Setting Matters Straight (part I): return to Keynesian economics

Setting Matters Straight (part I): return to Keynesian economics

(A version of this article was published in Typepad on September, 2008)

I

It’s odd how people’s perceptions differ. It’s also odd how new ideas come to one from the least expected quarters, especially if you’re attuned to criticism.

Both observations have their basis in the kind of responses I had gotten to my last two pieces – “The Met on the Net” in particular. Let me explain.

II

“You must be off your rocker,” writes one respondent and an old-time friend. “The country is facing the greatest crisis in 80 years, and you’re writing about film and music. I know you’re not going to vote for Obama, but still? Where is the old polemic now that we need it? Come on!”

I suppose the crisis my good friend was referring to is the Great Depression of 1929.

And the polemic?

Well, the bulk of this weblog has been political, but I also believe I have since provided my reasons as to why this particular bent may have been misguided. (See, for example, “A History of this Blog: in search of an anchor” – once a feature article, now in August archives – in which I tried to set my writings on a firmer and hopefully more comprehensive basis.)  

But I can only be grateful to good ol’ Scott for allowing me to set matters straight – even at the cost of being accused of irrelevancy. Besides, the present meltdown of our financial institutions – once the bulwark of the West and its capitalist system – I indeed must address.  So let me take this opportunity and kill two proverbial birds with one stone.

III

So what had gone wrong? What are the root causes? And most importantly, perhaps, how do we fix it?

Explanations abound.

George Cooper, for one, a strategist at J. P. Morgan, blames central banks for their so-called “pre-emptive asymmetric monetary policy”: they behave one way when the economy is expanding and quite another when it’s contracting. [For those of you who are not in the know, such a policy is a by-product of a naïve belief in “efficient-market theory,” namely, that prices reflect all available information . . . (and that) investors are the perfectly informed paragons. On such a theory, the markets always find their true level — eventually! We may not have the luxury, suggests Mr. Cooper, and central-bank intervention is a necessary corrective. But it, too, must be applied with the greatest of caution, not in any ad hoc or haphazard kind of way.]

Oddly enough, a certain Mr. Buttonwood, a regular contributor to The Economist, credits Mr. Cooper with having provided the most lucid explanation yet; in fact, he bills Mr. Cooper’s recent book on the subject as “a must-read on the origins of the crisis.”

Go figure!

IV

Somewhat more informative, I suppose, is an editorial piece from the same publication, “What next?”

There we’re told that “the finance industry [had been] caught between two brutally simple forces. [First,] it needs capital, because assets like houses and promises to pay debts are worth less than most people thought. [And second,] finance also needs to shrink. The credit boom not only inflated asset prices, it also inflated finance itself.  By one calculation, profits in the past decade amounted to $1.2 trillion more than you would have expected.”

Hence the dilemma, the editors conclude: “This industry will not be able to make money after the boom unless it is far smaller – and it will be hard to make money while it shrinks.”

V

I don’t know about you,  but such explanations leave me cold. Not only are they couched in the most impenetrable jargon; what’s their greatest weakness by far, they fail to address the fundamentals.  What you get, in effect, is a “technical analysis” – an analysis in terms of the internal elements of the system, its inner workings, etc., from within rather than from without – whereas it’s “the fundamental analysis” that is most desperately needed.

But that’s only to be expected from such propagandists of the capitalist system as The Wall Street Journal or The Economist, prestigious as these publications may be. They suffer from a kind of myopia. They’re all “part of the system,” as it were, and even the best-intentioned of the analysts – many great minds, no doubt – can’t help but subscribe to the major premises.

You can’t get them to think outside the box.

VI

If you’re looking for wisdom or common sense these days, you had better turn to less conventional sources. Timothy Egan, for instance, is neither an economist nor an expert by any means, just a journalist. Here are some noteworthy excerpts from Crash in “Timothy Egan Blog,” courtesy of The New York Times:

The big guy with the crew cut and a hand that lost three fingers to a meat grinder looked out at the most powerful men in global capitalism Tuesday, and asked a pointed question: “I’m a dirt farmer,” said Senator Jon Tester, the Montana Democrat who still lives on his family homestead. “Why do we have one week to determine that $700 billion has to be appropriated or this country’s financial system goes down the pipes?”

There is certainly a food chain of greed, from the lowliest house-flipper in the South Carolina exurbs to the Hamptons hedge funds manager. We all put reason in a box and buried it for a time. But before $700 billion is committed to a secretary whose decisions “may not be reviewed by any court of law or any administrative agency,” as the original draft of the bailout states, it’s worth remembering where the biggest heist took place, and how Wall Street dragged down the rest of the country once before. You could hear the echoes of history in Tester’s question, riding the fierce urgency of now at a time when the Great Depression and all its gloomy atmospherics are in the air again.

