Liquidation, Inflation, Or Growth?

WEDNESDAY, MAY 06, 2009

Liquidation, Inflation, Or Growth?

Giving liquidation a bad name

George will be starting from that place nobody would start from. According toMartin Wolf in today's FT:

"We have three alternatives: liquidation; inflation; or growth. A policy of liquidation would proceed via mass bankruptcy and the collapse of a large part of the existing credit. That is an insane choice. A deliberate policy of inflation would re-awaken inflationary expectations and lead, inevitably, to another recession, in order to re-establish monetary stability. This leaves us only with growth. It is essential to sustain demand and return to growth without stoking up another credit bubble. This is going to be hard. That is why we should not have fallen into the quagmire in the first place."

Well, quite.

But given we're here, what should George do?

Liquidation got itself rather a bad name during the Great Depression. Indeed, ex-President Hoover (right in pic) - Roosevelt's "guilty man" predecessor - sought to excuse himself by blaming:

"the “leave it alone liquidationists” headed by [my] Secretary of the Treasury Mellon (centre in pic), who felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. He held that even a panic was not altogether a bad thing. He said: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people”...

Since no modern politico is up for "purging rottenness", we can agree with Wolf that liquidation is out (and note how Hoover reckoned he wasn't responsible for the actions of his own Treasury Secretary - cf NuLab blaming their own quangos).

Inflation?

Ah, well, note that Wolf shimmies his argument into focusing on "deliberate inflation". And since no politico is ever going to stoke deliberate inflation, we can rule that out too.

Which means George has to pursue growth.

QED.

He has to follow the same recipe as Brown/Darling.

In truth, these are not the three choices before George at all: these are simply the Green and Scaly choices (do you want to do as I suggest, or do you want to go green and scaly?).

We all agree that growth is the way to go: the real question is how do we secure it?

Our present approach - as we've blogged many times - is taking far too much risk with inflation. It may not be deliberately stoking inflation, but huge government deficits combined with printing presses in overdrive are a surefire recipe for bigtime inflation down the road.

Brown/Darling don't care. Socialists always relish the chance to dispossess the rentier class by inflating away their savings, and besides, they'll be long gone before the inflationary ordure hits the whirling blades.

But we'll expect more from a Conservative Chancellor. Especially one who harbours ambitions to be PM in two or three parliaments' time.

The real question is how can George deliver growth without condemning us to another decade of unintended inflationary conflagration?

And there is only one realistic answer: he must engineer a fundamental rebalancing of the economy away from the inefficient public sector towards the market-based private sector. Which means:

• Big cuts in public spending
• Smaller but still vital cuts in taxation, especially income and business taxes
• Privatisation of many public sector activities, including schools and health (eg see this post)

He must also ensure the Bank of England acts early and decisively to reverse the huge monetary easing it has implemented. Today's press is full of stories about how green shoots are bustin'out all over, and by the time George gets in, some of them could be as high an elephant's eye. He will need to withdraw the fertiliser asap.

Given the depth of the quagmire, there is no easy fix. But unless George lays the foundations for sustainable growth led by the market sector of the economy, we are doomed to another decade of 70s style fantasy growth, ultimately collapsing in another inflationary spiral.

As we've said before, he shouldn't expect many plaudits from the FT and the rest of the economics establishment. But he has to do it.

Brace up, lad.

PS The Hoover quote is taken from an old blog written by Berkeley economics prof and longtime pundit Brad DeLong (here's his current blog). As you may know, Brad is a notorious self-confessed lefty, but he's also very interesting. On my brand-new ipod (why did I never get one before??) I've been listening to his lecture course on American Economic History (free from the istore). Fantastic stuff - his political position is certainly not mine, but he's so well informed, so clear, and so wonderfully prone to wander off-piste, it's compulsive listening. I've learned a lot.