Re: The Politics of Recession

[larson@xxxxxx]

Henry,

> The negative wealth effect impacts debt in two ways: 1) it creates a
> cash flow shortfall in servicing the debt with interesst payment and 2) it
> erodes the value of the collateral behind the loans, causing margin calls and
> rolloever difficulties.  Both impact generate selling pressure to
> generate cash which in turn exacerbate further negative wealth effect.  This
> downward slide can come in great force quickly.

There is a great deal of Minsky in this, which I like. We saw this happen in
Sweden a decade ago, the most recent example of a Minsky meltdown. However, I
see no reason whatsoever to believe the US will come anywhere near this
situation. For one thing, equity markets will be scouted by bargain hunters
rife with cash and eager to resume their profit making of the last eight or so
years. It will take a major international depression to send the US economy
into a Minsky avalanche. But within the range of a fairly stable macroeconomic
recession I do believe there will be some changes in wealth that can consumers
hurt a bit.

One small but not insignificant problem is the new bankruptcy laws in the US.
Bankruptcy filing is no longer as easy as it used to be, and boldly borrowing
consumers falling short of cash for their debt service may find it harder to
rebuild their credit status. That will somewhat hamper a recovery.


> Here we have a difference of view. My take is that we have exhausted the
> "expectation" or "confidence" effect.  There is no more additional credit
> available unless Greenspan is prepared to inject massive creddit into the
> system and accept high inflation.  The falling consumer spending is now
> slowed by a real cash flow crunch: no new credit, no additional disposable
> income, therefore lower sales and lower coroporate profits.  Two year from
> now, when the tax cut kicks in, many personal loans and credit card loans
> would have defaulted long before.

You have a point here. Financial analyst bigshots like Abbey Cohen constantly
complain that timing in prediction is the hardest thing of it all. I think we
can do a lot more if we devote research resources here. The fast moving
financial sector together with a highly sophisticated credit system have
equipped the macroeconomy with new "confidence transmittors" the exact effect
of which is largely unexplored.

Best,
/srl

--
Sven R Larson
PhD; Assistant professor of economics
Department of Social Sciences, Bldg. 22.2
Roskilde University
Pb 260
DK-4000 Roskilde
Telephone: (+45) 4674 2910