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Credit Crunch

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Crisis lessons from Irving Fisher. Enrique G.

Crisis lessons from Irving Fisher

Mendoza, 12 February 2009 This column rehabilitates Irving Fisher’s debt-deflation theory to explain the current crisis. It suggests that fiscal stimulus will do little to prevent the crisis from becoming a protracted slump because the problem lies in finance. A cure will require reversing deflation and restarting the credit system. “…in the great booms and depressions, each of the above named factors (over production, underconsumption, over capacity, price dislocation, over confidence, over investment, over saving etc.) has played a subordinate role as compared with two dominant factors, namely, over indebtedness to start with and deflation following soon after;… where any of the other factors do become conspicuous, they are often merely effects or symptoms of these two.” The credit crunch may cause another great depression. The crisis is shaping up to be a perfect storm – a huge surge in uncertainty that is generating a rapid slow-down in activity, a collapse of banking preventing many of the few remaining firms and consumers that want to invest from doing so, and a shift in the political landscape locking in the damage through protectionism and anti-competitive policies.

The credit crunch may cause another great depression

Back in June 2008 I wrote a piece for VOXEU predicting a mild recession in 2009. Over the last few weeks the situation has become far worse, and I believe even these pessimistic predictions were too optimistic. I now believe Europe and the US will sink into a severe recession next year, with GDP contracting by 3% in 2009 and unemployment rising by about 3 million in both Europe and the US. This would be the worst recession since 1974/75. The crisis of 2008: Structural lessons for and from economics. Foreign Policy: Why China's Currency Manipulation Doesn't Matter.

With just a few words in his Senate confirmation hearing, U.S. Treasury Secretary Timothy Geithner resurrected the long-held American accusation that China's penchant for money management is hurting the U.S. economy. President Obama -- backed by the conclusions of a broad range of economists -- believes that China is manipulating its currency, Geithner wrote in his prepared remarks.

As the argument goes, an undervalued Chinese currency makes the country's exports artificially cheap, giving Chinese goods an unfair competitive edge. Reduced demand for American goods hurts U.S. manufacturers and limits the size of the U.S. job market. China is taking jobs from the American heartland. Blaming China for flailing U.S. manufacturing may be good domestic politics, but Geithner should hold his tongue.

Geithner's is certainly not the last Western complaint we will hear of China's currency, particularly now with an economic crisis in full swing. It Was the Saving Glut? The paradox of thrift. Or, how come you used to say that if consumers don’t save more, it will wreck the economy, and now you say, if consumers do save more, it will wreck the economy?

The paradox of thrift

For the record, I am certainly among those who had been suggesting that America’s low saving rate was a significant problem. Let me begin by reviewing why I said that. Recall that we can separate the various components of GDP (Y) in terms of goods and services purchased by consumers (C), government purchases (G), investment spending (I), and net exports (X):

Opinion: Expect a Prolonged Slump - - Mozilla Firefox. Updated Feb. 3, 2009 12:01 a.m.

Opinion: Expect a Prolonged Slump - - Mozilla Firefox

ET Perhaps the Obama administration will be able to bring a surprisingly early end to the ongoing U.S. financial crisis. We hope so, but it is not going to be easy. Until now, the U.S. economy has been driving straight down the tracks of past severe financial crises, at least according to a variety of standard macroeconomic indicators we evaluated in a study for the National Bureau of Economic Research (NBER) last December. In particular, when one compares the U.S. crisis to serious financial crises in developed countries (e.g., Spain 1977, Norway 1987, Finland 1991, Sweden 1991, and Japan 1992), or even to banking crises in major emerging-market economies, the parallels are nothing short of stunning.

Mortgage Rates Likely Headed to 4.5%: Pimco's Gross - Economy * Pimco's Gross on the Current Financial Crisis The shift in economic growth has most of the world's connected economies and their citizens in shock, says William Gross, Pimco co-chief investment officer/founder In addition to driving down mortgage rates and stimulating home-buying, the government's efforts also could include a move to cap Treasurys rates to encourage investors to take more risk, Gross said during a live interview on CNBC.

