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OpEdNews Op Eds    H3'ed 7/2/09

Liquidation and Creative Destruction.

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"It seems an extraordinary imbecility that this wonderful outburst of productive energy [over 1924-1929] should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much over-expansion, as they call it; a nemesis on man's speculative spirit. It would, they feel, be a victory for the Mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a 'prolonged liquidation' to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again.

I do not take this view. I find the explanation of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding up to the spring of 1929, but in the subsequent cessation of this investment.

I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity... [p. 349].
While some part of the investment which was going on in the world at large was doubtless ill judged and unfruitful, there can, I think, be no doubt that the world was enormously enriched by the constructions of the quinquennium from 1925 to 1929; its wealth increased in these five years by as much as in any other ten or twenty years of its history...
[p. 347].
Doubtless, as was inevitable in a period of such rapid changes, the rate of growth of some individual commodities [over 1924-1929] could not always be in just the appropriate relation to that of others. But, on the whole, I see little sign of any serious want of balance such as is alleged by some authorities. The rates of growth [of different sectors]seem to me, looking back, to have been in as good a balance as one could have expected them to be. A few more quinquennia of equal activity might, indeed, have brought us near to the economic Eldorado where all our reasonable economic needs would be satisfied...
[pp. 347-48]."

John Maynard Keynes
The General Theory and After.
Part I, Preparation.

The fact of the matter is that it is the enormous amount of savings and investments that did cause the vast increase of Income Disparity [ID] and, hence, the vast decrease of long-term interest rates that caused the Keynes' Liquidity Trap and the Great Depression.

I want to stress something here: although Keynes discovered the Liquidity Trap he never claimed it was the cause of the Great Depression. In fact, Keynes, contrary to my theory, believed it had no cause, he thought it was due to a random phenomenon. Having no cause, he didn't have to care for them, only cure the symptoms and the sickness would be gone!

In order to get out of the Keynes' Liquidity Trap, you need to increase ID above its Liquidity Trap value. How can this be done? We see that ID is independent of the price level. It only depends on income repartition. Is there any way that a Depression or a Economic Policy changes ID in a meaningful way and hence gets us out of the Liquidity Trap?

At first sight, some might think that a crash would lower the ID. But in fact the poor lose even more income (proportionately) than the rich. Hence in a Depression ID increases and doesn't decrease.

In fact, the Wealth Disparity being independent of price level is dependent on the distribution of the physical assets. Only their physical destruction alters in a meaningful way their distributions.

An arbitrary increase of lower incomes can instantaneously increase demand. However, because it doesn't change the Wealth Disparity [WD] it can't have a lasting effect on ID, hence on Demand.

In order to get out of the Liquidity Trap you need a drastic New Deal, a a new repartition of wealth and incomes. In a capitalist economy the only way that can be done is by the physical destruction of productive assets through rust or war. That can take an excessively long time or be extremely deadly.

The only way Capitalism knows how to get out of a Liquidity Trap is through Liquidation (May be this is why Liquidity Trap and Liquidation have the same origin). It is not that I like it or enjoy it: it is a mathematical fact: I am not a Liquidationist, Capitalism is Liquidationist!

A striking example of Liquidation or Creative Destruction is WWII. I will show that is is the almost necessary consequence of the Great Depression. No one, I hope, is saying it is something we want to repeat, even if it brought some of the fantastic historic economic growth we have witnessed since.

"Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence."
John Adams US diplomat & politician (1735 - 1826) Argument in Defence of the Soldiers in the Boston Massacre Trials. December 1770

Don't get me wrong; I am not saying that you shouldn't use a Keynesian fiscal stimulus in order to keep some sort of aggregate demand, I am just saying that it wouldn't be enough to get an economy out of a Liquidity Trap. No fiscal or monetary policy can get an economy out of a Liquidity Trap (confer Chapter IV: Economic Policy in a Depression.). Although it is a necessary evil, we must be aware that a long period of Keynesian intervention will necessarily stifle the free market forces and would give raise to arbitrary economic policy by those who would decide which venture will be funded (Private bank and financing don't work in a Liquidity Trap.) and which sector would be the customers of the government.

"But this long run is a misleading guide to current affairs. In the long run we are all dead.

Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again."

John Maynard Keynes A Tract on Monetary Reform. Ch. 3 1923

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Shalom P. Hamou Tel Aviv, Ramat Aviv, Israel I am the youngest economist at My Yield Curve. Since spring of 1994 I have been working on economic depressions. I am writing The Tract The Religious Interpretation of (more...)
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