The “let them fall” concept of macroeconomics

Last night, on the Daily Show with Jon Stewart, Peter Schiff was interviewed.  Schiff is an “economic commentator” (as compared to an economist?) and the head of a brokerage firm.  Stewart showed a number of clips of Schiff on CNBC prior to the current economic crisis warning of the dangers of the housing bubble, sub-prime mortgages, and over-leveraged companies and individuals.  These comments were made well in advance of the actual recognition of the situation and there is audio of people actually laughing while he is talking (I got the impression they were other guests of panel shows, not the moderators or CNBC folks themselves, but I cannot be sure).

At any rate, the gist of Schiff’s argument is that

1. The government should have let companies fail.  No company is too big to fail.
2. The market will dictate how things will fall out in the end, even if it means massive recession for now.  The market is strong.
3. This is all because of how messed up things were, so let’s let the bad die out
4. The government is just making things worse by intervening, and we might have hyperinflation.

In some ways, I find this very dangerous.  In others, thought-provoking.

The dangerous part is the very fast bit about hyperinflation.  I am NOT an economist.  I’m barely even an armchair economist.  But I have my opinions and this is my blog so there :-).

First, there is a common but not quite accurate connection between an increase in nominal money supply (ie – we print more money, like we are now – and by “we” I mean the Federal Reserve Bank) and inflation, or the loss of value of that money (money supply / prices, which is called “real” money supply).  These are connected but the latter is not an instantaneous result of the former.  What really happens is that money supply goes up, which actually does stimulate the economy.  People get more jobs and now have income that they didn’t in the past.  They then spend that money.  Then they are willing to pay more for a loaf of bread today than yesterday.  Prices are set by what people are willing and able to pay, and if they have more money (able) and still need the bread and want it (willing) then the prices go up.  The bread is more expensive, but you don’t get any additional bread for the dollar.  You get less.  That is inflation.

But if you consider that there is the very important step in the middle there of economic stimulus, then increasing money supply isn’t such a terrible thing.  And in 2009, we’re looking at inflation of maybe 1% or so.  This is because while we are printing money like crazy, we haven’t yet had an increase in prices since people are still without jobs and therefore not able to pay higher prices.

Now, inflation will happen, but hyperinflation is a totally different thing.  We will eventually have inflation and I am certain that someone as smart as Ben Bernanke (Chairman of the Fed) will pull back and fight it off (possibly putting us into a slow-down but hopefully not another mini-recession).  But hyperinflation is in the range of 100%, 1000%, maybe even 3000% in the case of Argentina and Germany between the World Wars.  I think we’d have to get ridiculously out of control to ever achieve that.

That’s why I think the word hyperinflation is so dangerous.  Deflation – that’s a different issue and a reasonable one.  But hyperinflation?

The thought-provoking part of this is that Schiff sounds an awful lot like what I understand the pre-Great Depression macroeconomists were saying.  The market is just self-correcting, and things will work out.  Well, it didn’t correct, and those neoclassical economists (as they are sometimes called now) didn’t have an answer.  Eventually, John Maynard Keynes came along and proposed that the government had to intervene to push the market back up again (the market just needed a push – he never argued for nationalization or anything like that, as far as I know).

The compromise conclusion is that the economy and the market is a bit “sticky” and does not move as quickly as the neoclassicists predicted.  The market may well indeed correct itself, but not right away.  Prices in particular are sticky, meaning that they don’t just slide back and forth.  Supply and inventories don’t just disappear when demand goes down, nor does production decrease to a recession level instantaneously, so the supply and demand curves don’t move that quickly, which means prices don’t change that fast, which means people can’t buy anything anymore after they’ve lost their jobs due to some bubble bursting, and we have a recession.  Back in 1929, we plunged into a Depression.

But I have been torn all along about this whole “too big to fail” thing.  On the one hand, it really is the fault of Lehman Brothers and Citigroup and others.  They took on far, far too much risk and found themselves trapped.  Perhaps they should just fall, and the market will separate the weak (or stupid) from the strong, and we’ll all end up the better for it.

But it’s undeniable that the fall of these companies would be huge impacts on our economy.  Billions of dollars are held in the (admittedly overleveraged) portfolios of AIG, Merril Lynch, and Washington Mutual had all of these mortgages in theirs.  The impact on individuals and companies and groups and whatever would be so widespread that I do wonder if they are too big to fail.  Regulations should have been in place such that they never got that big in the first place, and “non-bank banks” such as Merril Lynch should never have been allowed to operate as they did in the first place, but the fact is that so many people would be hit that it’s hard to just “let the market decide” and it’s “survival of the fittest.”

Another example would be GM.  GM has been pretty dumb for a long time.  Investing in the wrong cars, not even considering technologies that were blatantly up and coming, etc.  But if GM and Ford and Chrysler were to go under – it’s not just about them, or slicing and dicing them to make them leaner and sustainable.  It’s about all the people that make the parts that get put together with other parts that become drive trains and transmissions and etc.  A staggering number of people would be heavily affected if those companies truly went under (I forget the estimates), and as it is the bankruptcy filings of GM and Chrysler have had ripple effects (200 Chrysler dealerships were just flat-out cut in one fell swoop.  How are those folks going to deal with that?).  How do we stand by when we can see that coming?

I don’t know.  The concept of just letting the market figure things out is provocative, but I’m not sure it’s tenable.