Thursday, September 3, 2009

Thoughts on Paul Mason’s book ‘The End of the Age of Greed’

I just finished reading Paul Mason’s book Meltdown: The End of The Age of Greed. I found the book very informative and enriching. While reading the book, sometimes you feel that the blame for the whole financial crisis should be heaped upon the corporate elites and the policymakers, who aided elite’s greedy nature in order to fulfill their own greed. The nexus between the corporate elites, who only cared about increasing profits and dividends by often going roundabout laws and lobbying for easier rules, and politicians who shared similar ideology (economic) in principal was something much deeper than what I had imagined.

He walks readers through events like the repealing in 1999 of Glass-Steagall Act of 1933 in the US and the wave of deregulation (propounded by conservative policymakers by flowing with the partisan findings of conservative think tanks, which are funded by the business community that have vested interested in profit- making only), separating investment banking from regulation, allowing the sub-prime market to deliberately bloat, giving derivatives markets to free ride without supervision, and a deep-rooted belief on a flawed ideology (to borrow Krugman’s words “crank philosophy”) among others, all of which contributed to the global financial crisis.

Mason offers a fairly detailed timeline and description of the events that occurred during the makeup to and after the crisis. I will briefly note and quote the stuff I find interesting in the book.This blog post is not a review of his book.

In human terms, the commodities craze was the shortest, steepest and most disastrous of the bubbles. If subprime ruined the credit scores of millions of Americans, the commodity inflation took food out of the mouths of mouths of children from Haiti to Bangladesh, and made many middle-income people in the developed world feel instantly poor. [...] G7 politicians generally tried to address the combined credit freeze and commodity inflation with the old tools and the old obsession. The inflation hawks fought inflation; the monetarists flooded the system with money; fiscal conservatives attacked government profligacy. And economists, consulting their graphs, saw the end of a cycle instead of the end of an era.

He argues that the credit freeze and commodity prices boom originated in the parts of the financial system that were impenetrable to public scrutiny. The derivatives market had no surveillance despite it being about six folds the size of global real GDP. Similar was the case with credit default swaps, whose market was valued at $58 trillion. He believes that a blind belief in neoliberal ideology, which is focused too much on self-interest and self-regulation, is partly the cause of this crisis.

Neoliberalism, like all ideologies, needs to be understood exactly as it wishes to avoid being understood: as the product of history. [...] Neoliberalism fought its way to dominance against the power of the Keynesian establishment: against Nixon, Carter, Callaghan; against the Marxist and Keynesian influence in the academia. Above all it was a doctrine of conflict and vision. [...] The problem with neoliberalism's critics, for now, is that they have no coherent world view to take its place. There are elements of such a world view, scattered within the writings of neo-Keynesians, the anti-globalisation left and the Stiglitz critique of neoliberalism.

He maintains that information technology has shaped our lives and lifestyles beyond what we could imagine. This, along with political changes and heavily funded conservative think tanks, has also accelerated the adoption of neoliberal ideas across the society.

It is too crude to say the silicon chip 'causes' the rise of the free market, globalisation and finance capitalism. But the silicon chip and the internet protocol were surely key to their rapid rise to dominance.

He gives details of works of two economists who more or less predicted periodic booms and busts in the market. First, he talks about Kondratiev wave, a path first described by Russian economist Nikolai Kondrative. It predicts that capitalism moves through, on average, fifty-year cycles in which periods of economic growth are followed by periods of crisis and then depression. This theory explains the booms and busts except for the period after 80s and 90s, when the gold standard was abandoned, central banks developed new measures to expand credit and tame inflation, and  the Berlin Wall fell down.

He then talks about Hyman Minsky, who laid out the reasoning and tools to predict the crisis and recommended how to resolve it. Minsky argues that capitalist society is inherently flawed and when it is uncontrolled, the government has to step in to remedy the uncontrolled aspects. He warned, "The normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciation, unemployment and poverty in the midst of what could be virtually universal affluence- in short ... financially complex capitalism is inherently flawed." We need to live with the fact that capitalism is flawed; it is not perfect and efficient; and policymakers can use policy tools to mitigate the effects of downsides of capitalism.

