reserve Bank president recently estimated), it seems reckless to
gamble. Taking strong measures now would be messy and disruptive to
regular order (maybe wasteful if they aren't needed), but in the
present circumstances that would seem more prudent than a false
optimism that lamely repeats that the "good times" are right around
the corner.

A depression can be read as a "market signal" of a dysfunctional
economy that requires fundamental restructuring. Japan learned this
the hard way. In this case, such a signal may be flashing the need for
deep changes both in the American economic system and the world's.
Surely it is not too soon for Americans to ask themselves what might
be out of whack and how to correct things--starting with their own
much-celebrated economy.

I asked a financial economist at a major US hedge fund where the
United States appears to be at this point. "We are in the second or
third year of what Japan has gone through," he surmised. How much
longer might this go on? "Another ten years," he said, "if you think
about Japan, another ten years."

The good news, so to speak, is that the Federal Reserve is on the
case. At least Fed Chairman Alan Greenspan and colleagues now
acknowledge that the gravest danger lurking in this situation is a
general deflation of prices, and they promise to make sure that
doesn't happen. For many months, Greenspan and other governors
dismissed the growing anxieties expressed in financial circles by
describing the chances of deflation as "extremely small" and "quite
unlikely." After the indexes for wholesale and consumer prices both
fell in April, the Fed dropped those reassuring phrases. The chairman
instead announced that pre-emptive actions may be needed to head off
the threat. Declining prices, if they persist generally, create a
vicious spiral of negatives--falling profits, more closed factories,
shrinking employment and incomes, accompanied by waves of failing
debtors, both corporations and families. In short, a far larger
calamity than stagnation.

Though Greenspan doesn't say so in plain English, Fed governors
recognize the corrective action that may be required of monetary
policy: Pump up the money supply and deliberately induce rising
prices--that is, foster a renewal of inflation, their old scourge.
Rising prices provide an essential lubricant for any sustained
recovery because a dose of inflation helps businesses get well and
takes some of the depressive pressures off wages and debtors of every
kind. The central bankers, however, are facing a very awkward moment.
After twenty years of relentlessly reducing the inflation rate to near
zero and winning great praise for their triumph, the governors are
naturally reluctant to announce that the "disease" they conquered has
become the "cure."

But at least the Fed is thinking about doing something. Washington's
elected politicians, by contrast, continue to act as if this is just a
temporary downturn in the normal business cycle, an opportunity to
score political points with measures that show folks they care.
Neither Republicans nor Democrats seem to grasp the enormity of what
the economy is facing. Their ignorance matters. Without a full and
contentious public airing of the cause-and-effect implications, there
is no way to develop the political foundation for undertaking large
and controversial measures. If Washington responds tentatively with
cautious half-measures, as Japan's government did for many years, then
the results for us may look a lot like Japan.

Basically, what's under way is a brutal unwinding of the delusional
optimism that reigned during the 1990s--excesses like the
hyperinflation in financial assets and the swollen ambitions that led
investors and companies to wildly overvalue their prospects for future
returns. The stock-market bubble was the most obvious expression of
excess, but not the most serious dimension. In an era of Internet
fantasies and collective self-delusion, business sectors (and their
financiers) overinvested on a grand scale and generally used borrowed
money to do so. That is, they built too many factories, shopping
centers and office buildings--creating more productive capacity than
the marketplace could possibly absorb. Consumers indulged in their own
version of wishful thinking, borrowing heavily to keep on buying,
hoping the "good times" would last long enough to bail them out.

This legacy of accumulated excesses lies across the American economy
like a heavy wet blanket--overcapacity in production, overpriced
financial investments, mountainous debt burdens for corporations and
households, and thus a deepening reluctance to invest or to consume.
Personal debt is now at an extraordinary 130 percent of disposable
income, up by nearly one-third since the mid-1990s. Manufacturing is
operating at only 72.5 percent of its productive capacity, greater
idleness than during the 1990-91 recession and approaching the
severity of the 1982 recession. For producers of semiconductors and
related electronic components, capacity utilization has fallen to 65
percent. In telecom equipment, it is at 50 percent. That's why there
is so little new investment. What company is foolish enough to build
new plants when so many existing ones are shuttered? And who would
lend them the capital? If consumers run out of capacity to borrow more
or can no longer refinance home mortgages, the collapse of aggregate
demand will become far worse.

The US economy is unlikely to recover its full vigor until this dead
weight from the past is substantially reduced. In the meantime, the
struggle of companies (and other countries) to dump their excess
production by selling cheap, while also shrinking jobs and workweeks,
threatens to make things still worse, eventually tipping into a
general deflation of prices. The broader meaning of deflation,
however, is that assets of almost every kind, from financial
investments and real estate to manufactured goods and commodities, are
being revalued downward--slowly, steadily correcting for the falsely
optimistic asset valuations achieved during the boom years. The
overvaluations, though most dramatic in Japan and the United States,
were transmitted worldwide through trade and the hyped-up energies of
global investing. In this sense, deflation is already under way and
started five or six years ago with the violent financial collapses
that swept across developing nations in Asia and that continue to
stalk weakening economies on other continents. China, given its
burgeoning low-wage output, is now the world's main deflationary
engine. Its exports are underpricing Japan's and taking market share
away from other poor countries, thus forcing rival producers to lower
prices still further (China now has the largest trade surplus with the
United States, surpassing Japan). When too many goods are chasing too
few buyers, the main game is to make sure someone else gets stuck with
the unsold surpluses.

