Wednesday, January 6, 2010

Insightful New Year's address on

This excerpt from Mikhail Khazin's New Year's address to the readers of his -- a Russian site I check from time to time -- in my opinion helps to put things into perspective. So I've translated from the Russian what I think might be of interest to the English-reading public.

The start of a New Year calls for the summing up of the previous one. A detailed analysis of 2009 as well as a forecast for 2010 are on my to-do list. Now I am about to say just a few words about the main results of the year. From my point of view, the main result is the categoric refusal of the authorities of most large countries to discuss the causes and consequences of the world economic crisis publicly. That the crisis is not over need not be explained to the readers of this site ( -- CF), but the authorities understand this as well. Take discussions in the US leadership about borrowing stimulation as an example... It is clear that one can not credit the real sector of economy under the conditions of falling household demand (who to sell the new products to?), therefore one will have to start with the households. But here a natural question arises: what's the logic behind this Obama's desire? For the households are in debt up to their eyeballs, their incomes do not allow them to even pay back the previous loans without a dramatic lowering of the living standards. So why does Obama want them to borrow more?

The thing is as follows. Because, thanks to the growing household debt, the demand had been growing quite strongly for the past decade, and the economy had been growing with it, today's situation is a dead-end in a sense. If one lowers the demand to bring it in equilibrium with the income, the demand will drop by $3 billion a year, at least. Since such a decline in demand (a reminder: the entire GDP of the USA is, officially, $14 billion a year, and in reality is less) will unavoidably cause an economic downturn, incomes will fall, which in its turn will necessitate a drop in demand and so on. The equilibrium corresponds to a drop in US demand of about $6 billion a year. This adjustment can be made rapidly -- and then the sociopolitical catastrophe in the country will be stronger, but the compensatory growth following it will begin almost instantly. Or it can be made slowly -- then the downturn will be less painful, but it will last longer.

The first of these economic scenarios is a deflationary one. In that case, the credit emission stops (actually, it is stopping already), the prices begin to drop precipitously, companies go bankrupt (like in Fall 2008), but those financial institutions who have access to liquidity, i.e. to the FRS credits, have a strong advantage. They use the credit money to pay their deposit holders (it is the depositors' runs on the banks that were devastating the US banking system in the early '30s, which is why Roosevelt declared a default in 1933, the one modestly called "banking holiday" today), and then buy all the industry and all profitable assets in general. The '30s -- the age of deflation -- became the time of the largest redistribution of property in favor of the financial elite in the Western world. The industrialists' lucky star descended for good, the XIX century, the age of industrialists, came to a final closure; the next century began -- the one which belongs to bankers.

But if the banks continue crediting, the situation is different. In that case all of them will keep accumulating bad debts which will unavoidably lead them to bankruptcy. The only way to survive will be to escalate credit emission in hope for inflation, that is, the depreciation of debts. The abilities of the FRS will be limited, which is something that keeps Obama busy these days. And the main thing: he will have lots of money in the budget, which will allow him to conduct active social policy, to lower the political tension and (it must be owned) to determine, who and how will bankrupt the financial institutions. In that sense the notorious health care reform (which is practically impossible under the deflationary scenario: there will be no money for it in the budget), the reforms to limit the FRS and the borrowing stimulation -- are all parts of the same policy aimed at lowering the role of the financial sector in the ecomony and at strengthening that of the state.

Let's note one important thing. The choice will be made even before Obama's first (and possibly last) presidential term is over, since, once the hyperinflation is started, it will be practically impossible to stop. Which by the way is true for a real deflation too.

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