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Minyan Mailbag: What Paradox of Thrift?


Recession is no paradox; it's caused by real cyclical and structural change.


Dear Professor Depew,

You excoriate the Times today for suggesting that if everyone saves and pays down debt, it might be good for them but bad for the economy as a whole.

Yet isn't that what's referred to as "the paradox of thrift"?

In other words, if everyone cuts consumption aggressively and pays down debt at a mad rate, the result is ever faster demand destruction, more business failure, even higher unemployment. These nasties make it even harder to bring income into line with debt obligations -- the stability equilibrium goals--because the necessary result will be a fall in real

In short, an economic downward spiral.

I agree wholeheartedly that the government bailout plan is doomed from the outset - it's little more than a wealth transfer scheme from the middle class to the upper middle class.

The reason it can't work is that you can't jump start a car whose gas tank is empty. You can't prime the pump of an empty well. And it's pointless to medicate the dead.

But the dry wells will refill over time - if we let them.

But first, we must let things rest.

It's tough for Americans to accept that when there's nothing to be said, one should say nothing; when there's nothing to be done, we should do nothing.

Yet that's just what we should do, for a change: Nothing.

Yours in nihilism,
Minyan Robert

Dear Minyan Robert,

Good thoughts, but the paradox of thrift is different from what i was referring to. Yes, if no one ever consumes anything, that creates the paradox you're referring to. but there are 2 separate considerations here: 1. Why is there a lack of consumption, and 2. What constitutes "real" demand and wealth creation?

If everyone decides they're going to hoard cash and stop spending because they just want to watch their pile of twenties grow, that creates the paradox you're talking about.

But in our case, that isn't what's happening. In the aggregate, burdened by debt that's increasingly difficult to service, people are choosing not to take on more debt. And, if we have a certain amount of savings and choose to deploy that into the economy, that can create real economic growth.

In this case, however, the government is attempting to offer credit, and encouraging everyone to take on more debt to "save the economy." But that is neither "real" demand nor "real" growth, and is precisely the paradigm we've operated under for the past 15 to 20 years. Consequently, we have arrived at the stage of consumer and business "balance sheet repair," fueled by what i believe are 2 things: 1. an unserviceable debt load, and 2. a social mood shift which influences how people interpret the idea of "serviceable debt load" in the first place.

Negative social mood = increased caution, risk aversion and negativity. Under "normal" circumstances -- i.e. positive social mood -- people may reach a point where they're forced to reduce debt, but in the aggregate, the positive mood will rationalize taking on increased debt as the cost of doing business (i.e. You have to spend money to make money). The increased tolerance for risk and generally optimistic outlook will help push continued debt-fueled consumption and spending. But nothing lasts forever.

To sum up, there are 2 trends at work here: One is cyclical (consumers, and some businesses, with unserviceable debt loads; one is structural (a long-term darkening of social mood that will have profound implications for risk perceptions and tolerance). The structural trend in this case will reinforce the cyclical trend, making it harsher.

When the cyclical trend changes, as it most surely will, perhaps as soon as 2010, there will be a corrective move to embrace some degree of risk and consumption; but, because the structural trend has changed, that corrective move will be weak by nature.

And once the shorter-term corrective cycle runs its course, we will experience another severe and self-reinforcing impulse of risk aversion, caution and negativity.

Professor Depew

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