Just returned from a break in Wales.
Part of an e mail in my in box.
First Published in 1933:
http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdfHe uses the analogy of a ship capsizing. A ship can only be tipped so far before it is unable to right itself. And the same is true of markets. Once a market reaches a certain level of indebtedness, it reaches a point of no return.
Fisher argued that while over-investment and too much speculation play an important role in markets, their influence tends to be relatively modest provided they are not conducted with borrowed money. It is, in other words, the presence of debt, followed by deflation, that transforms inevitable booms into altogether more damaging collapses in asset prices. Fisher’s debt-deflation chain of consequences, then, is as follows:
• Debt liquidation leads to distressed selling;
• The money supply (“deposit currency”) contracts, as bank loans are paid off, leading in turn to a slowdown in the velocity of circulation – the speed with which money is recycled through the economy;
• The contraction in broad money leads to a fall in the level of prices. If this fall is not counterbalanced by reflation by the central bank then it leads to
• A still greater fall in the valuation of businesses, precipitating bankruptcies, and
• A similar fall in profits; and to
• A reduction in output, in trade and in employment; these losses, bankruptcies and unemployment lead to
• Pessimism and loss of confidence, which in turn lead to
• Hoarding and a further slowdown in the velocity of circulation. These eight changes cause
• Complicated disturbances in the rates of interest; a fall in “the nominal, or money, rates and a rise in the real, or commodity, rates of interest”.
“Each dollar of debt still unpaid becomes a bigger dollar - and the liquidation of debts cannot keep up with the fall in prices which it causes,” said Fisher. And that leads us to what, I submit, is the chief secret of most great depressions: The more the debtors pay, the more they owe. The more the economic boat tips, the more it tends towards capsizing altogether.
This is the stage that western governments have now reached. The origin of our current crisis was an orgy of indebtedness on the part of banks and consumers. Stage 2 saw governments step in to guarantee the banks and save the financial system from itself.
But now that government finances have become imperilled by the extent of the bailout and the cost of the resultant recession, governments throughout the industrialised world are now urgently tackling their debts and promising austerity on their bewildered populations, to keep the financial markets onside.
Having rushed onto one side of the ship during the worst of the banking crisis, politicians are now rushing to the other. In isolation, one or two governments may be successful in righting the balance. But when governments en masse start to pay down their colossal debt burdens, the outcome of a ‘double dip’ recession may be all but guaranteed.
So it is only government spending that is keeping us from something closer to a full-blown depression – the very spending that is now under fire and under the threat of the axe from politicians determined to maintain the sovereignty of national credit ratings. Governments are now damned if they do, and damned if they don’t. We are caught in Fisher’s debt-deflation trap.
ATB
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