Why Icelanders aren't starving in the streets

From a comment on Vox Popoli, the Bush/Obama/Bernanke bailout did not avert a crisis for the economy, it averted a crisis for the banks.

There are two economies, the "real" economy and the "bubble" economy.

The real economy draws down real savings (i.e., capital) for production and sells for consumption. If you save up your paychecks and buy a Subway franchise, you're participating in the real economy.

The bubble economy depends on fake savings--units of account out of thin air. If you're a government contractor, or a welfare recipient, and you cash one of the government's checks, the government is overdrawn to the tune of $1T a year. But instead of handing you the check back stamped NSF, the bank ultimately presents it to the Fed which enters a credit of pure magic-money. The Fed's banking and open market operations are more complex but at bottom it's the same thing: the Fed just makes a credit entry and the new money enters the economy.

The economy is dynamic and fluid, so figuring out which is "real" and which is "bubble" can be difficult. Sometimes it's obvious: student loans, McMansions.

What happened in 2008 (and in 2001, and in 1987, and in 1929) was the "bubble" economy became unmarketable. People figured out prices had become detached from underlying value, so all those people trying to pass off that bundle of mortgage-backed securities to the greater fool suddenly found themselves holding the bag. The fake savings stoke demand and prices lose their signaling capacity. Six bedroom homes in the middle of a California desert seem like a really good deal. That's how the bubble economy works: everything's great, until it isn't.

So long as there's a store of human capital and raw materials, people survive. That's why you don't see Icelanders starving in the streets. The only crisis is that early recipients of the new money--bankers, net tax consumers, people who overpaid for assets--are no longer rich.


Anonymous said…
We get many of our real goods from China and our energy from the Middle East. We get real stuff in exchange for pieces of fake paper. Our real economy is dependent on the fake economy, because we have hallowed out our real economy capacity.

That doesn't necessarily mean people starving in the streets (how could they when 2% of the population can produce enough food that obesity is an affliction of the poor). It does mean less "stuff", including real physical stuff.
Our real economy is dependent on the fake economy, because we have hallowed out our real economy capacity.

That is true as well. The "fake" capital outbids the "real" capital for resources.