Minsky's proposed solution to financial crisis (which is more or less is close to what Krugman and other Keynesian economists have been rightly saying):

... state intervention in two fronts: the government should run a big budget and the central bank should pump money into the economy. It will be noted, despite Minsky's pariah status in economics, that his remedy is exactly what has been adopted- in the US, the UK, the eurozone and much of the developed world. The problem is, it has not so far worked. Trillions of dollars of ready money, tax cuts and state spending were shoveled into the world economy to stop the credit crunch producing another Great Depression. yet all those trillions are up against a powerful backwash of collapse within the real economy.

I think Mason is misguided here and is taking a very short-sighted view about the impact of stimulus. First, the global fiscal stimulus is just above a trillion dollars and is not expected to kick in until early 2010. Second, the fiscal stimulus was small if we look at the historic nature of this slump. In the US economy, Krugman has been calling for a stimulus equivalent to 4 percent of GDP, which is not politically feasible though it would have been the best policy move if enacted. The global economy needs to be heated (because the economy still is slightly close to deflationary point) and slight inflation with budget deficit must be tolerated. In fact, the global economy, especially the emerging Asia and some EU nations, have rebounded from the first quarter of 2009. So, the fiscal stimulus (clearly worked in China, France, Germany, Australia) along with liquidity injection from the central banks have worked for now. It needs to be seen if the current nascent recovery is sustainable.

Mason outlines three rational alternatives for the developed world: (i) revive the high-debt/low-wage model under the more controlled conditions (pretty much the one agreed by G20); (ii) abandon high growth as an objective altogether; (iii) a return to higher wages, redistribution and a highly regulated finance system. The third one is close to what Minsky argued for-- a high-growth economy that transcends the limitations of both Keynesian and neoliberal models (nationalization/semi-nationalization of banking and insurance industries; strict limits on speculative finance; address inequality by changing tax structure so that the bottom half of the income scale benefit from growth; and consumer demand sustained by growth itself; create permanently benign conditions for entrepreneurs by limiting the power of large-scale enterprises).

On a side note, I think Mason does not fully explore Sachs’ prescribed "shock therapy" that created mess during Russia’s transformation from socialist to capitalist economy. He is favorable of Sachs and wrongly attributes some of the events to Sachs’s academic and policy activism. That said, he does mention the role played by Sachs, and Stiglitz, in making policymakers aware that the IMF-prescribed policies to East Asia after the 1997 crisis was flawed.

He thinks that the Minsky model would be the likely outcome because of heavy government involvement in the market (as was necessitated by the mess created by the markets):

As the crises worsens, it is becoming commonplace for pundits to observe, while capitalism is collapsing, that nobody has thought of an alternative. This is not true. The Minsky alternative- a socialised banking system plus redistribution- is, I believe, the ground on which the most radical of the capitalist re-regulators will coalesce with social justice activists. And it may even go mainstream if the only alternative is seen to be low growth, decades of debt-imposed stagnation, or another re-run of this crisis a few years down the line. It is also possible that a socialised banking system, by allowing the central allocation of financial resources, could be harnessed to the rapid development and large-scale production of post-carbon technologies.

Overall, a very good and informative book about the meltdown. John Kay reviews Mason's book here.

Is the global economy rebounding?

Carnegie Endowment hosted a session about global recovery in the aftermath of the global financial crisis yesterday. Four analysts shared their forecasts and views about where the global economy is heading now.

Hans Timmer, lead economist of Development Prospects Group at the World Bank, argued that though gradual recovery is happening , the pace would depend not only on performance of the US economy but also on the magnitude of rebound in the emerging economies. During the crisis, the emerging economies plunged the most, so in order to rebound strongly, they have to grow strongly. He argued that Fareed Zakaria's misread the numbers in his recent column in the sense that he holds the view that if the US spends enough, things will be okay. Rebound in the developing countries, especially the emerging economies, will determine how fast the global economy will be pulled out of this mess. In the emerging economies, the decline in imports was higher than the decline in exports; the opposite is true for high-income countries. The developing countries reconsidered their investment projects and used up their inventories while reducing imports, deepening the crisis.

