Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Tuesday, February 10, 2009

"Shock and Awe" Needed to Combat Recession

See the full article here.

A selected excerpt:

Government leaders will need to take a "shock-and-awe" approach towards the economy as indicators show a worsening recession, Mohamed El-Erian, co-CEO of the Pimco bond fund, said Friday. Asked what he would do if he stood in Treasury Secretary Timothy Geithner's shoes, El-Erian said the government needs to take drastic, immediate and comprehensive action to combat the threats posed by the crumbling economy.

Do people like El-Erian actually think before speaking? Do they think at all? Perhaps not thinking is a luxury that only the very rich can afford?

A leading bond fund manager is asked for his views on how U.S. government policy might be designed to combat what appears to be a worsening recession. How will he answer? One might hope that the experienced sage will draw on the lessons learned from past interventions in the U.S. and elsewhere. Nope. Perhaps he will draw on a few philosophical principles concerning the role of government in the economy. Nope. Perhaps he will frame his views in the context of a coherent economic theory. Yeah, right.

Nosiree...forget all that BS. Instead, for inspiration and as a model of successful intervention, our high-paid fund manager draws on one of the greatest U.S. policy failures of all time -- the "shock and awe" bombing campaign that preceeded the U.S. invasion of Iraq. How's that as an example of "drastic, immediate, and comprehensive" action? And oh boy, that sure turned out well, didn't it?


  1. Not to take away from your point, which I think is generally well-made, but it's quite possible that, despite the quotation marks, El-Erian may very likely never have actually said "shock and awe". Newspapers, even the most "reputable" ones, seem to have little compunction about putting words into people's mouths.

  2. Poor choice of words, and likely completely wrong anyway. But certainly no worse than what numerous economists are expressing; a desire for "massive" stimulus. I can't help but think that this conventional wisdom is as wrong-headed as the loose monetary policies that got us into this mess in the first place.

    My personal view has always been, and remains, that the goal of government policy during recessions should be palliative, as opposed to curative. That is, they should aim to soften the blow for the vulnerable and the unemployed. They should NOT be attempting to reflate the housing market, or the construction industry, or embarking upon massive "stimulus" programs which will have little effect.

    When Keynes was doing his work, there was a much stronger case for intervention. At that time, governments comprised maybe 12% of GDP. There was no healthcare, little public education, no EI, no public pensions; no welfare state to speak of. He quite rightly insisted that government needed to take on a more active role. Today, with typical western governments accounting for 40% to 50% of GDP, we have all the Keynesian stabilization we could ever need built right into the economic system. Running huge deficits just to increase that percentage from, say 39% to 41% or so, seems the height of recklessness and futility.

    Recessions are unavoidable. In fact, I'd say they are necessary. Perhaps, if we'd have allowed a couple mild recessions (one in the late 1990s after the Asian collapse, and another one in 2001-2003) we'd have avoided "the big one" we're facing right now. Instead the Fed panicked, and lowered rates to ridiculous levels (we weren't quite as bad here in Canada)exacerbating the stock market bubble, and then creating a housing bubble. Not to mention colossal levels of consumer debt. Can anyone be surprised it ended the way it did?

  3. Brett: you raise a fair point. I've had my own personal experiences with misquotations of this sort.

    Raging Ranter: Can't really disagree, although my own view is that misguided monetary policy is not solely to blame.


  4. David, I think misguided monetary policy was probably the biggest cock-up, that co-existed along with - perhaps enabled - numerous others.

    A colossal failure on the part of bond rating agencies, who rubber-stamped the mortgage fund equivalents of junk bonds with AAA ratings, comes to mind. Funny how little press has been directed at the bond rating agencies. They were mentioned a lot in the early days of the ABCP crisis, but lately, it's like they've just kind of been forgiven and forgotten.

  5. El-Erian is giving the media what it wants: drama and excitement.

    'Media head' is a great form of free and credible advertising. He's not so much 'selling his book' as practicing self-promotion.

  6. FWIW, 'shock and awe' predates the invasion and occupation of Iraq. I paste:

    The aim of Rapid Dominance is to affect the will, perception, and understanding of the adversary to fit or respond to our strategic policy ends through imposing a regime of Shock and Awe. Clearly, the traditional military aim of destroying, defeating, or neutralizing the adversary's military capability is a fundamental and necessary component of Rapid Dominance. Our intent, however, is to field a range of capabilities to induce sufficient Shock and Awe to render the adversary impotent.
    —Harlan Ullman, James P. Wade, L. A. Edney, "Shock and Awe: Achieving Rapid Dominance," National Defense University Press, June 1996

  7. More musings hopefully more relevant than my first post on this subject.

    Yes, the choice of metaphor is unfortunate.

