What’s wrong with Economics?
This article is a prerequisite to understanding many of the arguments put forth on this blog in the future and therefore probably one of the most important if not the most important one. It is, as many of CrisisMaven’s posts, rather lengthy, however, compared to so many trillions lost in paper money, what are a few hours spent reading “between friends”?
Quite obviously the current global economic crisis, which will, if it not already has, turn into a greater rout than even the well-remembered “Great Depression” (yes, even that is open to debate, the money shamans having faith healed the economy, but I don’t see it that way and that’s why I write here), affects nearly everyone on this globe (for the time being, the only ones it doesn’t yet affect that come to my mind are probably some Buddhist monks that own nothing more than a cloak and a wooden bowl with which to beg for rice – but even they will begin to feel the crisis when their benefactors on whom they depend feel the pinch). One might even say it affects outer space, as probably many nations will eventually curtail their space programs after giving all their money to zombie banks, labour etc. subsidies and ailing earthly manufacturers.
Already we see compulsory furloughs for civil servants like in California – as to when the first criminals will be released prematurely due to lack of funds for their wardens or new criminals will not be brought to justice for lack of policemen or because these themselves have to resort to graft to make ends meet remains to be seen. It has happened before in such crises and it will happen again. By the time it does, most people will have other things on their minds than discussing prison finance and might even profit from slack law enforcement to make their own ends meet …
So how did we get there? Could it have been prevented? How do we get out of this mess (if we can get out at all)? How bad will it yet become? Why seems “no one” to have seen this coming, in fact, how can something go on for so long with almost everyone enjoying the ride and then every wisdom that held true yesterday seems to be false the day after all of a sudden? And is there a way to understand the past in order to build a better, and this time more stable, future? Because if we don’t we’ll probably repeat the same mistakes over and over again.
Obviously, the current crisis originated in the domain of money, credit and finance, that much seems to be clear and undisputed. But after that, reasoning frays out into different and mostly contradictory schools of “economic thought”. Funny, when you come to think of it, how uneconomical economics is when it comes to its own progress, much unlike most other sciences as it seems!
Let’s not, as in most economics textbooks, begin with trying to define what “economics” is – it’s as much fraught with pitfalls as trying to define what a “table” is – although any five-year-old will infallibly know one if he/she sees one.
Also let’s take every economist’s statement that he was one bona-fide even if others deny that were so.
That way, we hope not to exclude any aspect of the question before even setting out on our quest. (Many of the headings here will eventually be expanded into separate posts that go into much more depth on each subject, and will then be referenced here via making the respective heading a hyperlink to that more detailed post.)
The “homo oeconomicus”
One of the most contentious issues in economics is whether it should restrict itself to supposing a “strictly economical” behaviour on the part of the acting agents in an economy and thus declare any “uneconomical” behaviour as outside its remit.
To CrisisMaven the latter approach sounds a bit as if medicine were to study healthy individuals only and define all invalids as “unmedical”. Or if ethics were to exclude all unsavoury behaviour from its course of study. In fact, had physics and astronomy not looked at the tiny irregularities in the planets’ “circular” movements we might still take for granted that the sun and planets revolve around our earth.
If we look closely at the supposition of man’s all-out “rational” or “economic” behaviour as a prerequisite for economic inquiry when it comes to trade and industry we immediately run into insurmountable difficulties: is it “rational” to buy an “iPhone” when one struggles to pay off a mortgage? Is it “rational” to buy ice-cream when the doctor said that one may develop diabetes if one didn’t cut back on sugar? Is it “rational” to stitch a crocodile onto a T-shirt? This list obviously could go on indefinitely.
Let’s stay with that crocodile as there was a joke about it when Lacoste started: there was a man who sat on a pile of crocodile stickers he didn’t know what to do with. In despair, he fell asleep and had a dream. Some kind of angel appeared and said in a booming voice “Take those stickers and sew them onto T-shirts”. And ever since he “had it made”.
Is “rational behaviour” then a sensible category when it comes to economic research? “Beauty lies in the eyes of the beholder” – one man’s “rational” reasoning is utterly irrational in the eyes of another – why, if it weren’t so, then a smoker wouldn’t relish a cigarette after dinner while another points out that tobacco should be prohibited.
