Freedom Lawyers of America

OR MAYBE IT DOES. LAST FOR TODAY.
Corrigan heads Capital Insight, http://www.capital-insight.com/default.asp
a financial consultancy. He was interviewed at the Mises Institute prior to
his lecture on the "What Happened to Recovery?" You can listen to the audio
of his speech here http://www.mises.org/mp3/corrigan.mp3 , and follow his
charts and research here http://www.mises.org/pdf/corrigan.pdf .
[Posted December 5, 2002]
http://www.mises.org/fullstory.asp?control=1108
MISES.ORG: It seems like the Austrian story of the boom is getting out there.
CORRIGAN: My sense is that many Austrians have described the process of the
boom very well. The literature deals very elegantly with how unwarranted
credit expansion leads people en masse to misjudge the capabilities of an
economy. The result is malinvestment which leads to overbuilding in
capital-intensive industries. In today's modern institutions, this leads to
a share price boom, company floatation, and all the symptoms we saw in the
upswing of the late 1990s.
In retrospect, this process has become better understood by the masses.
Even the Wall Street Journal has picked up on this. They still miss the key
element, namely that it has to be the elastic credit which fuels this
process. It is this elasticity that brings about an asset-credit spiral
that sucks more and more people in. It becomes effectively a firestorm in
the end. More credit is available, prices go up, that makes more collateral
available, that makes the asset look more attractive, the banks lend more
money, and round and round we go.
MISES.ORG: To think that the Austrian cycle theory was only recently
considered outmoded.
CORRIGAN: When, in fact, in today's extremely fast and liquid markets, the
credit-creation process of the Austrian cycle becomes more and more
exacerbated. Nowadays it is not just narrow money but nearly everything
these days in financial markets is a money substitute of some form or
other. We have clearing mechanism, netting mechanisms, we have derivatives,
and great deal of leverage. So now, a small amount of money, however
narrowly defined, can exert an enormous impact on asset prices.
As we know, once prices go up, everyone wants to buy because things are
going up. We might even know that there is no underlying income in these
companies. We just buy them because prices are going up.
So it is true that the process of the boom, and what went wrong-the
symptoms, if you will-are much better understood. The link to credit
creation is not as widely understood, but we are getting there. Greenspan,
for instance, has been coming in for some unwanted criticism. This is not
something he is used to.
MISES.ORG: But also, in your work, you have closely tracked the unfolding
of the bust.
CORRIGAN: Austrians have given far less attention to the process of the
bust. For ordinary people looking after savings, and for people in
financial markets trying to make decisions, the critical thing is not the
pathology of what happened. It is the prognosis of what might happen in the
future, as the bust unfolds. This is very unclear, and the Austrian
literature is somewhat lacking in this respect.
In the main literature, we get the boom and the collapse, and then most
authors try to glibly say that in the hopeful case when government does
nothing, prices and costs become more equilibrated, wages have adjusted,
financial capital is written off, and therefore physical capital which
still persists can be better used. Therefore, we have come down so far that
the only place we can go is up again. All of this is clearly stated.
But in today's world, the liquidation is never allowed to take place. Every
single fiber of government and central bank policy is designed to avoid the
liquidation. The literature is quite unclear about what will happen in this
case.
Rothbard, I think, said that new credit creates another boom on the back of
the ruins of the old boom. But there is no clear guiding path. Richard
Strigl deals with it
http://www.mises.org/store/product1.asp?SID=2&Product_ID=106 a little bit.
He says that we never quite liquidate the previous boom, and that seeds of
another boom are always coming through. Some of Hayek's work deals with the
concept of capital consumption, which is very relevant to where we are today.
MISES.ORG: You find his triangle of production stages to be useful, then.
CORRIGAN: Yes, but I tend to think of it as a cone, because we have a flux
of goods and services moving through these cones and they have to go
through each successive stage. The cone gets over- lengthened in the boom.