    El-Erian's view is internally consistent; his call for quick and bold action is natural given a worry that confidence and optimism are gushing out of the US economy further excacerbating an increasingly uncoordinated economy.

    It is unfortunate that the Iraq fiasco will make it difficult for the USA to intervene miltarily in the future with a fast-moving, overwhelming show of aerial and ground force. The strategic and tactical advantages are many, as are the broader benefits for deterrence.

    Naturally, those hoping to hobble the ability of the USA and western allies to forcefully intervene will view the outcome as positive. Ideally, the potential for an effective military response should be complimentary to multi-lateralism and diplomacy, not a substitute.

    In this way, the former President has gravely weakened the western alliance of free market parliamentary democracies in a world of unexpected substantive threats to security, not low-budget, box-cutter wielding terrorists who got lucky.

    Do secure property rights matter? Do signals and credible commitment matter for both international security and economic crisis management? Will hobbling the flexibility of the state lead to better policy outcomes in both spheres?

  8. Westslope,

    Well, we can all agree that it was a poor metaphor and that we should cut him some slack on this. And you are correct that, in principle, "quick and bold action" may be desirable. But of course, in addition to being "quick and bold," actions need to based on evidence and these actions need to be the correct ones.

    Delving deeper into his comments, look at what he recommends:

    "A four-pronged approach needs to happen to restore confidence, he said: Private capital must begin flowing; banks need to start lending; the government has to provide capital guarantees, and bad assets must be lifted off balance sheets."

    [1] Private capital must begin flowing. What does he mean by this? What is his evidence that it is not "flowing?" And how does one get it to "flow" if it isn't? Should the government command it to flow?

    [2] Banks need to start lending. What is his evidence to suggest that they are not? How do we square this view with evidence that points to the contrary? See:

    [3] The government has to provide capital guarantees. Why? And doesn't the government do this already (FDIC)? Has he heard of the concept of moral hazard?

    [4] Bad assets must be lifted off balance sheets? Why? Why not just let the banks write them off, the way that you and I must do when our bets go wrong? Why is the general taxpayer expected to pay for bad decisions on the part of others?

  9. David, I appreciate your comments. Let me quibble and then ask what you would do.

    [1] What El-Erian actually means by "capital must begin to flow" is open to speculation. Can or should government command, cajole or embarrass financial institutions into lending? No.

    Can government help boost confidence to the point that "capital begins to flow"? Yes. Are "capital flows the problem or simply the symptom? Likely the symptom.

    [2] True. But credit is much tighter and more difficult and expensive to acquire now than before the second half of 2008.

    [3] Moral hazard arguments have been frequently raised. Let's drill down. The offending institutions, their senior executives and shareholders have been heavily penalized by this crisis in terms of direct financial loss and loss of stature.

    The moral hazard issue raises the broader issue of dysfunctional incentives. Perhaps now then is the time to remove the mortgage payment tax credit, and even more important impose northern European level excise taxes on gasoline, and diesel? It seems rather plausible that record high fuel prices provided the catalyst for this crisis. North Americans continue to loudly signal to global markets that they are unrepentant energy-hungry, growth junkies. That said, somehow I doubt many would emphasize hiking fuel taxes as a burning priority during this period of recession-imposed 'conservation'.

    [4] Agreed. Socially recapitalizing the banks strikes me as the lesser of evils. Let private institutions make the case-by-case decisions.

    Question. Start with the assumption that broad confidence is a key factor and that government has some role in bolstering confidence. What bold, salient action can or should the US government take at this point to inspire confidence and lay the groundwork for economic recovery?

  10. Westslope:

    Obviously, we are not too far off in our views on this. Let me try to answer the question you leave me with.

    I do believe that the government has an important role to play in promoting "confidence." Confidence that private property will be protected; confidence that the judicial system is fair; confidence that the rules of the game will not be shifted capriciously to meet the demands of local special interests; etc.

    I do not believe that the government can magically manufacture the type of confidence you (and many others) appear to seek. When confidence is broken (think of a person who got caught cheating on their spouse), confidence can only be repaired slowly over time and with evidence that supports ever increasing confidence.

    In terms of a concrete government action, how does the following sound to you? This "too big to fail" argument seems to be what ultimately supports massive bailouts. Why not pass legislation that breaks up firms that are "too large to fail" into smaller sized firms that are not?

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