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Morning Must-Read: Simon Wren-Lewis: Asymmetries and Uncertainties

Weekend Reading: Best Review of Martin Wolf's "The Shifts and the Shocks"

It is Eric Rauchway in the Times Literary Supplement. My only complaints about the review are:

  1. It was more than just the desire of rapidly-growing emerging markets not to find themselves under the hammer of a 1998 that produced the global savings glut. It was increased income inequality in the North Atlantic core, plus increased wealth in the periphery seeking a North Atlantic bolthole as a form of political risk insurance as well and in addition.

  2. Although Keynes argued that deflation was worse than inflation, he sought to avoid both rather than lean on the inflation side.

  3. Keynes did not win at Bretton Woods: Bretton Woods did not mandate symmetrical adjustment. Keynes's victory was partial, and for the most part came after his death: policy during his life was hardly Keynesian.

  4. Summers served Obama; Summers's preferred policies were not adopted by Obama. But that failure was by no means written in the stars. It was contingent--depending on both a Treasury Secretary and senior political advisors who did not understand the situation and on Obama's imprinting on them rather than on Summers. It was a near-run thing, in the United States at least. A much better world is only a butterfly wing-flap away on some alternative quantum frequency of the multiverse.

Here it is:

Eric Rauchway: Debt Piled Up: "Martin Wolf THE SHIFTS AND THE SHOCKS: What we’ve learned--and still have to learn--from the financial crisis. 496pp. Allen Lane. £25. 978 1 84614 697 8 Published: 29 December 2014:

Over the course of his new book on the current economic unpleasantness, Martin Wolf conveys a sense of increasing frustration. He begins with a sober account of recent history and a capsule proposal for how to solve the malaise with which we are confronted, and then begins to evaluate competing accounts and proposed solutions, often with a single word. Here is a non-exhaustive list of those words: nonsensical, simplistic, mistaken, childish, asinine, self-refuting, nonsense, silly, insouciant and grotesquely dangerous, and--most frequently--wrong (at least once, totally so).

While this bluntness may simply reflect the author’s temperament, it also especially suits his analysis, which holds that we knew how to avoid, counter and cure these troubles; we have simply--largely out of wilful ignorance and lack of courage--failed to do more than the barest minimum of what was necessary. Governments, banks and international institutions did ‘just enough, almost too late’ to prevent the worst possible result, which would have been a note-for-note replay of the 1930s including a slide into fascism and world war. But having done no more than avoid world-historic catastrophe, we find ourselves mired in a dim morass of our own making, with no sunlit uplands in sight. No wonder Wolf is exasperated.

Although what happened is recent--only six years past--it bears retelling, as so much has gone on since. Wolf offers a persuasive account that is also clear, though he relies on no single factor but several: hence the title of the book. It took both long-term shifts and a series of shocks to cause a crisis of such magnitude.

Our world was born in the end of the Cold War. With capitalism triumphant, the victors liberalized their economies and so did the Communist nations, particularly China. Yet all was not well in this brave new world; international finance and trade threatened the stability of smaller, emerging economies, as the crises of the 1990s demonstrated.

In consequence, a number of these emerging nations decided to defend themselves against the effects of international capital flows by accumulating large reserves of foreign currencies. The resulting glut of savings and low interest rates created conditions ripe for crisis, exacerbating the intrinsic instability of the credit cycle. Normally reliable, short-term assets financed unreliable, long-term assets. Debt piled up in richer economies. Also encouraging this increase of debt was, Wolf writes, growing inequality, which encouraged poorer people to close the gap with their richer neighbours by borrowing to buy the trappings of affluence.

To those shifts should be added the establishment of a rigid Eurozone, whose only provision for adjustment to international conditions is an increase of suffering:

The euro has been a disaster. No other word will do...

Wolf writes. The United States had a strong political union and national banking system before creating a currency union. Europe went at the project from the other direction. Nations within the euro cannot conduct their own monetary policy. Thus if they need to increase exports, they can only pursue a course of increased productivity via higher unemployment and lower wages. As Wolf says:

The mechanism of Eurozone adjustment is simply that of the old gold standard...

It forces misery on nations in the name of preserving a stable exchange rate.

This system was vulnerable to shocks, which bankers and regulators either failed to predict or succeeded in ignoring. Even participants who knew better did not want to stop lending, lest they miss a few more profits before the inevitable debacle. Wolf quotes Charles Prince, former head of Citibank, saying in 2007:

as long as the music is playing, you’ve got to get up and dance.

Prince’s view can be explained by greed and circumstance. It is less easy to explain the view of Ben Bernanke, head of the Federal Reserve System, whom Wolf quotes as saying in the same year that collapses in unreliable securities were ‘unlikely to seriously spill over to the broader economy or the financial system’--a view that Wolf describes as ‘almost clueless’. It is not clear that he needs the ‘almost’.

