The forest for the trees

Who's handling the economic crisis better -- the US or Europe? Today, New York Times columnist Paul Krugman points out the stark differences in response. His conclusion is that by doing less, Europe is asking for more trouble.

Krugman writes:

Europe has fallen short in terms of both fiscal and monetary policy: it's facing at least as severe a slump as the United States, yet it's doing far less to combat the downturn.... Many economists, myself included, have argued that the Obama administration's stimulus plan is too small, given the depth of the crisis. But America's actions dwarf anything the Europeans are doing.

The difference in monetary policy is equally striking. The European Central Bank has been far less proactive than the Federal Reserve; it has been slow to cut interest rates (it actually raised rates last July), and it has shied away from any strong measures to unfreeze credit markets.

I found another viewpoint in of all places, a real estate blog. The author says the Federal Reserve could learn a thing or two from the US Forest Service. For decades, the Forest Service policy used to be: put all fires out quickly. Don't let anything burn. Protect as many trees as possible for timber production:

To its chagrin, the US Forest Service discovered its policy was flawed. By not allowing small fires to burn, leaf litter and other combustible natural growth accumulated. In unmanaged forests, periodic fires eliminate this source of fire fuel. In managed forests this accumulation of fuel fosters fires that get out of control.

The Forest Service changed its policy and allowed smaller fires to burn. The article continues:

Just like the accumulation of fire fuel on the forest floor, our economy accumulates unsound business plans, Ponzi Scheme financing arrangements, idiotic investment strategies, and behavioral moral hazards. Recessions are supposed to be the small fires that destroy these destructive agents, but when the Federal Reserve manipulates interest rates and stimulates the economy, recessions are not allowed to serve their purpose, and the economic problems pile up.

Obviously, this about the Fed's policies over time, not just the crisis management mode we're in now. But it does relate to the issue of doing something versus doing nothing. At what point does manipulation of the economy backfire? The Fed shouldn't shoulder all the blame for this economic implosion, but it's certainly worth discussing how much is too much and in Europe's case, whether less is sometimes more.

It's hard to believe we're talking about Europe being more laissez-faire than the US. But here we are. On the other side of this crisis, it'll be interesting to see whose forest is in better condition.

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Nice add, Ethan. I particularly like what the Agriculture Secretary says: "We've had these fires that have become extraordinarily intense because there's a lot of fuel. And there's a lot of fuel because we've taken money from the maintenance budget and using it to fight fires. So we've got to stop that practice."

If I didn't know I was reading about forest fires, I might think that pertained to something else...

Lately I have been wondering if we still have the stomach for capitalism that we used to. Every recession that goes by it appears we yelp louder for a quick fix even though (as the author explains) the recession IS the fix. This time maybe we should all put our big boy paints on and sacrifice, reinvent ourselves, etc. Don't just let it burn, but at the same time don't overreact to every little down turn going forward. Sounds like good policy to me.

As tempting as it is to think of this as a supremely geeky, economist version of the Super Bowl ("QB Geithner's off to a rocky start playing for the States, but European team captain Merckel still refuses to call the first play!"), surely the US and European economies are far too intertwined to make such an analysis- even postgame- possible?

Ciara, I like the play-by-play. I wasn't trying to portray it as a contest (although in some measure, it is), but the gov't responses are distinct enough that the results may be also.
If European economies fall off a cliff, I'm sure they'll be no shortage of I-told-you-so's from this side of the pond. On the other hand, if Europe rebounds without dipping too far into the gov't well, and our deficits are astronomical, maybe the I-told-you-so's will be coming the other way. The value of the dollar versus the euro may be a telling sign down the road.

Capital markets are unstable. In the past there was no way to make them stable. But today we have computer power that can be used to make them stable. By using the greater computer power of today we can have a much higher turn over of capital in the capital market. This higher turnover will make the market harder to game or control and the market will no longer have the unstable run ups or declines. Who can change or control the market when say 20% of the capital is trading each day? So now that we have the compute power to provide for all these transactions that will smooth out the market how do we force people to turn over at a rate of 20% a day? Easy, put a cap gains tax of 0% (zero) on all gains of 7 days or less and put a cap gains tax of 90% of all gains of more than 7 days. The likes of Yahoo, Micosoft and/or Sun Micro Systems will give us the systems that will provide automated software agents to support turning over one's investments every 7 days (based on the specs you give the agent). A system like this will make the financial markets work as smoothly as the local fruit market.

I'm agnostic on the U.S. vs. Europe, but maybe a couple of things need to be kept in mind in regard to forestry analogies?

One is that the current disaster has its roots in specifically political decisions at the behest of financial interests. Those political decisions permitted high-risk highly leveraged transactions to take place without oversight or transparency. "Unsound business plans, Ponzi Scheme financing arrangements, idiotic investment strategies, and behavioral moral hazards" don't appear out of thin air, as Adam Smith well understood when he wrote of "those who live by profit" that they are "an order of men whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it."

The part of the forest to be burned is people like me, not the CEOs and politicians who created the disaster.

Second, economists like Krugman aren't talking about simply bailing out banks when they discuss stimulus programs. They are talking about getting money into the hands of people who will spend it, on the one hand, and putting insolvent, irresponsible "too big to fail" banks into receivership, on the other, "burning" the executives and stockholders but saving the depositors.

And keep in mind, the best way to get someone like me to spend is to see to it I have a job, not to give me a few hundred dollars as a tax cut, even on a permanent basis.

Michael, good points. And I understand that Krugman is also referring to job-creating stimulus. But when you combine that with the financial system rescue, it adds up to a phenomenal amount of spending. European countries are at least warning of the need for fiscal discipline. You have to draw the line somewhere. The answer may lie somewhere in between the two responses, but I prefer a government that thinks carefully before it acts. Last fall, an awful lot of money went out the door without the slightest hesitation, and I think that's made it more difficult to swallow the subsequent waves of spending.

I certainly agree regarding what happened last fall. I believe Krugman and economists like him, at least as I've been reading them, would agree too. The lack of accountability was shocking.

I would like to throw this out. The first reaction of Governments is to lower interest rates to solve all problems. I have read that higher interest rates might do more good because the available pool of money would be put to better uses. If a business has low borrowing costs then they may gamble on a project. If the cost is higher they would have to carefully plan to make it a success. This extra planning may revel flaws and stop a project before big money is wasted on a gamble.


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