Vernon L. Smith Responds

The key point in the article is “underlying solvency problems.” Bank insolvency was induced by household insolvency. Neither monetary policy nor fiscal policy can be effective under these conditions. The belief that fiscal policy can be effective is based on a flawed interpretation of the association between increased government spending after 1939-40 and our recovery from the Depression. But the government spending came after ten years of balance sheet repair–failed banks, foreclosures and the HOLC bought a million mortgages and reissued them at mark to market value. This means that we cannot infer that the same response would have followed if the spending had occurred ten years earlier. 

We have now entered only our fifth year of agonizingly slow balance sheet repair since the 4th quarter of 2007. That is equivalent to 1934, in the Depression. I believe we are stuck now for the same reason we were stuck then–insolvency. This time the central banks have kicked the can down the road, and the slump was less severe, but its duration so far is exactly parallel. 

If there is a bridge to somewhere it must directly address the bank/household insolvency problem. Countries with flexible currencies and who let their currencies devalue are doing better because it is a form of bankruptcy that revalues most of the country’s liability claims in line with asset value.“- Vernon L. Smith, response to Wall Street Journal article “The Great Central Bank Bridge to Nowhere”

I am always looking for well articulated insights and Vernon Smith is one of the economists I follow.

Smith shared the Nobel Memorial Prize in Economics in 2002.


About Christopher Hessenflow

Christopher Hessenflow is a financial planner in the Chicago area. He works with all sorts of people who are much more interesting than he is. He enjoys his career which lends him time to think and, sometimes, be creative. Chip was born bald.
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