CrisisMaven, on closer inspection, can’t understand, why the concept of “rational economic behaviour” as a limitation to economic’s field of research was ever introduced in the first place. As the buying decisions for consumer goods by and large define what higher order goods (“means of production”, steel mills etc.) are utilised, what raw materials (and in what quantities) are procured, and so, if a lot if not most consumer decisions were irrational would that not imply that almost all business decisions that are based on that equally became “irrational” by definition? (With the exception of defense spending of course.)
Consider: why are iPhones manufactured and sold, even to people whose house equity is negative? We could even argue, that this behaviour negatively affects Apple itself as a company in the long run, be it, because that particular buyer happens to be one of their employees and now due to his or her financial difficulties becomes more likely to embezzle or becomes despondent or depressed resulting in shoddy work etc. Or be it because such financial difficulties in the long run lead to bail-outs (e.g. “mortgage modifications”) that are then financed through imposing new or higher taxes on Apple (or by taking on more public debt, which makes credit scarcer or more costly for the likes of Apple and other private enterprises). So, the rationale of manufacturing any iPhones in the first place could already be disputed. In fact, any and all human action can have negative consequences that either diminish or even wipe out the “economic” success of the whole endeavour.
Now, when Apple develops and then (successfully) markets a new gadget such as the iPhone, there’s a lot of stuff that goes into making it: airline tickets for people in the purchasing dept. visiting potential suppliers’ or manufacturers’ sites in, say, China, mining of metal ores that eventually go into soldering, silicon purification to make microchips, oil gets transformed into plastic for the casing, trees get turned into cardboard for the packaging, coal gets burned to drive the factories, soot being used for black colouring etc. etc.
Let’s dwell on this a little longer: in any of these steps just described there are literally hundreds (if not bordering on the infinite) of decisions to be made, each of which can be disputed as to their rationality. Do I order from this or that manufacturer? Ok, one has a record of shoddiness, however, if I write up the contract so that I only pay for the functioning percentage of their produce … Oh, and that other manufacturer has good connections to the purchasing department of a huge company – that could give sales a boost, so shouldn’t I rather use them, even as they’re 3% more expensive?
When as a young student I began studying economics for the first time (Paul Samuelson’s Economics at the time was all the rage) I always had a feeling that those who were academic economists by and large were not at the same time entrepreneurs and that on the other hand entrepreneurs rarely ventured into (economic) academia. Countless chemists or pharmacists over the centuries have set up chemical or pharmaceutical companies, countless blacksmiths gone into manufacturing, bakers opened bread factories, butchers abattoirs or meat factories, seamstresses have turned into fashion designers, computer scientists even dropped out of university only now to rank among the world’s wealthiest. But macro-economists?
Oh, indeed, there is a profitable niche where they flourish: in the consulting business to public or supranational entities and, at least some, as advisors to major banks (why that’s probably a similar activity we’ll shed light on in a minute). Pinochet hired Samuelson after his coup d’etat and so on.
So, when I began looking into economics a lot of its premises always struck me as counter-intuitive if not outright contrafactual. One of them was that it was purely “rational” behaviour that drove “economic” decisions. Not only did I often discover subtle circular reasoning in that what was deemed economical was deemed rational or vice versa, I found, most of all, that macro-economics did not deal with real humans but some abstract concept, nowadays often called “agents”and as elusive as agents in real life.
The rationality hoax
Descartes wrote “I think therefore I am” (cogito ergo sum – he is said to have vanished when while in a coffee-house the waiter approached Descartes “Coffee, Sir?” “I think not” – and gone was he …). However, that motto may have satisfied Descartes – but did it pay his bills???
To pay his bills he needed not only to think, but to act (accordingly, e.g. write and sell books, hold lectures etc. – however, again this acting as a way to achieve conscious ends is now disputed by neurologists who say that there’s no free will really -don’t know, why I’m writing this- and that some neural connections drive how we act, only to be consciously rationalised later, after the [f]act). Be that as it may:
In order to exist, humans need to act, to do something, whatever it is (and which they deem practical at the time). And since every human being always claims to have (had) a good reason to act like he or she did, to all intents and purposes this behaviour is rational, as “reason” is but an English word derived from the Latin “ratio” which can be translated as “calculating”. To this day we calculate e.g. the ratio of the unemployed (as against the total employable) etc.
So this all is a war of words – whenever a human being does something he or she at the time feels this act to be “within reason”, to have done exactly this (and not something else) “for a good reason” and so on. Nothing happens for no reason – even when Bill Clinton later owned up to his tryst with Monica Lewinsky he then gave a reason “I did it just because I could”.