When the stock market crashed in 1929, losing 40 percent of its value over a brutal autumn, barely 2 percent of Americans owned stocks. People asked, sensibly: how could this affect me? Who cared about those swells on Walls Street when cars were rolling off factory lines and the big open expanse of middle America was flush with wheat and corn?

Today, with more than 90 percent of all homeowners paying their mortgages on time and on budget, the parallel question arises: how could this minority of bad loans drag down Western capitalism?

 [T]he larger lesson is how Wall Street brought down Main Street. Banks were largely unregulated then, free to gamble people’s savings on stock market long-shots. When the market collapsed, the uninsured deposit went with it. By the end of 1932, one fourth of all banks were shuttered, and 9 million people lost their savings.

In this century, thanks to the deregulatory demons released by former McCain advisor Phil Gramm [one might as well mention Reagan here as the chief architect of “deregulation”] and embraced by just enough lobbyist-greased Democrats, Wall Street was greenlighted again to act like a casino. Banks in the heartland passed on their mortgages to Wall Street, where they were sliced and diced in hundreds of largely incomprehensible ways. And while few people understand how those investment giants made money, this much is clear: it was a killing. In 2006 alone, Wall Street firms paid out $62 billion in bonuses.

With all the urgency of that famous National Lampoon magazine cover that showed a cute pooch with a gun to its head, and the line “If You Don’t Buy This Magazine, We’ll Kill This Fog,” President Bush says the biggest bailout in American history must be passed now or the world will crumble. He said a similar thing in the run-up to war.

Just once, it might be worthwhile to listen to a dirt farmer like Jon Tester, who wonders why the same breathless attention is not given to the concerns of average Americans.

Politics aside now — and apart from the impending question concerning the necessity of the bailout and why now – if there’s one thing that comes across Mr. Egan’s provocative article as the root cause of our present ailments, it is greed, greed, and more unmitigated greed.

VII

In a sense, the editors of The Economist agree, and I cite here from the conclusion of “What Next?”

Regulation is necessary, and much must now be done to improve the laws of finance. But it must be the right regulation: an end to America’s fragmented system of oversight; more transparency; capital requirements that lean against booms and flex with busts; supervision of giants like AIG, that are too big and too interconnected to fail; accounting that values risks better and that everyone accepts; clearing houses and exchanges to make derivatives safer and less opaque.

All that would count as progress. But naïve faith in regulators’ powers creates ruinous false security. Financiers know more than regulators and their voices carry more weight in a boom. Banks can exploit the regulations’ inevitable blind spots: assets hidden off their balance sheets, or insurance (such as that provided by AIG) which enables them to profit by sliding out of the capital requirements the regulators set. It is no accident that both schemes were at the heart of the crisis (my italics).

This [was] a black week. Those of us who support financial capitalism are open to the charge that the system we championed has merely enabled a few spivs to get rich. But it helped produce healthy economic growth and low inflation for a generation. It would take a very big recession indeed to wipe out those gains. Do not forget that in the debate ahead.

VIII

Notice, however, that they’re almost glib about it.  Thus, “financiers know more than regulators” (and can therefore cheat) – sweeping it under the carpet as though an afterthought, for in the closing paragraph they go on extolling the virtues of the capitalist system and all the gains it had produced:   “Those gains are not about to be wiped out,” they’re quick to reassure us.

But I guess they’re true die-hards, and as is true of all die-hards, their cherished beliefs are the last thing to go.

In the same editorial, they speak of finance as “the brain of the economy.” The idea, of course, is to resist the understandable temptation to regulate modern finance into submission. “For all its excesses,” they argue, “it allocates resources to where they are productive better than any central planner ever could.”

That may be so, in theory at least, but what they fail to realize – that brain has long been diseased!

IX

So, where are we now?

I guess we’re back to Keynesian economics – long-discredited by the proponents of the free market system, presumably rational to the core and therefore in need of no regulation — along with a more realistic view of economics as a dismal science.

Why Keynes?

John Maynard Keynes was one of the first to have advocated an interventionist, proactive government policy, which meant the government could use fiscal and monetary measures to mitigate the adverse effects of economic recessions, depressions, and booms.

On a side note, it’s generally agreed that Keynes had influenced much of FDR’s New Deal legislation (though it wasn’t until 1960 that the New Dealers fully recognized the Keynesian argument for government spending as a vehicle for recovery).

X

Is it socialism?

You bet!

But when FDR was asked a similar question regarding his extensive programs, he was reputed to retort that we wouldn’t have public highways if it weren’t for the Federal Government.

XI

In the concluding segment, I’ll try to connect the dots and make a plausible, I hope, argument as to why all is not lost.

There is a basis for hope!

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