Why Can’t We Deleverage Gradually?

The richest and most successful Keynesian on Wall St has summarized his current policy advice succinctly. The Fed should monetize all kinds of debt in order to keep the nominal economic growth rate north of the nominal interest rate. In this way, necessary deleveraging can take place gradually and less painfully.

This policy of course won’t work. Instead of letting the economy adjust to reality, it will just make more ( and more painful) adjustment necessary. It might be nice to have a short but  more technical explanation of why it won’t work. If one of you wish to take this on, I would be glad to share it with the Keynesian in question for response.

Apropos of this, although QE 2 supposedly ended, the Fed is still growing the monetary base at a rapid clip ( 4.1% over the last 26 weeks). As Ned Davis has pointed out, this is like QE 3 in disguise. Some of this may be an attempt to deleverage the economy gradually, but it may also reflect the Fed’s fear that the government securities market will collapse without help. Over the same half year, global central banks have provided monetary ” stimulus” at a rate equaling about 50% of what was done at the peak of the crisis.


  1. Hunter,

    I wrote a reply for you. Please feel free to use it as ammo:


    Summary of the dangers of low interest rates as a policy response to financial crises:
    • Prepayments, refi-s and balance sheet contraction create asset quality deterioration
    • Zombie institutions will gamble for resurrection with cheap funds and externalize risk
    • New loans and investments made in a ZIRP world will be systemically risky as investors search for yield

    • Thanks for all these responses.

      One point that hasn’t been addressed is the ” richest Keynesian’s” idea of a national growth rate and a national interest rate. Even if the former is meant to refer to GDP growth, what can the latter refer to? It’s a fiction. And just how is this fiction supposed to affect the economy? Actual interest rates of course affect the economy deeply, or rather affect individual industries and businesses, but how do we define an aggregated interest rate, much less explain how it is supposed to interact with “growth?” But if we abandon the concept of a national interest rate, then what appears at first glance to be a succinct policy prescription is revealed to be mostly a conceit.

  2. Also, I am not suggesting that successful entrepreneurs are merely lucky. Successful entrepreneurs seek creatively to satisfy the wants and needs of free consuming laborers, and some succeed better than others largely because they are more skilled entrepreneurs; however, even the most skilled entrepreneurs cannot predict profitability with much certainty in sufficiently free markets.

    In free markets, the most skilled entrepreneurs compete to predict prices that cannot be predicted precisely. The prices are unpredictable, because they emerge from complex interactions among free people. Competition among capitalists makes the prices even less predictable by increasing market efficiency.

    If the cleverest entrepreneur could predict market prices precisely, we might elect him King of the economy and subject ourselves to his enlightened, socialist planning. We are foolish to trust anyone with so much power, but political corruption does not explain the impossibility of socialist calculation in Austrian terms. Fundamentally decentralized information explains it. Even the cleverest, most virtuous planner cannot know what he needs to know to plan an economy satisfying free people.

    • One might add that amongst the information a central planner lacks is prices for capital goods. They are thus clueless in their bid to efficiently allocate these pivotal resources, to the degree that they want to at all.

      • Agreed. Predicting the price of capital in an efficient market is fundamentally difficult, but an entrepreneur can know the current price at least. Organizing capital most productively, in anything like a utility maximizing way, without market prices is impossible.

  3. The idea is so full of mistakes it is difficult to know where to begin, so I will pick one that the Fed is already making. The Fed is replacing bank credit with raw money, but the two have completely different functions.
    Money is the medium that allows us to turn the fruits of our labour into needed goods and services. Bank credit is generally applied to providing circulating capital for businesses and to buy goods of a higher order. Businesses and people who live beyond their means by drawing on credit for current spending go bust. This policy advice amounts to an institutionalisation of this error.
    The replacement of cash (income) by bank credit is what led to the housing bubble and its inevitable collapse. An acceleration of this policy as advised by our Keynesian will simply lead to the next financial bubble in very short order.
    Far from resolving economic difficulties it will make them far worse (if such a thing is possible!). I don’t know who this Keynesian is, but he is either pushing a vested interest or exhibiting an alarming lack of basic sense.

  4. Monetizing debt prevents the liquidation of productive resources frozen in unprofitable organizations. A financial “bond” is analogous to a chemical “bond” in this sense. If an economic organization held together by financial bonds need not dissolve when it is unprofitable, because a monetary authority substitutes nominal profitability for real profitability through inflation, then unprofitable organizations persist.

    If an organization is only nominally profitable, it doesn’t really add value to the resources comprising it. If money borrowed to organize the resources initially is worth more than money obtained to service the debt and thus hold the organization together, the organization need not produce goods more valuable than the goods it consumes. The more a monetary authority inflates, the more unprofitable organizations (in real terms) persist.

    The creative destruction of market capitalism is like evolution by natural selection. Central planners do not design profitable organizations. Even the private entrepreneurs that start successful enterprises do not design profitable organizations. Entrepreneurs only place bets on organizations that might be profitable, and some entrepreneurs win their bets while others lose.

    An entrepreneur cannot design profit into an enterprise, because he cannot design the choices of free consumers and free providers of the factors of production that he requires. At best, an entrepreneur designs a potentially profitable enterprise, hoping to satisfy these other factors profitably.

    An entrepreneurial enterprise is like a new creature resulting from the recombination of genes in sexual production. Entrepreneurial experiments must fail for economic progress to occur, just as creatures must die for evolutionary progress to occur.

    Here, I certainly do not advocate “social Darwinism” in the usual, disparaging sense of this term. Individual human beings are not entrepreneurial experiments. We don’t want human beings to die or long to suffer when unprofitable organizations dissolve. On the contrary, we want the process of creative destruction to find ever more profitable organizations providing humanity with ever growing wealth. Turning really unprofitable organizations into nominally profitable organizations has the opposite effect.

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