Saturday, September 18, 2010

Pricing clearing to restart the Economy

In my previous post, I left out the most urgent mistake we must somehow fix to clear the markets.

Bryan Caplan explains the issue in his post regarding the auctioneer.

I give my two cents worth in the comments:

While I agree with your post, I am surprised by your answer. The market is not clearing because the Federal Reserve and the Government will not allow it to clear.
Do we really believe propping up residential and commercial prices on fake bank Balance Sheets does not have a freezing effect that ripples throughout the whole economy?
Bailing out the banks and preventing the market adaptation (sell-off) that would have occurred (yes, some of it at very depressed prices) would have resulted in a quick but painful re-arrangement of the economy. But then it could move on and repair itself.
TARP ended up being very stupid, because the toxic securities were never repriced and cleared, which is what Paulson originally said his purpose was. They sit like moldering wheat, festering away in a barrel. Bankruptcy and liquidation of those securities would have helped clear the markets.
The auctioneer is not senile. He is frozen. He refuses to go down when there is no bid. He is preventing the market from working at all.
The stimulus is doing the same thing. It is freezing the auction from taking place. It is not allowing the public employees, where all the stimulus is being spent, to revalue.
Until the auctioneer begins calling prices again according to the rules, we will limp along half in and half out of recession.
 Those toxic assets must be repriced.  That means a lot of mortgages will need to be rewritten.  Many people will need to move.  Real estate will collapse for a short period of time.

But the economy can not revive until a market is made.  Right now, there is no market.

Troy Camplin then chimes in with the perfect rejoinder:
Perhaps equilibrium is as mythical as the Walrasian auctioneer. Any dynamic, evolving network process -- like an economy -- is on the edge of order and chaos and, thus, in the far-from-equilibrium realm where creativity is maximized. Thus positing equilibrium to be anything even close to a reality is like accepting the geocentric view of the universe or the homonoculus theory of mind. Economics has to get caught up with 21st century science, and leave 19th century science far behind.
Exactly. Keynes and Marx assume the economy is a statist 'thing' that is in a state of equilibrium. That is not true at all.

Economies and markets are complex systems that are in continual adaptation, like a huge ant colony self-autonomously finding value in their environments. The auctioneer sets the price at which all the participants trade and exchange their goodies.

UPDATE: In further comments, a professor suggests that the economy is more accurately viewed as a flea market than an auction, where people do not necessarily need to buy or sell.  I like that.

My above stipulations regarding the government fits in even better with that analogy.  It is preventing the vendors and the buyers from reaching a settlement.


  1. The federal government is doing a number of things that are preventing the kind of restructuring necessary for the economy to recover. They are artificially propping up prices of the very things that are overprices, and which need to readjuct to real market prices for the market to recover. More, they are discouraging people from retraining (one way of which is to get another job rather than wait for your old job to return while getting unemployment). Thus, capital -- both physical and human -- remains misallocated. So long as it remains misallocated, we will remain in recession. Thus, we remain in recession.

  2. Exactly.

    Fully utilized adaptive systems are achieved through utilization of both capital and human investment.

    It is not a demand issue as Keynes says.

    Government stimulus does not inspire either. In fact, it retards it.

  3. Government stimulus makes the Keynesian mistake of thinking it's a demand issue. That's why it won't work. Of course, the stimulus is merely a reflection of people's folk economics -- which gets economic reality mostly backwards -- and Keynesianism is merely folk economics with a gloss of math to make it appear respectable.