Man also always chooses. That may not be quite so obvious, however, even when someone does something and, when questioned about the rationale of that particular act, he or she replies “I had no other option” this would not be the whole truth – of course he or she could have chosen to do nothing instead!
So let’s sum up our ingoing propositions in the investigation of economic behaviour and why we are in this mess:
Real Man always chooses rationally (as per the definitions above).
But is that choice always economical? While I already argued that this question leads to the circular reasoning about what behaviour is rational, we should lay all doubts at rest for the simple reason that we don’t want another economic “science” that deals with everything but what can be observed “in the market place”, as CrisisMaven feels that this was exactly what got us into the present conundrum. We need not another generation of economists who can’t see bubbles before they burst and afterwards not knowing what really caused them.
Let us therefore prove that any elective behaviour (“choice”) also has an economic effect (meaning that after that choice someone is better or worse of for it, which is nothing but the concept of welfare):
Say, you have chosen to buy ice-cream today. After you checked out at the cashier the world has changed forever and for everyone. Not only have you got less money to spend, say, on socks, also, however minutely, you have potentially driven up the price of ice-cream (demand) as against socks (less demand, all other things being equal, leads to falling prices). Now this obviously affects all future buyers of ice-cream as well as socks.
Not only that: perhaps now some woman in a Chinese sweat shop has less pay because of the falling demand for socks while some farmer has more business due to the rising consumption of eggs that go into ice-cream. And not only that: all other competitors for the scarce resource called eggs feel, however minutely, the tide changing. The supply of eggs for those who produce omelet(te)s has slightly dwindled as has the demand for their end product, as he, who eats ice-cream has not as much room in his stomach for omelet the same day.
So who would say, your decision had no economic implications, and in our world today truly potentially global consequences at that? We haven’t yet discussed the influence reduced sock demand in Wal-Mart translating into curtailed production in China has on US cotton farmers for example. Spotting trends such as these wins the bread for an agricultural analyst along the way whose child may therefore go to a more prestigious college if he builds a reputation in his field. All because of you, the consumer. All these events are run-of-the-mill economical processes, if anything!
So, if (a branch of) economics can’t deal with potentially 99% of human decisions affecting human welfare as a matter of course because it denies them the dignity of being just that – rational economic behaviour then no wonder it can’t fathom when markets seem to run wild. Irrational exuberance anyone?
In fact, wouldn’t it be rather strange and (at least equally) irrational, if one man’s sentence could move markets to the tune of billions in gains or losses?
Are we looking at shamanism (nothing against shamans, they wouldn’t exist if there weren’t a market for them!) or science?
Foundations of Economics
So if we assume that all human behaviour in its essence is economical in the sense that it directly influences other people’s welfare (and his or her own), then in order to “economise”, i.e. to make prudent choices where means employed lead to desired ends, economic science needs to deal with real behaviour. Science should not be too aloof to deal with the observable facts whether they follow mathematical rules or not.
In order to deduce scientifically one needs to be able to observe. But in order to make sense of things observed one needs to first have a theory. That theory precedes practice is probably one of the most contested tenets of epistemology, however nothing can be proven more easily. Why do you get up in the morning? Not because you woke up, but because you have a theory that, if you don’t e.g. in order to get something to eat, you might eventually starve to death right there.
Have you ever truly validated that theory? Certainly not or you wouldn’t be around to read this. So there are obvious behavioural facts that economics couldn’t test in a laboratory situation, however, pure thinking tells us which concept is right and which is not. When you do get up, you put one foot out of bed. Why do you do that? Because you have a theory that after another few inches there will be solid floor for you to stand on. While many may not be aware of it, that is a theory, corroborated morning after morning, but never fully proven, as some day part of your floor may have caved in and the theory would then not quite fit the facts.
Now where do we observe economic behaviour? Did anyone observe Robinson the castaway on his solitary island? Not quite – he wrote about it and then did we know (okay, okay, it’s a novel, he wasn’t even there, but there are cases as this only they may not have been so eloquent as to warrant publication). You can observe economic behaviour nowhere but in the marketplace. There is only an indirect way of observing human economic behaviour in that you cannot know the mind of man until he or she really acts! Again, acting comprises inaction also, since, when confronted with choices, inaction is deliberate behaviour.
Let’s cut to the chase now with an example (thanks to all who bore with me to this point).
