No theory can stop recurrent boom and bust ( it's the nature of things -- live with it ! )

In 1847, a Dr Hyde Clark wrote a paper entitled Physical Economy - a Preliminary Inquiry into the Physical Laws Governing the Periods of Famines and Panics. His paper was published in the Railway Register.

It opens with the comment: “We have just gone through a time of busy industry and are come upon sorrow and ill-fortune; but the same things have befallen us often within the knowledge of those now living...a period of bustle, or of gambling, cut short in a trice and turned into a period of suffering and loss, is a phenomenon so often recorded, that what is most to be noted is that it should excite any wonder.” We can say that again in 2008.

The 1840s were the period of the great railway mania and of Sir Robert Peel's Bank Act. They were one of the periods in which economists were concerned to explain economic crises and, if possible, prevent them recurring. We are back in such a period and should expect a similar public debate. Within a few days, the 2008 crisis has overwhelmed leading banks in the United States and Britain; the US Administration has had to pledge unimaginably large sums in defence of the surviving banks. The US Government has taken on contingent liabilities of more than $1 trillion.

At least Dr Hyde Clark enables us to put this crisis in ahistoric context. There had been crises before the 1840s, including such spectacular events as the collapse of the Dutch tulip mania in the 1630s. There have been crises since the 19th century, including the Great Wall Street Crash of 1929. We are not dealing with a unique phenomenon now, but with a recurrent event that the world economy has always survived in the end.

Very interesting article which tries to inform us that booms and bust are like hurricanes -- they are a force of nature that we have to learn to live with.

I found this part of the article to be quite informative :

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"In 1847 Samuel Jones Loyd, a London banker who became Lord Overstone, wrote his classic description of the natural lifecycle of trade. “We found the state of trade subject to various conditions which are periodically returning; it revolves apparently in an established cycle. But first we find it in a state of quiescence, - next improvement, - growing confidence, - prosperity, - excitement, - overtrading, - convulsion, - pressure, - stagnation, - distress, - ending again in quiescence.”

We can take it that our present stage is one of “convulsion”, and that we may be moving on through pressure towards stagnation and distress. Anything that could be called recovery may be some way away.

A number of economists have tried to construct new theories that would stabilise the trade cycle and at the same time stabilise prices. This has engaged the attention of economists of the standing of David Ricardo, W.S. Jevons and Maynard Keynes, of the English school, and of the American, Irving Fisher. There was also a brilliant contribution from Ludwig von Mises, of the Austrian school, who came to the conclusion that this task might be impossible. That will not stop people trying again and again."

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In essence, I think what the author is saying is this --- it is futile to try to solve the problem of booms and busts -- just let the market heal itself.

I would agree that it is futile to always try and have endless economic upturn, with two interesting propositions.

First of all, economic upturn and downturn have two important elements, severity and time. If you have time, you can often mitigate upturns and downturns to be less severe. It still happens, but with far less disruption.

However, and this is the real devil we are facing right now, the economy we are in right now is an *experimental* economy, different from the pre-WWII economy that had existed for centuries and proven itself. And it is only now obvious that this new, *experimental* “Frank Roosevelt” economy has a fatal flaw.

Only since WWII, has there been a surfeit of easy credit. Before then, “loans were only for people who didn’t need them.” Literally, unless you had close to 100% collateral, you could not get a loan.

So the US government went on a spending spree, on credit. There were a seemingly endless supply of people willing to loan the US government money, so the US government spent all its tax revenues, and took out loans on top of that. Now we directly owe $9.7 Trillion that has to be paid back. 9%, and growing, of the annual federal budget is just the interest on that debt.

To make matters much worse, corporations, speculators and individuals did the same with easy credit. This created “imaginary” money, completely disconnected from reality. And just one unregulated market, called “derivatives”, is tossing around some $130 Trillion.

The difference between “real” money and this “imaginary” money is now so great, that it would serve our economy very well for the US government to print high denomination currency from $100,000 to $10,000,000 bills, to give to critical corporations in exchange for a ‘virtual’ equivalent amount of money.

These bills could only be owned, and spent, by authorized corporations, not individuals. And they could only be used or transferred for any reason, with government permission, to another authorized holder. This would provide several very important functions.

First of all, these corporations would have “guaranteed collateral”, so that no matter what happened to the rest of their money, they would still be able to get loans to operate their core business, up to 100% of their paper money. The paper could not be used for other purposes or debts, or transferred between individuals, only corporations.

Importantly, they would still have their virtual, ordinary money that would have no such constraints, so their net income could drop to zero, yet they would still be in business. They would still pay their employees, still obtain raw materials, etc.

Second of all, those corporations that collect cash as part of their business could be given these controlled bills in exchange for an equal amount of low denomination currency, so some of it would remain in the economy as well.

It is becoming increasingly likely that the US government is soon to face a default of its long term treasury bills. If it does so, then officially the US government is bankrupt.

The experiment will have been concluded, and our economy will have to return to a “cash” instead of a “credit” economy.

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