A Different Approach to Analysis of the U.S. and Global Economic Crisis
Both major wings of contemporary mainstream economists—‘Retro Classicalists’ and ‘Hybrid Keynesians’—fail in fundamental ways to understand the qualitative characteristics of the economic crisis that continues to impact the U.S. and global economy. Neither wing has been successful predicting the deep and rapid contraction that began in 2007; explaining why massive, multi-trillion dollar liquidity injections into the banking system since 2007 have failed to generate a sustained economic recovery; or understanding why the current US and global economies are today, in 2012, steadily slipping toward another global banking crisis and consequent general economic contraction.
There are various reasons for this mainstream failure. But a short list would include the inability to understand the nature of investment in the 21st century, in particular the relationship between speculative forms of investment vs. real asset investment; the changing relationship between central bank money supply and internal bank forms of credit creation; and the critical causal interdependencies between forms of debt and income, which this writer has summarized elsewhere by creating a new conceptual analysis based on terms such as ‘systemic fragility’.
Fragility as a concept of analysis is derived from the Minskyan notion of financial fragility, where fragility is a function of levels of debt, terms of debt repayment, and cash flow. This notion is developed further, expanded, and extended to include household consumption fragility and public balance sheet fragility. A quantitative relationship exists between the three forms of fragility that together constitute ‘systemic fragility’. Causal interdependencies between the three forms of fragility shift over the course of the business cycle. At the cycle peak, at which a financial bust occurs in one or more asset price markets, systemic fragility also peaks. As the asset price bubble(s) crack, systemic fragility in turn undergoes a further rapid deterioration and corresponding ‘fracturing’. The further rapid deterioration of fragility results in a significantly worse contraction of business spending and household consumption that otherwise would have occurred in a ‘normal’ recession precipitated by external shocks. However, financial crash precipitated contractions are not normal and are not due to external shocks. They are ‘epic’ recessions, characterized by deteriorating systemic fragility, asset price bubbles and crashes, and more severe real economic contractions than occur in ‘normal’ recessions. Epic recessions are endogenous contractions, precipitated by financial instability events. Epic recessions are also differentiated from so-called ‘Great Recessions’, a popular term employed by mainstream economists which has no analysis but simply suggests the recession is ‘worse than’ a typical (normal) recession but ‘not as bad as’ a bona fide depression. This kind of analysis by adverb is rejected.
In epic recession analysis, ‘systemic fragility’ is the condition that explains how and why financial instability (asset price bubbles) events result in contractions of the real economy that are deeper, more rapid, more intractable and consequently more resistant to traditional central bank monetary policy actions and government fiscal policy responses. System fragility explains why these traditional responses are increasingly inelastic in terms of generating a sustained economic recovery from the ‘epic’ contraction, and simultaneously increasingly elastic in terms of provoking a relapse and even double dip re-recession when contractionary policies are reintroduced in the recovery phase.
Monetary policy responses, if of sufficient magnitude, may result in a temporary stabilization of the banking system but cannot generate a sustained economic recovery of the rest of the economy. They also have the negative consequence of generating a further deterioration of systemic fragility over the longer term if continued. Similarly, traditional fiscal policy responses fail to address the fundamental problems of household consumption fragility. Both traditional (i.e. mainstream economics) monetary and fiscal policy result in a worsening of public balance sheet fragility, which ultimately feeds back on financial and consumption fragility over time.
The mechanisms by which system fragility transmits to the rest of the economy are located in the relationship between debt, deflation, and default in various forms. Debt is defined as debt levels, rate of change of debt, plus terms of debt repayment. Deflation is considered within a three-dimension price system: asset prices, product prices, and factor prices. Asset price deflation in the post-bubble contraction phase drives product price deflation, which in turn drives wage deflation. The three forms of deflation feed back upon each other in turn, and also upon real debt as a consequence. Deflation results in default, which in turn also feeds back on both debt and deflation. Together this debt-deflation-default mechanism transmits ‘systemic fragility’ conditions to the various economic indicators, by which NBER economists define recession conditions.
Contrary to mainstream economics, therefore, there is no such thing as a single price system responding predictably to supply and demand to enable a return to equilibrium conditions. There are three separate price systems—asset, product, and wage—with asset prices serving as an originating destabilizing force and not an element that restores instability to equilibrium.
Among the fundamental driving forces in the global economy is the explosion of global liquidity, driven not only by the decades long uninterrupted creation of money by central banks’ international reserve currencies, but by the growing separation of credit creation by the banking (and shadow banking) system from the central banks in order to feed the increasing ‘speculative investing shift’ underway since the 1960s. New global financial institutions are created to accommodate the liquidity, new liquid markets are created to permit its reproduction, and new financial instruments are introduced to enable its circuit. Together they constitute the ‘global money parade’. Money and credit capital consequently shift into the more profitable financial forms of investing, causing an increasing divergence and imbalance between speculative financial investing and real asset investing over the course of the business cycle. Debt expansion based increasingly on non-money credit is a key characteristic of the speculative shift, which results in a growing adverse relationship between debt and income (fragility) within the system in all forms, as described above.
NOTE: For a further detail of the major elements of this analysis see this writer’s recent books, “Epic Recession: Prelude to Global Depression”, May 2010, and “Obama’s Economy: Recovery for the Few”, April 2012, and the forthcoming third sequel, “Transitions to Global Depression”. (For an analysis translated into Marxist economic categories see a forthcoming submission to Monthly Review).