The main failure in explaining the current crisis through standard (i.e. as taught in academia) economic “reasoning” is that almost all of the behaviour of almost all market participants had unforeseen consequences and no theory explains why people collectively would “cooperate” to make everyone (well, almost everyone) poorer. That, in hindsight, appears as rather uneconomical. And what can’t be justified afterwards (although it well could at the time) must have been “irrational” in the first place or wouldn’t it be? So economics as a science has to be re-written or at least heftily added to, some say.
Ok, let’s see: there’s this physicist who missteps and falls, maybe even breaking a leg. Does that disprove the basic tenets of (Newtonian) physics? Wouldn’t it not be better now if physics incorporated some wisdoms from medicine to mitigate some shortcomings of classical physics?
Why then does economics feel it has to change course after every other crisis? (Not every, only every other. After the LTCM debacle and the Dotcom bubble, mainstream economists first prescribed “more of the same” only to now head for the exit.)
Why has macro-economics first to fail only to then come up with agent models as a stopgap only to then being fecundated by psychology and controlled laboratory experiments? When you study a rat in a maze it behaves like a rat in a maze, take the maze away and give it back its freedom and it will most certainly proceed differently. So:
What’s wrong with economics?
(Mainstream) economists by and large cannot calculate, not, that is, in the sense that a consumer or entrepreneur would.
Let’s say you want to buy a TV set. You see one you like for 1000 dollars. You could have gotten it last week for 900 dollars, but now, with the Super Bowl approaching, supplies have become scarce and the price has gone up. So why didn’t you buy it back then? Was it because you had a feeling you might lose your job last week seeing that so many colleagues already were laid off (and now your boss has just given you a raise and renewed your contract)? Or did you not buy it because you weren’t interested until … in a last ditch attempt and with a bit of luck your favourite team made it into the final against all odds (and against your original expectations)? Or have your neighbours just bought one and you are of the type who needs “to keep up”? You might also argue it’s better for your eyes, or simply your old set has just now broken down. Let’s dwell on that last reason a little: obviously a brand new cut-price TV set was not “as valuable” to you as your old one at that point, rather you would have saved that money for, say, a vacation, a new kitchen sink, retirement or to get your kids through college etc. Of course, with that frame of mind, your national TV industry must be ailing. So let’s bring on a “cash for clunkers” programme and destroy loads of existing TV sets in order to make room for new ones. And in order to not impair aggregate demand, destroy the old sets (why, they could just as well have been used in the garden shed, or given to some poor neighbours etc.). And you are aware, aren’t you, that you just took money from your left pocket (via taxation) to put it into your right pocket (via a subsidy) to go out and destroy your old set to buy a new one, only to still be left with only one set and overall being a lot poorer? Ah, and weren’t you buying an imported set (yes, yes, they are cheaper, while still being better maybe) – that’s not right, but as you can’t seem to rationally choose we’ll help you by raising tariffs. Hm, not only do I destroy something, then buy at an exaggerated price, but now my hotel also has fewer bookings from these Japanese tourists who can’t afford to visit as their TV exports have gone down. Hang on a minute …
Myriads of reasons every second go into myriads of purchasing decisions. However, (mainstream) economics knows none of all this – all it cares about is “aggregate demand”. Whether you buy that TV set because you are an engineer with a competitor and need to take it apart to see what your competition is up to – no matter, there is but one average reason (and one average TV set by the way) or else macroeconomic mathematical models would break down. Current (macro) economic theory is a bit like the drunk who lost his key in the dark and now searches for it under the light as he deems that easier.
Some eternal economic truths
When there’s more of a good, then, all other things being equal, e.g. demand unchanged, its price tends to go down.
If demand decreases for a product, then, all other things being equal, e.g. supply unchanged, its price tends to go down.
Sure “we all knew that”, no? Ok, now let’s say, I, the state, borrow from the (capital) market. Then, all other things being equal, the price of credit, i.e. interest rates, will go up, right? So, when interest rates go up, capital expenditure will go down as anything that is bought on credit (and, for example, most factories somehow are) will become more expensive as a consequence. For example, if I want to stick to the same monthly leasing (or credit) rate for my car I intend to purchase then I need to buy (lease) a smaller car, right? Well, clearly, so if the state raises money in the capital markets, all other things being equal, car sales will go down as measured by turnover, as either fewer or smaller (i.e. cheaper) cars are bought. This may filter down to other areas of unforeseen or unintended consequences: the price of used cars may go up since for one some people will hang onto their cars for a while longer thus diminishing the supply of used cars coming to market while at the same time some people might settle for a used car instead of a credit-financed new one thus driving up demand.