We put too many resources in capital intensive industries, far way from the
end point of consumption. There are not enough resources to see these
profitably all the way from their inception through to their consummation
in individual consumption. We then have a shortening process as this boom
is being eradicated and collapsing in on itself.
Today's economy tries to overcome this by fostering consumption at any
expense. Debt-led consumption, credit-created consumption, spending
consumption: these stretch the cone the other way, shortening it as fast as
the higher industries try to keep up and find a foothold. It's as if the
cone is closing up even as business is trying to get back on the surface.
In this process, we therefore must be eating what we did not cook and
burning what we did not plant in the forest. We must be consuming capital.
We are taking the assets that remain to us today and monetizing and
spending them, or we must be borrowing against tomorrow's income and
thereby alienating what may come in the future, but which may never come
because this process is so destructive.
As business tries to reorganize itself, the structure of production is
changing faster than they can adapt. To move people and skills and fixed
capital, some of which may be very specific, to the industry in which it is
best employed can be problematic. This whole instability of credit and
interest rates and foreign currency parities is hugely detrimental to the
process. We are at the stage here in which it is clear from the financial
market evidence that while nonfinancial corporate profits have stabilized
in the last four to five months, they stabilized at levels which are in
current dollars where they were before the boom started.
But this new stability is an uneasy one. It does look, insofar as we can
judge aggregate statistics, like these companies are not replacing old
capital and they are not investing new capital. The depreciation levels
against the fixed-investment levels are at the narrowest margin that we've
seen in fifty years. In addition, where companies have reported profits
recently, when we strip out the one-off gains that they are still trying to
book, any profitability has come at the expense of cost cutting, both on
capital expenditure and on the payroll. So clearly, these companies are
trying to adjust to the fact that the useful capital stock has shrunk.
At the same time, we're encouraging everyone to go out and buy cars at zero
percent and houses with the lowest mortgage rates in 40-odd years. We are
encouraging people to consume ever-more capital, today's and tomorrow's.
The debt will have to be paid for at some point.
MISES.ORG: In real estate in particular, Freddie and Fannie were just
approved to accept higher-end mortgages.
CORRIGAN: Yes, Fannie is particularly bad in this way. But both Freddie and
Fannie are doing everything possible to encourage more debt. They have
online mortgage applications. You can even get an online appraisal of your
house.
There is a subterranean literature on the fringes of the mainstream press
about how the appraisal process in home loans has been corrupted in this
boom. The appraiser is paid if the loan goes through. Therefore, the
potential borrower or purchaser or even the vendor can prod the appraiser
to give a higher evaluation, just to get the deal done. Even with the
inflation in prices that we've seen, it's worse than it looks because the
house values aren't there in the first place.
MISES.ORG: Sounds a bit like the relationship between auditors and
corporations.
CORRIGAN: Inflations corrupt people, one way or another. Whether it is
through peer pressure or the pressure of commercial business, people are
pushed to cut corners.
MISES.ORG: Does anyone really believe that all this credit-fueled
consumption will help?
CORRIGAN: We have this curious cognitive dissonance at work. People are
borrowing hand over fist to buy houses and re-mortgage their houses to
maintain their standard of living. This means that they must, somehow, have
adopted an inflationary psychology. On the other hand, everybody is
terrified that the Fed is going to allow the economy to lapse into
deflation, that is, allow prices to go down. This schizophrenia pervades
the whole of the economic debate, from the man in the street to the top
traders on Wall Street. And nobody seems to be able to rationalize,
clearly, what the differences are.
At the Fed and the Treasury, you have this Keynesian view that the economy
operates like a toilet. You pull the handle and it empties, and then the
water automatically fills back up. The view is that if consumers empty the
stores of stuff, the stores will fill up again, and everyone will make
money. So they don't understand the intricacies and complexities of what
goes into a modern economy. To use another analogy, they believe that so
long as the fire is burning in the house, the logs will be put on it. They
don't seem to consider the possibility that you can be burning the
furniture and, indeed, the house!