Bernanke made his complacent remark while the world economy was teetering on a precipice--or perhaps after it had already overrun the brink but before it began to plummet. While the Fed chair himself soon dropped his blinkers, others have not done so. The efforts to recover from the crisis have left its harms unhealed. As Wolf notes, ‘largesse to banks’ was ‘not matched by comparable largesse’ to debtors. Lenders got bailouts while borrowers got lectures on prudence and suffered foreclosure, unemployment and benefits cut in the name of austerity. Yet leaders in politics and finance apparently remain sure that the proper course of action is to resume business at the old stand as soon as possible. It is this resilient smugness that provides the occasion for Wolf to thread his string of expostulations through the book. Someone has blundered; yet shame has yet to scourge the fatted souls of the land. The errors we made could have been avoided; the errors we are making we should know better than to commit, let alone elaborately justify.

Among the major errors we have made and continue to make is the insistence on austerity--cutbacks in government spending, justified by the commonsensical and often repeated but nonetheless (as Wolf likes to say) wrong assertion that one cannot get out of debt by piling on more debt. There are different kinds of debt, and public debt is not like private debt:

It is necessary for the creditworthy to borrow when those who are no longer creditworthy cannot...

Wolf explains slowly:

If everybody tries to cut down on borrowing and spending at the same time, the result will be a depression...

It must be the need to repeat such long-established and elementary observations that has robbed Wolf of his patience.

We live today (however poorly) according to thoroughly discredited bromides. For example, one of the major arguments against pursuing fiscal stimulus and indeed monetary stimulus is that it might produce inflation, a fear we often hear expressed. But John Maynard Keynes devoted the first chapter of his 1923 Tract on Monetary Reform to explaining why it would be better to risk inflation than deflation. Inflation robs creditors of their expected profit, which is bad, and destroys the confidence necessary to further investment, which is worse. But deflation can destroy the economy:

a general fear of falling prices may inhibit the productive process altogether... entrepreneurs will be reluctant to embark on lengthy productive processes involving a money outlay long in advance of money recoupment--whence unemployment...

On balance, Keynes concluded:

it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier...

Keynes won this argument in his own time and saw his priorities written into international monetary policy with the Bretton Woods agreements. But Keynes’s intellectual and institutional victories were subsequently undone. We now live in an impoverished world, and see little if any evidence of inflation, yet our chattering classes and political leaders live in constant fear of disappointing the rentier and demand we continue policies that provoke unemployment.

Keynes is only one of a canonical series of economists who remain right, and ignored. When Wolf asked the US economist Lawrence Summers whose analyses he finds useful to understand our ongoing economic troubles, Summers suggested Walter Bagehot (who outlined, in the nineteenth century, the case for a central bank’s aggressive intervention to relieve panics); Charles Kindleberger (a keen student of economic crises); Keynes; and (Wolf’s own favourite) Hyman Minsky, who argued that, capitalism being subject to inevitable crises, ‘the combination of ‘Big Government’ with the ‘Big Bank’ (the central bank) was the only way to contain the consequences of severe instability’.

And yet, the Summers who gave Wolf this list of canny and useful thinkers is the same Summers who served a US government that ignored their recommendations. We know what to do, but we will not do it: hence the impatience of Wolf, and also of Paul Krugman--another economic analyst who has proven more often right than wrong, and yet who has been driven to invective because, he says, the opposition:

keeps trotting out claims that have already been discredited...

thus arguing in ‘bad faith’.

In the 2011 film Margin Call, which dramatizes the onset of our dismal era, the banker character played by Jeremy Irons delivers a monologue with which he attempts to justify his ruthless self-interest. Events like this just happen, he says. He lists a series of dates corresponding to financial panics, the modern part of which runs like this: ‘1819, 1837, 1857, 1884, 1901, 1907, 1929, 1937’--and then Irons pauses slightly before continuing--‘1974, 1987....’ It is a slight pause, but there is room in it: room for, after the war, what the French call les trente glorieuses, the decades of widespread economic growth and prosperity. That gap in the string of crises undermines the Irons character’s argument: the disasters do not have to happen. During the period in that pause, banking was tightly regulated, capital movements were controlled, exchange rates pegged (if adjustable). As Wolf says, ‘finance was repressed. That certainly prevented crises’.

Wolf says finance desperately needs a bit of that old-time repression now. He would like to see banks required to hold much more capital, and deprived of their ability to generate money at whim. If achieving this goal means financiers can no longer operate globally, so be it: ‘unless regulation and the supply of fiscal backstops is to be much more global, finance should be far less so’. He wants also to see more fiscal stimulus, to move the world out of its economic doldrums, and the creation of a global currency, to replace the US dollar as the reserve asset of choice. Both these solutions were, like the acceptance of moderate inflation as an acceptable risk, also Keynes’s ideas, published and defended before the Great Depression saw them implemented as policy.

Even though he has carefully reinvented the Keynesian wheel, Wolf despairs of seeing anything like the necessary reforms implemented, mainly because they would inconvenience terribly rich people, especially bankers. And so this politically moderate Commander of the British Empire, a stalwart of the Financial Times features pages, concludes his book with a chapter title borrowed from the African American writer and activist James Baldwin, who warned in 1963 that if society continued on its rigid, stratified way, it would burn: we may have escaped a conflagration this time, Wolf tells us, but it is in the nature of the system that there will be another shock, and surely we will see ‘fire next time’.

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