From here we could go on and on. Let’s say, the car industry had not anticipated that latest state borrowing spree. Then it would have ramped up production to a higher degree than if it had. As a consequence, now that it has become aware of that miscalculation, it may have no choice but to lay off some workers, close some plants or transfer production abroad. Or some importers may gain the upper hand as their cars are generally cheaper due to lower labour costs abroad or for whatever reason. So, as we have already seen in the example of the choice of ice-cream over socks above, any decision that changes the current supply and/or demand of any good (or service) by and large “stirs up the whole marketplace”. So, if one innocent pack of ice-cream can do that, how much more a state requiring billions and billions of fresh capital? The state doesn’t have to intervene in the car industry to upset it, it is sufficient that he enters any “market” to throw everyone off balance!
(Macro) economics though prefers to do away with such trifling, and, above all, immeasurable effects. It prefers to construe equilibria where none ever exist then from that plank tends to jump to conclusions that have no counterpart in reality at all. We can’t go into that in too much depth here but will eventually do so in another post.
So how do we, for example, create a housing bubble? (This is a very short version of it, however, it contains all relevant elements.) Well we first see to it that someone who can’t afford a house is induced to buy one. For that we need maybe to redefine the meaning of “affordability”. We can use a kind of “affirmative action” whereby we force lenders to extend credit to people they wouldn’t normally consider by threatening to otherwise disrupt their normal business. Of course that would, all other things being equal, tend to make overall credit scarcer, i.e. also for those who would under normal circumstances have fulfilled normal lending criteria. We can’t have that, of course. So, we create a secondary, “government sponsored” mortgage market whereby we make mortgage money cheaper than it would otherwise have been. Now “the world and his wife” can “afford” a house, at least in theory. Well, what did we say happens, when demand increases? Well, wouldn’t house prices go up?
Wouldn’t rising prices eventually drive demand down? In the normal course of events, yes. So even the housing market would have inbuilt self-stabilising mechanisms that would put a check on demand. But wait: if bread goes up in price today and you expect it to go up tomorrow, would you then start hoarding bread? Well, there’s hardly a market for stale bread, so, no, you probably wouldn’t speculate with bread loaves. So most people buy and store no more bread on any given day than they are likely to consume while it were still edible.
However, when it comes to goods that have a relatively long life span, things are different. Those generally are called “assets”, be they bonds, shares or houses, that is, real estate in general. Sometimes it’s commodities as well, however, speculation in these is different – you need to eventually sell or use them up or you lose out in the long run. So there’s maybe speculation in commodities, but real bubbles will be in assets, or what is perceived as assets, such as even paintings (they too are durable goods that are not physically consumed). And as expected, art exhibitions and auctions have had their recent bubbles too.
Now, paintings aside, most assets are bought for the “services” they render, e.g. as a return on investment: bonds and shares pay dividends, real estate pays rent or its equivalent in “rent saved” when owner-occupied. That is the reason they exist, to be of use as an investment with a purpose. However, when you believed that such asset would appreciate considerably over a certain period of time, you would then begin to contemplate buying and holding it for such period of time that would allow you to sell it for a higher price that would surpass all costs involved in holding the asset for that period of time even if it did not pay a dividend (to speak of). If in any given interval the anticipated appreciation were considerably higher than interest paid on the capital needed for the purchase of such object of speculation, then you would buy it not for the service it normally rendered and that was the reason it would be created, but simply and only for the sake of speculation.
That’s what happens in a stock bubble: the stocks leave off where the stocks’ dividends compare favourably with interest earned on other investments and begin to overshoot when everyone thinks he’s eventually going to find a buyer at a higher price “no matter what”. The moment this process has set in, price/earnings ratios have lesser and lesser to do with the merits of the particular stock’s underlying business’ profitability and thus its potential to pay dividends but with future price expectations for the shares as items of price (not profitability) speculation (all investment is speculation, but in bubble speculation you do not speculate to get a return on investment due to the productivity of the asset but purely by its propensity to further appreciate, the asset becomes a speculation “for its own sake”). As you can get credit on your stock portfolio you might even purchase more stocks than you could originally afford, wich drives prices even higher, giving you again even more room to put these stock in hock and buy more and so on.
