[Marxism] For some, a silver lining in the credit squeeze

[Marvin Gandall <marvgandall@xxxxxxxxxxxx>]

While the volatile stock and bond markets are urging the Federal Reserve to
cut the fed funds rate sharply and fast, other voices within the ruling
class don't want it to unblock consumer and corporate bottlenecks to credit.
They want tighter money to engineer a long hoped-for recession in the US - a
"mild" one, to be sure, which doesn't spiral into a deep depression. They
have long worried that the earlier high-tech and more recent real estate
bubbles as well as America's widening current account deficit have raised
the odds of a calamitous economic collapse, and have sought a controlled
preemptive rise in interest rates which would gradually reduce US domestic
spending and boost savings. Now they see the higher cost of borrowing in all
but Treasuries, precipitated by the current crisis in the mortgage market,
as a window of opportunity to slow the economy, provided the Fed does not
ride to the rescue of the hedge funds and their bankers.This consensus
appears to have spread from the conservative Economist which was clear this
week that "America needs a recession" to the liberal New York Times which
today encouraged the Fed to adopt policies which ""improve savings at
home...come what may." The Fed's next moves should indicate which way the
wind is blowing.
=============================================
Does America need a recession?
Aug 23rd 2007
>From The Economist print edition

An intriguing, if unpopular, thought

THE late Rudi Dornbusch, an economist at the Massachusetts Institute of
Technology, once remarked: “None of the post-war expansions died of old age.
They were all murdered by the Fed.” Every recession since 1945, with the
exception of the one in 2001, was preceded by a sharp rise in inflation that
forced the central bank to raise interest rates. But today's Federal Reserve
is no serial killer. It seems keener on blood transfusions than on
bloodletting.

When the Fed cut its discount rate on August 17th, it admitted for the first
time that the credit crunch could hurt the economy. The markets are betting
it will soon cut its main federal funds rate. Economists are arguing
vigorously about how much damage falling house prices and the subprime
mortgage crisis will do. But there is one question that is rarely asked:
even if a downturn is in the offing, should the Fed try to prevent it?

Most people think the question smacks of madness. According to received
wisdom, the Fed should not cut interest rates to bail out lenders and
investors, because this creates moral hazard and encourages greater
risk-taking; but if financial troubles harm spending and jobs the Fed should
immediately ease policy so long as inflation remains modest. Central bankers
should be guided by the “Taylor rule”—and set interest rates in response to
deviations in both output and inflation from desired levels.

A necessary evil
But should a central bank always try to avoid recessions? Some economists
argue that this could create a much wider form of moral hazard. If long
periods of uninterrupted expansions lead people to believe that the Fed can
prevent any future recession, consumers, firms, investors and borrowers will
be encouraged to take bigger risks, borrowing more and saving less. During
the past quarter century the American economy has been in recession for only
5% of the time, compared with 22% of the previous 25 years. Partly this is
due to welcome structural changes that have made the economy more stable.
But what if it is due to repeated injections of adrenaline every time the
economy slows?

Many of America's current financial troubles can be blamed on the mildness
of the 2001 recession after the dotcom bubble burst. After its longest
unbroken expansion in history, GDP did not even fall for two consecutive
quarters, the traditional definition of a recession. It is popularly argued
that the tameness of the downturn was the benign result of the American
economy's increased flexibility, better inventory control and the Fed's
firmer grip on inflation. But the economy also received the biggest monetary
and fiscal boost in its history. By slashing interest rates (by more than
the Taylor rule prescribed), the Fed encouraged a house-price boom which
offset equity losses and allowed households to take out bigger mortgages to
prop up their spending. And by sheer luck, tax cuts, planned when the
economy was still strong, inflated demand at exactly the right time.

Many hope that the Fed will now repeat the trick. Slashing interest rates
would help to prop up house prices and encourage households to keep
borrowing and spending. But after such a long binge, might the economy not
benefit from a cold shower? Contrary to popular wisdom, it is not a central
bank's job to prevent recession at any cost. Its task is to keep inflation
down (helping smooth out the economic cycle), to protect the financial
system, and to prevent a recession turning into a deep slump.

