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 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.