Equally, if houses appreciate, you could take out another mortgage and use that to pay down a second house, thus eventually sending prices sky high, however, eventually this brings houses to market that no one has any use for but to also speculate with. In the end phase of any such boom purchases are not made to earn the fruits of the investment in the form of its uses but purely for the future gain through appreciation. So in the end things are produced not to be used at all. This is the ultimate waste of resources imaginable. No wonder, there is no price for these surplus items when things get back to normal and people begin to buy again only for the sake of getting a usage out of their purchase! Eventually the house of cards tumbles, bringing everyone down with it: the mortgage lenders who themselves borrowed to lend to you, the builders and developers who now not only have excess capacity but also probably a lot of as yet unpaid bills for the materials for houses under construction and lots of bills outstanding; then the manufacturers of machinery, realtors, advertising companies, shops that began to spring up in places where now every other house is unoccupied and so on.
Of course, that is no real concern for our macro economists: looking at the excess capacity in the building industry we diagnose “slack”, i.e. not enough demand to utilise those marvellous capacities. Rather than letting these lie idle, we now inject money into “the economy” which likely will come from state borrowing (the overall tax base is shrinking already in a downturn, so taxes would need to be increased just to keep absolute tax return constant, let alone increase the tax base, and raising tax rates would choke the economy further). Even Keynesian scholars have an inkling of that.
Now we’re back to the example above: state borrowing makes credit scarcer and thus more expensive. This leads, if nothing else, to higher interest rates. Higher interest rates make shares’ dividends look less attractive, aggravated by the fact that scarcer and dearer credit makes the companies issuing those shares less profitable thus lowering dividend expectations even further. By now everyone heads for the exit.
There’s only one last thing states can do to avoid those “unintended” consequences, if they can’t raise taxes nor borrow excessively in the marketplace yet still want to prop up “the economy” (say hello when next you meet her) they can create new money and inject that instead.
However, as we discussed earlier, if the amount of a good increases so must its price fall, all other things being equal. If the supply of money increases, so must its price fall.
Why doesn’t it happen, some ask. Oh, it already has, only there’s a common misconception about price inflation (oh no – not these economists again?):
There is no such thing as a price “level”. There are prices for stocks, prices for commodities, prices for cereals, bikes, cars, cobblestones, houses. And those prices are not only subjected to shifts in demand driven by monetary influences alone: even in a central bank regulated money system there are the factors of old at work: shifting consumer preferences (low fat, low carb, buy American, buy energy efficient, buy houses today, stocks tomorrow, spend more on Perrier than on Champagne another day). If oil prices rise it can be due to increased demand, due to (anticipated) shortages, due to the Chinese disowning their bikes, due to harsher environmental regulations, anything: but if oil prices rise so does not inflation. Inflation (Latin “inflare” = to blow up, to bloat) is the increase in the amount of money available. If the amount of money were stable and oil prices increased, putting a strain on the economy, all the economy needs is another “whack on the head” in terms of higher interest rates. That would mean, that a utility that had an oil-fired power station and hence would want to raise prices to reflect rising raw material costs now would have to rise prices doubly to then recoup rising capital costs (higher interest) as well. You might have guessed: such is the wisdom of contemporary macro economics. And you know what? Before you know, the (doubly) rising price for electricity would again drive up (“measured”) CPI or consumer price inflation, esp. since coal fired plants would be equally adversely affected by rising interest rates, so, coming to the rescue, the central bank would again be induced to raise interest rates and so on and on.
Clever, huh? You need to be a “mathematical” economist to contrive such helpful “market” interventions.
So here’s what really happens: like the guy looking for his key, lost elsewhere, under the light because that’s more comfortable, the central bank looks for “inflation” where it may not be found and thus can not diagnose a bubble before it bursts. And after it burst, it needs to keep the “slack”, the poor underutilised capacity, in high demand and if all the former speculators have left the (gambling) table it needs to step in itself to make up for that. And true to their human nature, once there are new chips on the table, at least some of the speculators will return to the table, some with fresh money, some hoping for credit, some to make profits, some in the vain hope of recouping former losses, but what can you expect? It is profit by anticipation of appreciation that drives a speculative market.
And that is what we are seeing right now: house prices haven’t yet fallen to where they would be without fresh money (and moratoria or loan modifications, which are nothing but artificially lowered capital costs), but that only means those house prices are nominally higher than they should be. The real value is lower. Still, that housing market rests on feet of clay, stock prices are nominally high because the monetary base has been diluted to an extent never before seen in human history (see previous post).
There’s nothing wrong with economics, that’s all perfectly rational, what’s (or who’s) wrong are the (mainstream) economists …