Paging Larry Summers what's the plan?

http://blogs.wsj.com/economics/2009/03/13/summers-on-how-to-deal-with-a-rarer-kind-of-recession/ One of the most important lessons in any introductory economics course is that markets are self-stabilizing. When there is an excess supply of wheat, its price falls. Farmers grow less and others consume more. The market equilibrates. When the economy slows, interest rates fall. When interest rates... [more]

http://blogs.wsj.com/economics/2009/03/13/summers-on-how-to-deal-with-a-rarer-kind-of-recession/ One of the most important lessons in any introductory economics course is that markets are self-stabilizing. When there is an excess supply of wheat, its price falls. Farmers grow less and others consume more. The market equilibrates. When the economy slows, interest rates fall. When interest rates fall, more people take advantage of credit, the economy speeds up, and the market equilibrates. This is much of what Adam Smith had in mind when he talked about the “invisible hand.” However, it was a central insight of Keynes’ General Theory that two or three times each century, the self-equilibrating properties of markets break down as stabilizing mechanisms are overwhelmed by vicious cycles. And the right economic metaphor becomes an avalanche rather than a thermostat. That is what we are experiencing right now. Declining asset prices lead to margin calls and de-leveraging, which leads to further declines in prices. Lower asset prices means banks hold less capital. Less capital means less lending. Less lending means lower asset prices. Falling home prices lead to foreclosures, which lead home prices to fall even further. A weakened financial system leads to less borrowing and spending which leads to a weakened economy, which leads to a weakened financial system. Lower incomes lead to less spending, which leads to less employment, which leads to lower incomes. *************************************************************** SOLUTION http://www.nakedcapitalism.com/2009/10/the-recession-is-over-but-the-depression-has-just-begun.html The U.S. government has finally realized this and is now moving to stem the tide. Their efforts point in four directions: 1. Increase asset prices. If the assets on the balance sheets of banks are falling, then why not buy them at higher prices and stop the bloodletting? This is the purpose of the TALF, Obama’s mortgage relief program and the original purpose of the TARP. 2. Increase asset prices. If assets on the balance sheet are falling, why not eliminate the accounting rules that are making them fall? Get rid of marking-to-market. This is the purpose of the newly proposed FASB accounting rule change. 3. Increase asset prices. If asset prices on the balance sheet are falling, why not reduce interest rates so that the debt payments which are crushing debtors ability to finance those assets are reduced? This is why short-term interest rates are near zero. 4. Increase asset prices. If asset prices on the balance sheet are falling, why not create Public-Private partnerships to buy up those assets at prices which reflect their longer-term value? This is what Geithner’s Capital Assistance Program is designed to do. so to recap: 1. A depression was borne out of high levels of private sector debt, the unsustainability of which became apparent after a financial crisis. 2. The effects of this depression have been lessened by economic stimulus and government support. 3. Government intervention led to a reduction in asset price declines, which led to stock market increases, which led to asset price stabilization and more stock market increases and eventually to asset price increases. This has led to a false sense that green shoots are leading to a sustainable recovery. 4. In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized 5. Because large scale government deficit spending is politically impossible, expect a second economic dip within three to four years at the latest. We’ve said it before and we’ll say it again. As a matter of national accounting, the domestic private sector cannot increase savings unless and until foreign or government sectors increase deficits. Call this the tyranny of double entry bookkeeping: the government’s deficit equals by identity the non-government’s surplus. So, if the US private sector is to rebuild its balance sheet by spending less than its income, the government will have to spend more than its tax revenue. The only other possibility is that the rest of the world stops saving on a massive scale — letting the US run a current account surplus. But that is highly implausible and socially undesirable, since it means we export our economic output, rather than consume it domestically. And if the government deficit does not grow fast enough to meet the saving needs of the private domestic sector, national income will decline, which, given the size of the private sector’s debt problem, will generate a huge debt deflation. [less]