Arnold Kling says

Circling back to Austrian economics, the crisis we are having does resemble the crisis that Austrians were predicting. That is, they thought that money was too easy and that this would result in malinvestment. In his essay on Austrian economics, Yglesias dismisses this because the decline in the economy proved to be so widespread. However, I would argue that the patterns of specialization and trade are so complex and interdependent that the crash in housing could in fact lead to widespread disruptions. It affects real estate agents, attorneys, firms involved in the manufacture and distribution of household durables, and so on. It has huge relative regional effects. It reverberates through the financial industry. It affects people overseas who had counted on an ongoing mortgage securities market.

I don’t think this is really correct either.

There are several problems but I think biggest is that the readjustment that one would expect, and that we got, went off without hitch and was associated with stable unemployment despite the fact that rebalancing had been going on for roughly 3 years, the unemployment rate in early 2008 was no higher than in 2005 – the year residential investment peaked.

FRED Graph

Indeed, a more complete answer might be that rebalancing was halted by a huge increase in the price of oil. That’s what caused that dip in the current account balance going into 2008.

However, while that played a role I don’t think that’s the crux of what went on and its hard to explain why unemployment continued to rise even as rebalancing caught up.

Not to be too, whatever, but I think only guys who got the over outline right were the folks like myself who were harping about collateral values and bank balance sheets and the people who thought that land price declines could have real wealth effects.

My current primary thinking is that something similar occurred. Instead real wealth effects from housing, we had household balance sheet effects. And, in the collateral game the total supply of low risk assets – the collateral crunch – was more important than I anticipated.

I am as I mentioned before also flirting with the notion that part of the whole story of 2000s is a decline in labor’s share of national income and that the drop in inflation expectations and the rise in the dollar in 2008 simply made that adjustment far more difficult.

I should say that Paul Krugman came close. If I remember his argument was that based on Tobin’s Q the US was still over capitalized going in the late 2000s and would have to see a sharp drop in the trade deficit and perhaps even run a surplus.

The fall of the dollar would not be enough to accomplish this and so US consumption would have to contract. However, it would not simply contract on foreign goods but US goods as well and that this would drag the US into recession.

It seemed like that could have been starting to happen in early 2008 but its hard to tell because any possible effects were swamped by the massive balance sheet moves.