“Toxicity” Is A State of Mind

You know, one of the things which amazes me about the present discourse surrounding the crisis is the way people seem to trot out all the old formulae, without giving a moments though to what they actually mean. “In the long run we are all dead” is an obvious case in point. Who really stops for long enough nowadays to think about what Keynes was actually getting at? “Animal Spirits” would be another.

The New York Times are running an interesting forum, called “Room For Debate“. Now Brad DeLong makes the following point (drat, you can’t link to individual posts, almost modernity):

The purpose of the Geithner plan is to boost financial asset prices and so make it easier for businesses to obtain financing on terms that will allow them to expand and hire.

Which really all sums it up in a nutshell, since with the sort of contraction we have running at the moment, what businessesmen in their right mind would want to expand and hire (oh, I know, I know, there are always interesting opportunities out there, even dismantling factories and selling for scrap, but I mean on aggregate, a not “i win but you lose more than i win” dynamic).

The whole thing about “animal spirits” is that since everyone can only see more of the same, and worse to come, everyone who can play gets involved in betting on the bankruptcy of the person next to them, and those who can’t play hide their money away somewhere.

In these circumstances it is the job of governments to change this dynamic, which is why the emphasise needs to be on the fiscal side and provoking inflation expectations.

If we think about how the present crisis works, the causal chain seems to go like this:

Financial Crisis -> Real Economy Crisis -> Political Crisis

Of course, then you need to build in all the circular, self reinforcing, feedback arrows. And the most striking thing about Eastern Europe at the present time is just how quickly we have gone from one end of the chain to the other. I would now expect this instability process to spread to Southern Europe (we have already seen some inkling in Greece).

And on the question of the toxic assets, and how many of them they are, or what they are worth, the whole point is we don’t have a finite quantity of toxic assets here, our economies have become huge machines for generating new toxic assets as we go. In its present state, a developed economy is more like a ball of negative energy which simply soaks up everything which comes near it, including all those carefully formulated stimulus plans. That is “toxicity” is a process as well as a state of mind. As our economies contract, and the value of houshold wealth, and companies, and even entire nations, drops (not only in real but soon, as we get into deflation) in nominal terms, the scale of toxicity simply rises and rises. There is not some finite quantity of “bad or doubtful assets” to tease out, we are creating new ones every day. Which is why, whatever the ins and outs of the Geithner plan arithmetic, Krugman “gets” the main point:

View #2 is that the banks really, truly messed up: they bet heavily on unrealistic beliefs about housing and consumer debt, and lost those bets. Confidence is low because people have become realistic.

Which is to say that while the crisis started because the banks were afraid to lend, it continues because people are now afraid to borrow (since they don’t know when they will lose their jobs, or even their homes), and so the modern citzen is simply working as hard as he or she can to repair their broken balance sheets, broken balance sheets which only deteriorate further the more they try to repair them (the so called paradox of thrift).

As I say, the whole crisis has now become a state of mind really.

This entry was posted in A Fistful Of Euros, Economics and demography by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

9 thoughts on ““Toxicity” Is A State of Mind

  1. Isn’t the whole economy a state of mind? All the “macro fundamentals” are fundamental because they are a result of actions and anticipations of millions (or billions) of people, and therefore may be stable for some continued periods of time.

    People (households, “investors”, purchasing managers, central banks, CEOs of banks, hedge funds and “real companies”), act based on their belief about what will happen. This makes economies move. The only reasons why this stuff is never analyzed are a) it’s too difficult, therefore top-down approaches are used and b) it wouldn’t look awfully scientific and professional.

    Yet basing analysis (and therefore beliefs) on assumptions that big numbers are so big that they correctly indicate what is (and will be) happening is what led the banks and all of us into this mess.

    At the same time, only when people will start to believe that things will improve we will start seeing positive changes.

    Just my 2 non-economist’s cents.

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  3. > and so the modern citzen is simply working as
    > hard as he or she can to repair their broken
    > balance sheets, broken balance sheets which
    > only deteriorate further the more they try to
    > repair them

    I don’t believe this as an outcome. I concur people are saving and I concur the shift of wealth into paying debt rather than investment or spending is reducing economic growth.

    What I think however is that once people have paid off enough debt, they will then begin spending and the economy will revive.

    The main bugbear in my view is taxation. Western first world States now extract *so* much wealth from their economies that economic growth is sickly at best. It’s like trying to be healthy when you have cancer.

  4. “As I say, the whole crisis has now become a state of mind really.”

    Spoken as someone who did not just lose 50% of one’s retirement savings at the age of 65.

  5. “…people are now afraid to borrow”

    Some businesses turn this into competitive advantage. Last year only one big automotive manufacturer increased sales in US. Hyundai offered leases and financing with option of no penalty termination in case the buyer loose his job.

  6. @ Wally,

    Look, I am very sorry you have lost half your savings, but the point of this post is that I am also worried about the other half.

    I think your point would be valid if I was saying:

    “As I say, the whole crisis has now become ONLY a state of mind really.”

    I am not saying this, as Vangrieg points out, it is also very real.

    My point is that we will only get out of all this (and save the other half of your savings) when we have policies which can convince people they will work. This is what will shift the state of mind. At present we don’t have that. At least I don’t believe they will work. I think there are others who think like me. What’s more, if what the ECB, the EU Commission and the IMF are up to now doesn’t work, then the problem will become even worse, becuase people will be even less likely to take risks.

    To see what I think should be done you need to read around my other posts.

    @ Xavier

    Well, we have fundamental different perspectives. So you and I are running an “experiment”, but nice to see you are staying the course to actually see what happens.

    “What I think however is that once people have paid off enough debt, they will then begin spending and the economy will revive.”

    Well, as you probably noted on the blog, Japan real estate prices hit 1984 level, German ones are at 1995 ones and poised to drop backwards. How many more years, or decades, do you think these people need to keep saving before they will be willing to start spending again?

    Or at what point would you be willing to throw the towel in? ie, what is the critical reality test for you? I think if we are not all out there testing our theories every day, we become mere ideologues.

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