He opined that the present rebound (industrial production), which has been visible since the first quarter of 2009, does not reflect a real recovery and might just be a "technical rebound". In the last five months, Asian exports and imports have increased. Japan’s growth is driven by imports by other Asian nations. Commodity prices have also begun to move up. The strength and sustainability of rebound would depend on investment levels and inventories build up and the looseness of international credit supply.

Jorg Decressin, division chief of European Department at IMF, argued that the global recovery is definitely real but is heavily policy dependent. It is a subdued recovery. Consumer confidence is gradually rebounding and so is trade. Interest rate is near zero and a lot of liquidity has been injected into the global economy. However, for sustainable recovery, private demand has to take the place of public demand. Moreover, global imbalances in trade have to be corrected and fiscal deficits have to be brought down. External deficit countries will have to invest less and save more while external surplus countries have to invest more and save less. China alone cannot do it because Chinese total consumption is almost 25 percent of the total US consumption. The Middle East countries also have to step in but they too are constrained by their own challenges. So, rebalancing will take time and recovery will be slow. It is not a self-sustaining recovery.

Philip Suttle, director of Global Macroeconomic Analysis at IIF, argued that the rebound is real and does not look “technical” to him. He made six points:

  • Inventories will be rebuilt steadily rather than suddenly in the coming quarters
  • Global financial condition is getting better. The transmission mechanism of money is working pretty good
  • There is an upward revision to capital spending plans
  • Housing collapse appear to be ceasing, especially in the US and UK
  • Fiscal stimulus is starting to kick in.
  • Labor market conditions will begin to improve.

All these positive signs signal that rebound is real and the trend is upwards. However, there are chances of “double-dip”, as happened during the first half of 1980s, but is not very likely. Events that could cause “doubled-dip” are (but unlikely):

  • Emerging markets don’t deliver
  • More financial turmoil (like Lehman Brothers debacle)
  • High inflation forcing policymakers to tighten up monetary and fiscal policies (he argues that this is possible because our errors in predicting inflation have typically been on the high side)

Uri Dadush, director of International Economics program at Carnegie, argued that stimulus and credit restoration has led to nascent recovery. Rebounding might be slow but it cannot be too slow because it is already a very low level. He argued that in six to twelve months from now, the stimulus will have to be withdrawn. The recovery will then depend on how much the private sector will be able to pick up from the public sector-driven growth path. In the next six months, recovery will persist. Asia, the Europe, and the US have to rely on their own restructuring and domestic demand for sustained growth, he said.

The discussion was focused exclusively on the emerging economies and the OECD countries, though the panelists kept on saying ‘developing countries’, trying to mean as if they were talking about the whole world. Nobody even mentioned Sub-Saharan Africa (except for Hans, who briefly said the focus of the next G20 would be on the developing countries, poverty reduction, and the financial crisis’s impact on the poor). No trading blocs like SAARC, SADC, AU, MENA, and BIMSTEC, among others were mentioned. It might partly be because only a handful of countries drive the global trade and economy and if they don’t grow, others might not as well.

Also, it appeared that the recovery they were talking about was based on the existing system. What would a recovery look like in a reformed system, where some banks are nationalized and investment banks and hedge funds are under tight supervision? The looseness in credit from these institutions is already restrained. Moreover, a huge chunk of liquidity and investment source-- derivatives markets-- is pretty much in doldrums now. So, the recovery now look like just stocking up of inventories. After it is near-full, the real recovery would actually depend on how we fill up the liquidity void created by busted investment banks, hedge funds, subprime markets and derivates markets. Due to these markets’ absorptive capacity, inflation was pretty low despite high liquidity in the past seven years (?!?). It won’t be the same now. So, where will the trend in recovery stop or satiate?