M-TH: Credit

[Doug Henwood]

rakesh bhandari wrote:

>I have two immediate questions:
>1)What are debt deflations?

The mechanism of debt deflation was laid out in a classic article by Irving
Fisher (Econometrica vol. 1 [1933] pp. 337-357). If I may quote myself from
my book Wall Street, which should hit the shops in just 6 weeks or so:

"In a classic paper, Irving Fisher (1933) argued that financial involvement
made all the difference between routine downturns (not yet called
recessions) and big-time collapses like 1873 and 1929. Typically, such a
collapse followed upon a credit-powered boom, which left businesses
excessively debt-burdened, unable to cope with an economic slowdown. The
process, which he labeled a debt deflation, was fairly simple, and makes
great intuitive sense, but it was an argument largely forgotten by
mainstream economics in the years after World War II. A mild slowdown,
caused perhaps by some shock to confidence, leaves debtors unable to meet
their obligations out of current cash flows. To satisfy their creditors,
they liquidate assets, which depresses the prices of real goods. The
general deflation in prices makes their current production unprofitable,
since cost structures were predicated on older, higher sales prices, at the
same time it increases the real value of their debt burden. So firms cut
back on production, employment falls and demand falls with it, profits turn
into losses, the debt burdens further increase, net worths sink into
negative territory - and so on into perdition. Fisher argued that there was
nothing on the horizon to stop the process from continuing in 1933 - until
Roosevelt took office and declared a bank holiday on March 4. This state
intervention broke the destructive pattern; otherwise, claimed Fisher, the
collapse would have taken out whole new realms of the economy, leading
inevitably to the bankruptcy of the U.S. government.14 The implication,
then, is that such deflations are impossible today, because governments
will intervene at a far earlier stage (Minsky 1982b)."

Minsky 1982b is: "Debt Deflation Processes in Today's Institutional
Environment," Banca Nazionale del Lavoro Review 143 (December), pp. 375-393.

>2)Why are they both disrputive and restorative of capital accumulation?

The disruption is obvious from the description. In theory, such deflations
clear the way for a new upswing - at some point, so much capital will be
devalued, that rates of return will look attractive, and the process of
accumulation can begin once again. Classicals and a lot of Marxists believe
this; most Keynesians don't - or if they do, believe the process could take
intolerably long. That was the context of Keynes's famous remark about how
we'll all be dead in the long run; it was an exasperated response to the
classical argument that depressions will fix themselves over the long run.


Doug

--

Doug Henwood
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