Mortgage Rates Likely Headed to 4.5%: Pimco's Gross - Economy *

Bank Balance Sheet: Liquidity and Solvency, Par. By Bill McBride on 4/26/2009 11:57:00 AM Note: I took some short cuts to make this simple - think of this conceptually.

Bank Balance Sheet: Liquidity and Solvency, Par

I'm intentionally mixing financial institutions. For commercial banks, the FDIC stopped the bank run by upping the FDIC insurance. For investment banks, the Fed provided the liquidity. Economics and the crisis of 2008. The global crisis is a challenge to and an opportunity for the economics profession.

Economics and the crisis of 2008

No, Greenspan Was Not Right. Nick Rowe asks an interesting question: In 2003, Alan Greenspan argued that the Fed needed to set low interest rates to prevent falling into a liquidity trap and deflationary spiral...

No, Greenspan Was Not Right

In 2008, Greenspan's critics argue that those same low interest rates caused an asset bubble, which burst, causing the economy to fall into a liquidity trap and deflationary spiral. A New Depression? The Lessons of the 1930s. Richard Rorty and the efficient markets debat. I use the efficient markets hypothesis in my research and in my blog.

Richard Rorty and the efficient markets debat

Once I started looking at the world through the EMH lens, I found it much easier to understand the relationship between policy and the financial markets—particularly in my research on the Depression. Here I’d like to do three things; indicate why I believe markets are more efficient than they seem, acknowledge that there are events that look like market inefficiency, and then argue that those perceived inefficiencies, even if real, don’t have the policy implications that many people assume they have. Last Sunday I discussed cognitive illusions, aspects of economic theory that are highly counter-intuitive. Far From Over - Mozilla Firefox. Floyd Norris writing in the NY Times reminds us that the problems in the U.S. financial sector are far from over: The loans went to borrowers who might never before have been allowed to borrow.

Far From Over - Mozilla Firefox

When they found repayment difficult, they were permitted to refinance their loans, generating fees for the lenders and postponing the ultimate reckoning. Then the credit markets turned and both the borrowers and lenders were in deep trouble.So it went with the subprime mortgage crisis. And so it is now going with corporate loans and bonds. It appears that defaults on leveraged loans and corporate bonds will soon rise to levels not seen since. The crisis and how to fix it: Part 1, causes. This is a financial crisis to remember. The financial losses are measured in trillions of dollars; elite financial institutions have fallen; fear and mistrust are widespread among investors and lenders; credit markets are not operating except for those with very short maturities; massive and unorthodox policy interventions are an every day occurrence; and we have been, and continue to be, on the verge of a global financial meltdown.

REFLECTIONS ON A CRISIS Daniel Kahneman & Nassim Taleb, Mo. FOCUS ONLINE January 28, 2009 ARE BANKERS CHARLATANS? Sind Banker Scharlatane? (German Original) At blame for the financial crisis is the nature of man, say two renowned scientists: Nobel Prize winner Daniel Kahneman and bestselling author Nassim Taleb ( "The Black Swan"). By Ansgar Siemens, FOCUS online editor Two men sitting on the stage. Buffett's Letter to Shareholders. By Bill McBride on 2/28/2009 08:27:00 AM Here is Buffett's Letter to Shareholders There are several interesting sections, but for housing I think the section on Clayton Homes (Buffett's manufactured home division) is especially interesting. The First Global Financial Crisis of the 21st Century Part II: J. The crisis and how to fix it: Part 2, solutions. How We Were Ruined & What We Can Do - The New York Review of Boo. The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash by Charles R.

Morris PublicAffairs, 194 pp., $22.95 Financial Shock: A 360° Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis by Mark Zandi FT Press, 270 pp., $24.99. Empirical evidence on the monetary policy trilemma since 1970. An $800 Billion Mistake. Start with the tax side. The plan is to give a tax cut of $500 a year for two years to each employed person. That's not a good way to increase consumer spending. Experience shows that the money from such temporary, lump-sum tax cuts is largely saved or used to pay down debt. Only about 15 percent of last year's tax rebates led to additional spending.