The economic and social costs of recession are painful: unemployment, lower
wages and profits, and bankruptcy. These cannot be dismissed lightly. But
there are also some purported benefits. Some economists believe that
recessions are a necessary feature of economic growth. Joseph Schumpeter
argued that recessions are a process of creative destruction in which
inefficient firms are weeded out. Only by allowing the “winds of creative
destruction” to blow freely could capital be released from dying firms to
new industries. Some evidence from cross-country studies suggests that
economies with higher output volatility tend to have slightly faster
productivity growth. Japan's zero interest rates allowed “zombie” companies
to survive in the 1990s. This depressed Japan's productivity growth, and the
excess capacity undercut the profits of other firms.

Another “benefit” of a recession is that it purges the excesses of the
previous boom, leaving the economy in a healthier state. The Fed's massive
easing after the dotcom bubble burst delayed this cleansing process and
simply replaced one bubble with another, leaving America's imbalances
(inadequate saving, excessive debt and a huge current-account deficit) in
place. A recession now would reduce America's trade gap as consumers would
at last be forced to trim their spending. Delaying the correction of past
excesses by pumping in more money and encouraging more borrowing is likely
to make the eventual correction more painful. The policy dilemma facing the
Fed may not be a choice of recession or no recession. It may be a choice
between a mild recession now and a nastier one later.

This does not mean that the Fed should follow the advice of Andrew Mellon,
the treasury secretary, after the 1929 crash: “liquidate labour, liquidate
stocks, liquidate the farmers, and liquidate real estate...It will purge the
rottenness out of the system.” America's output fell by 30% as the Fed sat
on its hands. As a scholar of the Great Depression, Ben Bernanke, the Fed's
chairman, will not make that mistake. Central banks must stop recessions
from turning into deep depressions. But it may be wrong to prevent them
altogether.

Of course, even if a recession were in America's long-term economic
interest, it would be political suicide. A central banker who mentioned the
idea might soon be out of a job. But that should not stop undiplomatic
economists asking whether a recession once in a while might actually be a
good thing.

*    *    *
Editorial
Dollars for Sale
New York Times
August 25, 2007

During the worst of the markets’ recent volatility, many investors moved
their money into supersafe Treasury securities, temporarily boosting the
dollar against the euro and the British pound. But of late, the dollar has
resumed its downward trend of the past several years. And policy makers and
currency traders are once again hypervigilant for signs that Asian central
banks might redeploy part of their dollar-based debt holdings into
non-American investments.

Such diversification — particularly by China, which is believed to have some
$1 trillion — could further weaken the dollar, presaging higher interest
rates and higher prices in the United States.

But Asian bankers, it turns out, are not the only ones to watch. According
to a new study by Stephen Jen, a currency economist at Morgan Stanley,
American investors may be a more powerful force than their foreign
counterparts in driving the dollar down.

Mr. Jen notes that since 2003, American mutual funds have increased their
allocation of overseas equities from 15 percent to 22.5 percent, a pace he
describes as “gradual but determined.” If America’s other big institutional
investors, such as pensions and insurance companies, have invested elsewhere
at the same pace, he calculates that the outflow of dollars would now amount
to $1.16 trillion, about the same as China’s total foreign reserves.

The outflow is not necessarily a thumbs down on the dollar’s prospects, says
Mr. Jen. Instead, it may reflect an increased willingness to invest overseas
in a prudent attempt at broad diversification.

But in a recent analysis of Mr. Jen’s study, the Economist magazine points
out that a negative view about the dollar may underlie the urge to
diversify. The Economist cites a Merrill Lynch survey showing that downbeat
expectations for the dollar have been common among fund managers for the
past five years. The push to diversify out of dollars was strongest three
years ago, but persists today.

If dollar wariness among American investors were a recent phenomenon, it
could be chalked up to temporary forces. But because the unease has been
marked for many years, it must emanate from something more entrenched. One
probable source is concern about America’s huge ongoing foreign
indebtedness.

Currency markets generally punish heavily indebted nations by pushing down
their currency. In the absence of policies to boost domestic savings — and
thereby slow the build up of debt — a steady decline of the dollar implies a
steady decline in American living standards. A sharply accelerating decline
would imply severe economic distress. By diversifying out of dollars,
American investors seem intent, at least in part, on reducing their exposure
to either eventuality.

Policy makers should spend less time worrying about what foreign creditors
could do to harm the dollar, and more time working to improve savings at
home, both public and private. That way, the nation would be less reliant on
imported capital and less vulnerable over all, come what may.








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