In another era, there would be clamoring voices not only from the
political sphere but also from business and finance demanding bold
action by Washington. In this era of conservative orthodoxy, there is
general complacency and silence, as if everyone agrees that the ugly
possibilities will go away if nobody talks about them. Aside from
subdued kibitzing of the Fed by selected financial experts, there is
no debate on these momentous matters. Governing elites are deeply
enthralled by "market fundamentalism" and dare not speak of the
alternatives (or perhaps don't even know about them). The principal
remedies sound to them like liberal heresies. And they are. This
political passivity may give way once the presidential campaign heats
up. Howard Dean was evidently the first Democratic candidate to invoke
the "d word" when he recently warned Iowans: "If we re-elect this
President, we'll be in a depression."

In broad strokes, the government has the power to intervene on three
fundamental fronts to remove the depressing overhang from the past.
First, the Federal Reserve can deliberately induce price inflation to
counter the deflationary forces and excite what Keynes called the
"animal spirits" of business leaders. Rising prices will also
automatically ease the debt burdens of borrowers by diluting money's
real value (that's why creditors always adamantly oppose inflation).
Second, Congress and the White House can simultaneously launch a major
stimulus program composed of public spending and quick-acting tax
cuts, thus running up far larger budget deficits than the Bush
Administration has engineered. Whether the money builds schools and
highways or hires more schoolteachers, it creates new jobs, incomes
and business activity. Finally, if these steps are insufficient, the
government may have to intervene more directly and manage a
substantial liquidation of debt burdens--either arrange ways to write
off failed loans (as it did in the savings-and-loan crisis of the
1980s) or create more lenient terms for the indebted companies and
households, much like a banker's "workout" for a financially troubled
business.

If this negative cycle worsens to extremes, only the federal
government can interrupt it and push the economy in a positive
direction. The basic task, as John Maynard Keynes explained in the
thirties, is to get the money moving again. The government does this
by borrowing idle wealth from the private sector and spending it or
distributing it to taxpayers who will--thus putting the money to
economic uses and stimulating business activity. Federal deficits, in
other words, are an essential element in the solution--very large
deficits if you intend to jump-start a $10.7 trillion economy. Yes,
borrow-and-spend therapy increases the national debt, but the renewal
of economic growth will handle that. (The alternative--doing
nothing--means allowing events to take their own course toward
destruction and multiplying failures. "Liquidate labor, liquidate
stocks, liquidate the farmers, liquidate real estate," Andrew Mellon
advised Herbert Hoover after the 1929 crash. "It will purge the
rottenness out of the system.")

The political choice is, Act now or wait and see. In terms of this
three-pronged crisis prevention, only the Federal Reserve has shown
any awareness of what may be required of it (revive the economy by
reviving inflation), perhaps because the Fed's historic disgrace was
its failure to act after 1929. Last fall, Fed governor Ben Bernanke
reassured the worriers in a boldly stated speech: "The US government
has a technology, called a printing press (or, today, its electronic
equivalent), that allows it to produce as many US dollars as it wishes
at essentially no cost.... A determined government can always generate
higher spending and hence positive inflation."

To underscore the commitment, Bernanke said the Fed is prepared to use
unorthodox tools to expand the money supply if short-term interest
rates (already close to zero) can be cut no further. Instead of buying
only short-term Treasury notes to inject new money into the economy,
the central bank may purchase long-term US bonds or foreign bonds. It
may accept corporate debt, private bank loans and mortgage securities
as collateral for the Fed's direct lending to banks--a way of pushing
bankers to lend more generously to business. In fact, the Fed has far
broader powers inherited from the Great Depression--the ability to
make emergency loans to private businesses or state and local
governments in extreme circumstances. But will the Fed act? Some
financial insiders are not persuaded by the official statements. One
told me that only three or four of the key decision makers on the
nineteen-member Federal Open Market Committee take the deflation
potential seriously--those who closely followed the slow-motion
unwinding of Japan.

By comparison, the more visible fiscal debate in Congress is utterly
out of sync with present reality, since both parties are dodging the
"d word" and its implications. The White House, I am told, is deeply
worried in private, but won't say so for fear of adding to the
public's anxieties. The GOP's misdirected tax cutting does help
modestly, putting money in motion by enlarging the federal deficits,
but Bush is pursuing "trickledown" Keynes--help the wealthiest
households get back their zest as consumers, and the rabble will
surely follow. Democrats, on the other hand, are still playing the
loser's role of Herbert Hoover and worrying obsessively about the
rising deficits--wrong economics and bad politics too. Instead of
fighting the last war, a clearheaded opposition would be leaning hard
on the Fed and the White House for immediate preventive actions,
advocating easy money, credit reform and aggressive public spending to
restart the economic engine.

