Liquidation is Vital

Many Keynesians really hate the concept of liquidationism. I’m trying to grasp why.

Paul Krugman wrote:

One discouraging feature of the current economic crisis is the way many economists and economic commentators — apparently ignorant of what went on over the last 75 years or so of macroeconomic debate — have been reinventing old fallacies, imagining that they were coming up with profound insights.

The Bank for International Settlements has decided to throw everything we’ve learned from 80 years of hard thought about macroeconomics out the window, and to embrace full-frontal liquidationism. The BIS is now advocating a position indistinguishable from that of Schumpeter in the 1930s, opposing any monetary expansion because that would leave “the work of depressions undone”.

Andrew Mellon summed up liquidationism as so:

The government must keep its hands off and let the slump liquidate itself. Liquidate labor, liquidate stocks, liquidate the farmes, liquidate real estate. When the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. A panic is not altogether a bad thing. 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.

In light of the zombification that now exists in Japan and also America (and coming soon to every single QE and bailout-heavy Western economy) — zombie companies, poorly managed, making all the same mistakes as before, rudderless, and yet still in business thanks to government intervention  — it is clear that the liquidationists grasped something that Keynesians are still missing. Markets are largely no longer trading fundamentals; they are just trading state intervention and money printing. Why debate earnings when instead you can debate the prospects of QE3? Why invest in profitable companies and ventures when instead you can pay yourself a fat bonus cheque out of monetary stimulus? Why exercise caution and consideration when you can just gamble and get a bailout?

Unfortunately, Mellon and his counterparts at the 30s Fed were the wrong kind of liquidationists — they could not heed their own advice and leave the market be. Ironically, the 30s Fed in raising interest rates and failing to act as lender-of-last resort drove the market into a deeper depression than was necessary (and certainly a deeper one than happened in 1907) and crushed any incipient recovery.

Liquidation is not merely some abstract policy directive, or government function. It is an organic function of the market. As the stunning bounce-back from the Panic of 1907 shows — especially when contrasted against the 1930s — a  market liquidation on the back of a panic avoids a depression. Prices fall as far as the market deems necessary, before market participants quickly come back in into the frame, setting the market on a new trail toward growth. For without a central bank, asset-holders who want to maintain a strong economy and growth (in 2008, that probably would have meant sovereigns like China and Arabia) have to come in and pick up falling masonry as lenders of last resort.

Under a central banking regime (especially a Bernankean or Krugmanite one committed to Rooseveltian Resolve) all expectations fall onto the central bank.

My own view is not just that liquidation is vital. It is that the market mechanism is vital. Without their own capital as skin in the game, central bankers are playing blind. The pace of the liquidation and the pace of the recovery should be dictated by market participants — in other words, by society at large — not by the whims of distant technocrats. Society has more skin in the game. The Great Depression was not a crisis of too little intervention — it was a crisis of too much well-intentioned intervention.

As we are learning in our own zombie depression, a central bank doing the opposite of the 1930s Fed and reinflating may solve the problem of debt-deflation, but it causes many of its own problems — zombie banks, zombie corporations, zombie markets, corporate welfarism, and the destruction of the market mechanism.

28 thoughts on “Liquidation is Vital

  1. Mellon was not a liquidationist, he was the exact opposite of it. Hoover attributed this quote to Mellon in order to make himself look like the good interventionist he actually is and make Mellon look like a liquidationist.

    Another myth of modern macro perishes. The policies of Hoover and his treasury were interventionist and reflationary. In fact, when FDR beat Hoover, he did so with an anti-interventionist and fiscally conservative platform. When he got into power, however, FDR played politics with the power groups of the time, which meant he reverted to Hoover’s failed interventionism and increased it. As this inevitably failed, history was rewritten to make Hoover and Mellon look like free marketeers who made the depression last till 1945 with their free market dogma, whereas FDR’s New Deal is the reason for the recovery–the recovery that only actually started in 1945 after the end of most New Deal, military and Keynesian policies.

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  8. So liquidation is good, stimulus is good, austerity is good (sometimes), spending is good, raising the interest rates is sometimes good/sometimes bad, a lender of last resort is good. How can we mix all these together in the right amounts and when needed? Why, with a good central planner in charge to decide it all!

    • Yeah, this is the problem, Andrei. I suppose you’re answering my question. The bulk of Keynesians hate organic market liquidations because they believe markets and wider society are stupid and incompetent, and that’s my fundamental disagreement with Keynesians even if share some ground with them at other times.

    • With enough computers, bureaucratic assistants to prepare reports (India has good outsourcing bureaus) our Keynesian Gods have the information they need to “tweak” the economy and get the “outcome” they desire to ensure reelection.

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  10. I believe we have a mix of mostly valid history with a little error.

    Mellon –1920s SecTreas under Presidents Harding and Coolidge — reduced sky-high taxes and other government obstacles to free markets. The post-war recession/depression was replaced by prosperity, with unemployment reaching a low of 1% in 1926.

    But, regrettably, Saifedean’s account of Hoover’s and FDR’s counter-productive government intervention is correct.

  11. Hey John,
    You do a great job of describing the things that so many of us feel, but can’t find the words for. The system needs to puke, but TPTB won’t let it (because they are the disease).

    I like how you imply a lot with few words, but I think the “trickle-down” effect of zombification warrants discussion. The collapsed bank that is allowed to stay in business prevents the purge of incompetants; The failed small business who is already into the bank for a couple million slurps up the credit that should go to finance people with better ideas, while siphoning the purchasing power of the prudent.

    As Herbert Spencer observed “The ultimate result of shielding men from the effects of folly is to fill the world with fools.”

    What’s so disheartening about that is that it isn’t very long until stupidity passes for wisdom, and the way society values everything gets more and more distorted,. Sicker and sicker.

    Can’t we just puke?

    Keep up the great work,


    • Agreed. How many undergraduates are believing the system. I know I was one if them until I found alternatives ideas via the web and discourse such as the ine we are having.

      I feel when enough people lose their life savings, they will want answers and when they find out why they lost their money, they will be very angry and ask for political change.

      The best solution goes all the way back to Bastiat. It is simple in that the general public can grasp it. The economy is too complex to control, much like nature, and when we stop playing god, things will improve for us.

      Voters will reject Politicians who promise to “fix” things. They will be seen as meddlers and dangerous.

      Socialism is akin to flirting with alcohol when you are young. At first you are going along with the group having a blast, you then wake up with a headache and a tattoo on your forehead!

      Let the liquidation begin. Lets find out what is important to our economy, and what is superfluous.

  12. Right on, Mark! There must be clever observations on the results of shielding from the effects of the Seven Deadly Sins — the world is filled with such sinners!

    What is “TPTB”?

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  21. The best option for all of the people involved may be liquidation, a process during which the business is closed and all of its assets are sold in order to pay off remaining debts.

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