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The Great Experiment

By Andy Shaw | January 25, 2010

Originally posted 13th March 2009

I’ve been meaning to write about this for some while now but there has never been enough time and as I stare at the notes I made whilst reading and evaluating the financial crisis, I see there really is an abundance that I could write about. However, this subject needs to be brought into play at some point as I will often refer back to it. It gives real insight into why the government appear to be making so many bad judgement calls with their (our) money – I will come back to this in the future as well.

Milton Friedman wrote in his book ‘Monetary History of the United States‘ (written in 1963  - and I haven’t read it, I am quoting from other sources) that the money stock decreased by a massive 31% in the Great Depression. The velocity of money (turnover) fell 21%. GDP equals money multiplied by velocity. Consequently, from 1929 to 1933, the breakdown of both resulted in a contraction in normal GDP of 50%. However, Friedman suggested that if the Fed had not let the money supply shrink then velocity would have been steady and the Great Depression would have been averted. Yeah right! I think he forgot to factor in the human equation there.

However, the Fed’s current chairman, Ben Bernanke, does not agree with me and he is an expert on the Great Depression. What’s more he has adopted Friedman’s strategy to greatly expand the money supply…as has Gordon Brown. Now whether this solution will work when the world is so much in debt is very uncertain. So uncertain in fact, that economists are already calling this, ‘The Great Experiment’ as this is pure economic theory which has never left the text books…until now.

My opinion is that an economy which is 100% funded on borrowed money revolves around two things:

1) Confidence that money will not be lost by a system that is outside of its control
2) The ability to initiate a new borrowing and lending cycle

Well firstly, I think everyone, including Warren Buffet, does not have full confidence that money will not be lost by a system that is outside of our control. Secondly, you can only initiate new borrowing if you have willing lenders and willing borrowers (neither of which are so inclinded at the moment – present company excepted, of course – but remember that we are a minority apart from what is generally accepted as the minority!).

I do not think this ‘Great Experiment’ will work as they are at least a year away from sorting out the banking crisis before they can start to re-build. So new money being dropped in is mainly going to the wrong people right now using the ‘trickle theory’, that is the hope that some will deposit it into the banks which will raise the banks’ capital ratios, thereby giving the banks funds to lend which will open the market up again (yes, these people really are running the economy for us all).

However, they have forgotten that the only ones who want to borrow at the moment are either us (and we don’t count) or businesses that are struggling and therefore not attractive to already weakened banks…

So what will solve it? Well in truth I don’t think it can be solved now; they have waited too long and they have gone down the wrong route and the longer they dither before making the right moves will mean that even more will need to be done.

The list I have provided already would be enough but that will probably not be taken up until it is past its sell by date, although I expect that some of the suggestions will HAVE to be taken up at some point. After that further action will be needed, of course. Frankly their actions – and inactions – have brought about a depression and will bring about some debt deflation – how much I simply do not know.

The time of waiting and seeing what they will do has now passed. They didn’t do the right thing, are any of us really surprised…No, of course not, but without hope then what have you got?

Now we have the period to go through which lasts until they realise that their chosen course of action has been the wrong one. This is really worrying as politicians hate U-turns and admitting that they’ve got it wrong but then here’s where Labour’s spin doctors have actually helped us for once. They’ll be able to spin it so that it won’t look like the wrong decision was made at all…and this is good for us because maybe, they’ll head in the right direction after that.

I think we now have 3 to 4 months of waiting while they begin to see the error of their ways. However, I could be wrong and it will takes 6 – 9 months instead. Either way, don’t expect too much good news for a while.

But What About Us?

Given that this is their course of action and that first time buyers are hopelessly trying to return to the market at the moment, my advice would be to only make a play if you are certain that you have a great deal. Do not chase anything as there is no need. Things are probably going to get a lot worse before they get better so do not be pushed to increase your prices.

Put in your low offers and let the first time buyers bid higher. In the good times over 30% of their offers fell away prior to completion, so we can expect much less to be approved now. Put an offer in today, watch the property and when it comes back to the market let the agent know you are still interested but given the market turndown (don’t worry there will be one) you can only offer £5k less now.

Basically we’ll make even more money if we don’t chase the deals. It is still the right time to buy, if you can get it at the price you want, just make sure of the maths for each deal.

Best wishes


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