I wanted to take a brief digression here. My interests have turned away from heavy literary theory into a combination of hands-on game design and understanding the current economic crisis through integrated complex systems. The two of those has caused me to start working on a microeconomics simulation; still deciding whether the theme will be cheese/mice or colors--they could both lend themselves to very nice systems.
But what of this on the economic crisis? As my intellectual direction changes, I feel like talking solely about aesthetics and technology doesn't cover the whole of the lens through which I look at the world. With the world economy on the brink of a profound change and the utter uncertainty that that brings to the future, I'd like to dedicate some of my time on this blog to talking about the subject.
Part I: Liquidity
So, where to begin...
It begins in my fall 2008 class on the subprime crisis; a clueless junior who had the privilege of meeting Jim Rokakis, former treasurer of Coyahoga County (Cleveland and its surrounding area.) As we all know, Cleveland was pretty awesome and then became gutted as manufacturing left the city. Apparently it experienced some revival in the early 2000s, but I don't know this, nor is it important. What's important is that it got devastated by the wave of defaults and foreclosures that ripped through its housing market.
This is where I was first introduced to the virtuous/vicious circle hypothesis that underlies what people know as "Keynesian" economics (some claim that this is a perversion; once again, I don't know.) Before that, we have classical and austrian economics talking about how the market corrects itself with supply and demand. Keynes, from what it seems, had a keen intuition for nonlinearity. Remember that term; anyone who ignores it shouldn't have an opinion on this.
Now, the reason why non-linearity is so important, is that the effects of a negative event can be disruptive in unforeseen ways. If there is a bubble in say... housing, the effects of its bursting will go well beyond the simple market connection of houses coming back down to realistic prices. With that drop, many people's savings are evaporated, and so they can't buy goods. If that happens, then they can't go out with their family to their weekly-movie night, so the movie theaters and restaurants in the area take a hit. Without revenue, they fire people; people who already may be having trouble paying off their house's mortgage. That of course means that housing prices go down even further. And of course, the people who loaned the money get screwed too. But suffice it to say, there is a cycle, so that a simple market correction can turn into a disproportionate cycle of people losing money--people who were perfectly responsible but have lost economic opportunity thanks to being at the wrong place at the wrong time.
This phenomenon is called a deflationary spiral. Why deflationary? Because the result of this is that people have less money, prices and wages lower, and so on. So money, in a sense, becomes worth more. This sounds like it shouldn't be a big deal then, doesn't the drop in prices make up for the hit to people's wallets?
Well, not really; because it doesn't quite cancel out. Economic activity, the very thing that this whole complicated system of money represents, slows down. People lose jobs, business go out; and suddenly we have a scarcity of resources to go around. That only intensifies the spiral. Like they say, you need to spend money to make money. There is also one other major factor... debt!
Huh? Debt? Oh wait, right! You still owe the same amount in dollars if you have a mortgage, silly me! Silly, silly, me! Doesn't matter whether your dollar "buys" more; if you have less money, but you owe the same amount of it, you're getting screwed! And this was happening to a lot of people. This is no good, there's got to be some way out of this. It's like the whole body is slowing down, but if only we could get someone to start moving again, this might all be fixed. If only we could get enough people to start running together that they'll bring back the momentum. Wait, we could use... *fanfare* the government!
And that is what we did, we enacted economic stimulus. This was done in the great depression; first with the new deal, and then with World War II.* If we can act early and re-invigorate enough people and businesses, then we can start growing out of it. As for the debt the government has to take on; well, in many cases, the loss will be a lot less than what we'd lose from all of the economic downturn.
But let's take a step back. Here we're talking about goods and services, but we're forgetting about one actor involved in this whole crisis: the banks. We love them, we hate them; can't live with 'em, and certainly can't live without 'em. Because of that last clause, we bailed them out. But we didn't stop there--the federal reserve, the central bank of the united states, the ones who create all of the currency in the U.S. Economy (in other words: they have infinite money; their job is simply to maintain the system of exchange that keeps everyone working together. Whether this is good or bad is not part of the point I'm making), decided to lend money to these large financial institutions at virtually no interest rate.
Now, this can all be very very very jargony to those who are new to this stuff. I'm here to try my best to explain this all in very plain English--partially because I believe that the convoluted language of economics is actually responsible for creating a lot of the sophistry that I believe is at large. But anyway, for those who are confused, you might be asking what does any of that mean? Why are they lending money at lower interest rates, or even bailing them out?
And that brings us to the word in bold from the heading, liquidity. Its logic is actually very similar to that of stimulus if you look closely. Let's have a little thought experiment. Alex, John and Christina are all playing outside when they see Jimmy and Katie kissing on a bench. They have a debate about if they're going to become an item. Alex bets Christina that they certainly will not, and willingly bets $100. Christina, however, later realizes that Alex may very well be right, but she can't take back the bet she already made. She decides to hedge her bet by making a $100 bet with John, who believes that they will become an item. He agrees.
But wait, Alex realizes if he loses, he won't have the money to pay Christina. He'll need to offset the bet. When he talks to John, he finds himself in the same predicament, so they agree to make bets opposite to what they think. Now, it turns out that Jimmy and Katie don't get together (because Alex is always right, just saying), so the bets get triggered. There's just one problem--nobody can pay back anyone. Alex needs to pay John, but he can't get the money from Christina, who is trying to get the money that John owes her. But John hasn't gotten the money from Alex yet!
They're all stressing out, not realizing that this all balances out because they all talked in private. Just as they're about to burst into tears, their parents find out and get them all together. They decide they're going to show them how this is done in the adult world. They decide to loan Alex $100, with which he pays Christina. Christina pays John, and John pays Alex back. Then Alex pays John, and John finally pays Christina. The day is saved!
What was this we experienced? A crisis of liquidity. All the bets cancelled each other out, but without any initial money to pay, nobody could get the cycle going. This is what was happening with our banks--they made similar such bets in the form of leverage, the lifeblood of economic expansion (try getting a car or a house without some kind of loan.) Without sufficient money, banks can't lend money to get businesses operating again, and the deflationary spiral gets much, much worse. And that's why the government and the central bank acted in the way they did; they believed that the pipes were simply clogged, and a temporary burst of cash could clear them out.
And so both this liquidity crisis in the banks and the idea of a deflationary spiral are the same thing. Resources were (mis)allocated in such a way that suddenly, even though they were there, the un-coordinated behavior of the group caused them to stop being used, worsening people's standards of living in a catch-22.
And that's what I believed this was about for quite some time. The economy had misallocated its resources, and letting it correct itself would cause massive disruptions that are at the end of the day are fundamentally irrelevant to the problem that needed to be fixed. Some cash would prevent the cycle of disruption, and we'd pay the relatively small cost with the inevitable growth of a healthy economy.
But then why aren't we growing out of it? Is this just an extremely nasty version of a liquidity crisis, one that would require far more stimulus and patience, or is there something else impeding growth? And what is growth, anyway?
I will leave you with this video (not made by me) as a preview of my next post.
*This itself is subject to debate in a way. Here is a link to a good counter-point article: http://www.atimes.com/atimes/global_economy/mh24dj01.html