Wednesday, July 8, 2009

Jean-Marie's Views on the Economic Crises

Jean-Marie Eveillard is a legendary investor who is now semi retired. In June he wrote about his views on the economic crises. I disagee with alot of them but I found the read very interesting. He talks about different schools of economics. I definitely lean towards the Austrian school which is you must prevent credit bubbles but if they exist you must purge and go through the pain. Highly recommend reading it. Thanks goes to Nathan.

To the Austrian School, the original sin, something that Friedman did not emphasize at all, was committed in the 1920s by the monetary authorities letting the credit boom go on too long and be too strong. The conclusion of the Austrians was, “Hey, you have to be very careful about credit booms because a credit bust follows a credit boom just as night follows day.” And nobody listened to them in the '30s when they made that observation, apropos the Great Depression, after the original sin had been committed in the '20s. In a sense, the idea that after the credit boom you get a credit bust is something of a hopeless message. Indeed, the attitude of the Austrians was, don't try to get the economy back again quickly. You have to purge, let most of the excesses be purged from the system; which is not a very encouraging message.

I disagree that inflation is bad but deflation is worse.

Once the authorities could see that it was a major financial crisis, they have three ways to go. The first possibility was immediately discarded. That's what the Austrians were talking about, “Hey, there are major excesses in the system. They have to be purged.” To purge the excesses at that stage would have resulted in a return to the Great Depression. It's not just a matter of the politicians liking the idea of being re-elected, but they would not like their name in the history books saying they were responsible for a return to the Great Depression. Inflation is bad but deflation is worse. So, there was no consideration whatsoever given to the idea of purging the excesses.

The second possibility was similar to what happened in Japan in the '90s after their gigantic credit bubble. The Japanese managed to avoid, after a gigantic credit bubble, a real estate credit bubble, which resulted in almost unimaginable real estate prices and abusively high stock prices. Then the double bubble burst in late 1989 and the Japanese managed to avoid a return to the Great Depression, but had economic stagnation for 10 years. American economists, including Mr. Bernanke, heavily criticized the Japanese, saying the Japanese government and central bank really botched it and their policies were miserable. My own impression is that there were policy mistakes. Everybody makes mistakes, but if the Japanese policymakers did not make mistakes, they would have had to settle for five years of economic stagnation instead of ten. In essence, there is always a price to be paid, in life as well as in finance, for the mistakes one makes.

The third way to go was full speed ahead, “Damn the torpedoes,” what the French call, the flight forward. Both Mr. Obama and Mr. Bernanke used the expression, "We will do whatever it takes," to get the economy going again as soon as possible. Let's fight the deleveraging process every step of the way, let's get credit expansion going again, let's have the banks lend. It was a combination of monetary and fiscal steps, some of them unorthodox. The monetary steps taken by the Fed had never been taken before since the Fed was created in 1913. Not only did the Fed take short-term interest rates down to practically zero very quickly, but they also engaged in quantitative easing, which is code for printing new money as quickly as possible. On the fiscal side, we're talking about a budget deficit of close to $2 trillion. Mr. Obama has already indicated that it is not just this year that the budget deficit would be gigantic, but also for several years afterwards.

No comments: