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Jukebox Economics

02/15/2010Bob Hoye

     Jukebox economics is a suitable description of the notion that the economy can only be kept going if the government feeds it quarters. Otherwise something bad would happen. Then as the signs of contraction appear, the establishment immediately boasts that a well-timed cut in administered rates will keep the "recovery" going. The problem with this economyth is that short-dated market rates of interest have always declined with a contraction. Moreover, where data are available the senior central bank has always followed important trend changes in market rates – by a number of months.

   The next step on the path to policy absurdity is on the subsequent liquidity crisis government concludes that unless it throws some quarters into the jukebox the panic will not end. All panics exhaust themselves naturally.

   Then, typically, authorities claim that their inspired intervention ended the crash. This was the case with the crash subsequent to the mania that blew out in 2007, when the traditional change in the credit markets signaled the start of liquidation of unsupportable positions in stocks, corporate bands and commodities.

   In early 1930, the Fed announced that that it had met the crisis in the classic way by discounting "liberally". With the vigorous rebound in financial markets the Street as well as the Harvard Economic Society boasted that problems were over and that a solid recovery was underway. This prevailed some six to nine months after the crash had ended, and the establishment was confident that throwing credit at a credit contraction would make it go away. The modern jukebox had yet to be invented and the term was "priming the pump".

   This time around, in the attempt to end a liquidity crisis, the government has primed the pump with enough to flood the low lands in at least 25 states. To what avail? The Dow accomplished a fifty-percent retracement of the crash, which matches the rebound of 1930, when Barron's noted that the "urge to speculate was just as speculative as ever" and that it would be difficult to "quench the fires of enthusiasm". Some six to nine months after the panic ended last March, similar speculation and confidence is widely apparent. The government has been feeding jillions of quarters into the jukebox and it has been playing tunes the government wants to hear. With this, cheers for Keynesian interventions have erupted – again.

   The problem is that restoration of prosperity is a natural rebound out of the worst financial crash since its equivalent 80 years ago. What's more, changes in 2007 that signaled the beginning of the credit train wreck are at it again. Corporate spreads have been widening, which is the alert on the availability of credit and copper's 21% plunge is an alert on the economy.

   There are two ways of looking at recent financial history. One is the view of those who think that the prosperity of asset inflation is a result of policy and that such policy will continue. The next phase of this is the discovery of a crash, when policy consensus immediately shifts to the notion that if government doesn't do "something" it won't end. Then on the rebound natural to a crash – a round of self-congratulations follow. Ironically, interventionism did not anticipate the crash.

   The other way of looking is from the point of view of a trader. Markets go up and markets go down, and the bigger the boom the bigger the bust. In the Seventeenth Century, when the Netherlands was the financial and commercial center of the world, Dutch traders described the good times as due to "easy" credit and the contraction as associated with "diseased" credit. Makes sense.

   What makes less sense is the idea that something needs to be done to prevent contraction, which is not a new idea. Actually it is a knee-jerk reaction to the sudden discovery of hard times that always follow an excess of speculation. Soaring confidence can inspire both governments and the public to dangerous behaviour.

   One of the earliest such examples occurred with the crash form 1618 to 1623 that marked the culmination of a century of chronic price inflation and experiment in authoritarian government. Perhaps disturbed by something he did not understand, Edward Misselden proposed that throwing credit at a credit contraction would make it go away – bringing back the prosperity of a boom.

   This was well before jukeboxes and the notion was independently revealed in similar financial conditions to John Law in the early 1700s. Even the highly-regarded editor of The Economist in the 1873 mania, Walter Bagehot, was convinced that throwing credit at a credit contraction would make it go away. That post-bubble contraction was eventually called the "Great Depression" and it lasted until 1895.

   Irony of course always prevails at the nexus of markets and intellectualism. That contraction was still being analyzed as the "Great Depression" until as late as 1939.

   In a short piece, The Dearth of Credit, Mises observed that all that was needed to initiate the contraction was that banks did not need to call loans, but just to become concerned enough to stop making them.

   In market terms, at the start of all seven great contractions since 1720 the margin clerk has always trumped the ambition of the state to keep the party going. In today's terms, Mister Margin is about to pull the plug on financial jukeboxes – again – even the big ones run by central bankers.

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Contact Bob Hoye

Bob Hoye heads up Institutional Advisors, a team that has been providing financial research for a couple of decades. Hoye has had articles published in Barron's, Financial Times, and other media. His speaking engagements have been in Manhattan, London, Toronto, New Orleans, Tokyo and Osaka.

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