MISES.ORG: What are the prospects for deflation?
CORRIGAN: It's true that we have such an unsupportable pyramid of credit on
such a miniscule base of real income. The idea that there could be a
cascade of debt default and asset fire sales is a real possibility. And yet
the Fed and central banks around the world-excluding somewhat the European
central bank-have clearly said that they will do anything to prevent
deflation.
The Fed has changed the rules under which they can inject liquidity into
the system. The Fed has made several
overt statements of intent that, if necessary, it will buy
anything-corporate securities, mortgages, physical assets-it will conduct a
"money rain" if it has to.
MISES.ORG: You are thinking in particular of the statement by Fed Governor
Ben Bernanke
http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm .
CORRIGAN: Yes. He said: think of it this way. If we were alchemists, we
could create more gold and drive the price down as low as we wanted. He
continued on to say that the Fed has that alchemy in the printing press.
This is the central bank that is supposed to be the guardian of stable
money! It's unbelievable. But, in my view, it would take a real crisis for
the Fed to resort to unlimited money creation by whatever means necessary.
There's a statement in that egregious book of hagiography called Maestro in
which it is said that Greenspan is prepared to take emergency measures, as
when a fire-truck drives down the wrong way of a one-way street in order to
put out a fire. In other words, he'll do what it takes. We saw this in
Mexico, Asia, and the dealings with Long Term Capital Management. We saw it
on September 11, when it was strongly rumored that mutual funds were
offered credit lines by money-center banks and by the Fed, so that the
funds wouldn't have to sell all their stocks. Whether or not this is true,
I can't say. But senior people in financial markets give it credence.
As for the short term, the Fed does have a very serious problem to deal
with. Somehow or other, we need to get the monetary value of our
liabilities in line with the monetary value of the real income we can
produce. There is a huge disparity now. A great wedge has been driven
between the two. The problem can be addressed through inflation or
deflation. We know which the central bank will choose.
MISES.ORG: Many have compared the current state of the US with that of Japan.
CORRIGAN: There are some differences. The Japanese banking system got
itself tied up with the land boom. It wasn't so much a share price
inflation as it was a land collateral inflation. Remember the tales of the
day when the real estate of the Emperor's garden was said to be worth more
than Canada. While we may not necessarily value Canada all that highly,
this is something of an unreality.
The Bank of Japan has been accused by the Fed of acting too timorously in
the aftermath. But the BoJ has disputed this vigorously. The Bank points
out that the collapse would have happened whether it had warned people or
not, and, in addition, there are rules and regulations and regimes and
constitutionality questions involved that might have prevented substantial
intervention. Of course in Japan, the crisis was entrenched not just by the
monetary policy but by the rigidities of the Japanese economic system.
The Japanese come in for some undue criticism now. They have made great
strides. The total of the debt involving corporate bankruptcies over the
last four years is $670 billion. That's about 4% of GDP every year for four
years. That is much higher than the US economy has managed, even with the
somewhat easy regime of Chapter 11. So the Japanese are tackling their
problems. It's just that the problems are so enormous and so entrenched.
Obviously, as in any country, politics intrudes to take short-term measures
that prove detrimental: witness the way the Bush administration has handled
this.
MISES.ORG: As one of the first to predict the bust, have you been basking
in glory?
CORRIGAN: Of course not. Immediately after the bust came, we had a long
period of denial. First we were told that technology had abolished the
business cycle. Then it was said to be merely a dot com bust, but then it
was a telecom bust as well. Then Greenspan was to give us a soft landing.
Then we were to have a V-shaped recovery. Then the recovery was to be
U-shaped. Suddenly it began to look W-shaped. And now, everyone is consumed
by the fear of deflation.
Remember that all the predictions come from the same people who thought the
boom could last forever. To know what's ahead, you are far better off
reading books on Austrian economics than listening to the latest forecasts
from economists, which are made with rulers and a couple of debatable
assumptions.

MISES.ORG: Thank you, Sean.