If things deteriorate further, who knows, the government's deficits
may have to grow twice as large to become effective therapy. While the
political climate is not yet ripe, forward-looking progressives should
already be drawing up a grand list of spending projects--repairing the
tattered infrastructure and launching innovative public investments
that speak to the future. If the money builds real improvements for
society, it will not be wasted, even if the Chicken Littles are wrong.


The third avenue for dealing with the potential crisis--reducing the
mountainous debt burdens on families and businesses--is a far more
controversial challenge and fraught with the potential for insider
favoritism. Rescuing the big boys while allowing others to drown has
been the conventional approach in recent decades, including the
banking bailouts engineered by the Fed. But a lively political debate
might inspire broader remedies that are both more equitable and more
effective. Just as the S&L bailout fifteen years ago aided major
financial players, government could create a "resolution trust
corporation" for people--an agency that supervises debt workouts for
households, gives them more time to catch up with mortgage and credit
card payments, and imposes these relaxed terms on the financial
industry, with government guarantees against failure. That would
represent stimulus with a democratic bottom line. More likely, we will
see one industrial sector after another line up for emergency
bailouts, and the government, including the Fed, will pick winners and
losers, defending politically influential elements of the status quo
in the name of protecting the soundness of the system.

If fundamental restructuring is also in store for America, the US
economy has advantages that Japan's lacks. The American system is more
flexible and able to adapt--more willing to throw the losers over the
side--while Japan's dense webs of business-financial relationships
promote mutual loyalties that are very difficult to dismantle. On the
other hand, Americans may discover in the next few years that the
United States is not the economic powerhouse described in popular
lore. Technological strengths notwithstanding, many US sectors have
steadily lost market share, both at home and abroad, to foreign
competitors (think of Boeing being surpassed by Airbus as the leading
producer of commercial airliners).

"Painful adjustment" means facing up to some long-suppressed truths.
Washington's single-minded championing of globalization, for instance,
has been good for US multinationals but not for the balance sheet of
the American economy, which is underwater and has been for years. That
is the meaning of the huge trade deficits, the accumulating
indebtedness that inevitably will produce a painful reckoning in
standards of living (as a nation, we manage to consume more than we
produce by borrowing every year from abroad).

But the even larger reality is that America's weakening position
signals the need for a deep restructuring of globalization as well.
The globalized system the United States launched and protected
throughout the cold war decades approaches its own reckoning with the
dilemma of too many factories and not enough buyers. Escaping this
condition will require fiendishly difficult diplomacy (made more so by
the Bush Administration's cockeyed imperialism), but the risks are
historic in dimension (the global trading system disintegrated after
1929 as worldwide depression led nations to protect their own
producers and markets from foreign competitors). First, leading
nations must join to launch worldwide stimulative policies and
persuade rising nations like China not to bring down the system by
overwhelming rival producers. The fundamental solution, however,
involves the kind of moderating reforms advocated by antiglobalization
activists worldwide--rules to rebalance the system and genuinely
promote wages as well as output, financial terms that give developing
countries more time and space to seek their own distinctive economic
plans, plus new institutions of governance that are truly equitable
and democratic, instead of corporatized lawmaking. That's a very tall
order for statesmanship in a world presently governed by small-minded
men.

Meanwhile, the economic dysfunction in the American system involves
many other contentious questions, including the overbearing scale of
certain dominant enterprises. The spectacular costs of allowing
ever-growing bigness in corporations are reflected every day in the
news (think of the doomed AOL Time Warner merger that has lost more
than $200 billion for investors, or the scandalous behavior of
financial mega-firms like Citigroup, or the conglomerate
homogenization of broadcasting). The gathering evidence also suggests
that the mass-consumption economy that has flourished since World War
II may at last be running out of gas. Too many indebted consumers are
tapped out or will be in hard times. Who's going to buy all this
stuff? Is this weakened condition related to the gross and growing
wage inequalities of the past two decades?

The "market signal" of small-d depression might be saying: Don't
invest more in the old stuff since we've already got too many shopping
centers. Start investing in "problems" the country has long
neglected--see these really as economic opportunities. Invest in the
energy technologies and industrial transformations required for the
posthydrocarbons age of ecologically sustainable prosperity. Invest in
healthcare and transportation and production systems to deliver safe,
healthy food. Invest in the smaller, more nimble firms ready to do
things differently. Invest in people--the human development that
begins with children at a very early age. These and other investment
opportunities are where the future jobs and higher returns are most
likely to be found. The status quo interests will naturally resist
such shifts in purpose and deploy their political muscle to block any
promising departures. But a fundamental restructuring at least would
open the way to think anew, to strive for a different kind of
politics. If the Chicken Littles turn out to be right, a pivotal
moment is approaching, one that may be both dreadful and promising.

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