I read this week's leader in the Economist and it has irked me. "Bold and decisive action" is what it called for, to muscle the global economy back on a path to growth, and to address the threat of deflationary spiral. "Bold and decisive action" indeed! What irked me was not the call to arms, as it has irked others, for I will admit to being reluctantly though pragmatically sympathetic, but rather the hypocrisy of the call NOW by the self-professed champion of free markets.
For it should be obvious to all NOW, that the reason why we are here, NOW, is the very lack of bold and decisive action by leaders, monetary authorities and regulators to address the inexorable build-up of excess credit creation, asset-price bubbles, as well as unsustainable fiscal policies coupled with unaddressed mercantile and exchange-rate policies in Asia. As such, any editorial call-to-arms should be prefaced with a "mea culpa" for admitting that their prior apologetic stance towards policy and regulatory neglect was incredibly short-sighted, for it not only fostered unimaginably large mis-allocations of resources, but created problems of such magnitude that large-scale socialization becomes the only viable option to prevent something approximating systemic collapse. This last phrase may sound like hyperbole, but most - even the Austrians amongst us (including perhaps Hayek too, admittedly in his old age were he alive)- would admit it is closer to the truth than not. It seems fair then, that any such mobilization of resources, or call upon the populace (and its descendants) to foot the bill, either through the burden of debt, or the imposition of a future inflationary regime, must highlight and categorically admit past mistakes, clearly for the avoidance of future doubt.
Failing this, there remains (for such an Editorial Leader) possible redemption for their lack of a mea culpa, if they perhaps attempted to quantify the present value of past benefits deriving from said policy neglect (externalities included) against the present value of costs and lost output attributed to mother of all post-war busts. But alas, The Economist is silent. Sadly, I am not a sufficiently qualified macroeconomist to weigh up such a complex cost vs. benefit question. But it is my belief - whether derived through my financial Calvinist sympathies - that we passed that threshold sometime in the latter part of the last decade (1997 ?!?) at about the time that "irrational exuberance" was banished from the ex-FRB Chairman's metaphorical arsenal. And in passing that threshold, each dollar spent thereafter was a dollar yielding diminished marginal returns to the future for the sake of present consumption thereby disastrously delaying the confrontation with fiscal and financial realities that would be met, sooner later, by market forces if not address directly through policy. Yet, it ismmy hunch, that even if it were - in pure financial terms - an economic wash (which it may very well be), the erosion of systemic confidence, the squandering of the commercial flexibility and diplomatic advantage attached to the Dollar as the global reserve currency, the impact of volatility upon investment decisions, the unnecesary delay by (primarily) Anglo-Saxon nations in converging their lifestyles and finances towards sustainable levels with their deleterious effects would likely tilt the cost vs. benefit determination in favor of more prudent fiscal and monetary policies yielding more moderate growth punctuated with mild rolling recessions - a proverbial victory for the tortoise over the hare. That's my story, and I'm sticking to it, until plausibly convinced otherwise.
There was no shortage of American triumphalism following the dissolution of the Soviet Union. And be certain that I shed no tears for this event, for conclusions regarding the inherent lameness of Central-Plan Economics were not wrong. But make no mistake, the decade since "irrational exuberance" was banished should be seen as an unmitigated failure of the unmitigated market, and here too, we should shed no tears in writing its epitaph. Issues of grandest importance indeed. I just wish more of our opinion formers would have had the humility to accept their culpability.
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Just one quibble, Cass: for decades we have had a pretty close approximation of Central Planning via a combination of central banks and unleashing of financial institutions (with implicit and explicit backstops.) It has failed just as spectacularly as Soviet style planning. I don't see how you can call that a market failure (without the loosest definition of same.)
It can't be said enough - fiat currency and fractional reserve banking have always been and always will be disasters waiting to happen.
Sure, with restraint such a system can be sustained for a long time (though with substantial hidden costs). But the temptation to let loose (and cause massive disruption and destruction, as now) has proven irresistable and will almost certainly continue to do so.
Second everything Anon @ 12.18 says and would add that the ultimate source causing the stress and fissures in our financial system is government-subsidized mortgage finance vis a vis Fannie and Freddie and the "housing is good for stability because it gives people a stake in society" mantra. The question is not more regulation, it is better regulation. Let's not forget the administration you detest attempted to regulate these guys better but was continually hindered by liberals hell-bent on home ownership (Google Barney Frank and "roll the dice" if you want ammo for a good ol' lynchin)
Anyone who witnessed and thought through what was going on in real estate five years ago knew what was going on, all you had to do was get on the ground, kick the tires, and talk to people. Any regulator, housing/mortgage executive, and politician who has seen 1-2 housing cycles should have understood this and regulated accordingly.
You also mention the mercantilist Asian FX "piss takers" in MM's words, and that is as antithetical to free markets as you can get in currency land. These micro-regulated currency regimes were large contributors to the savings glut, term/risk premia compression in fixed income, and ubiquitous availability of capital for 2003-2007. Given a positive trade surplus, these currencies HAVE to attribute, all else equal, without regulation and government intervention.
It's not a question of more regulation, but better regulation. To castigate the banks, funds, and free marketeers without a corresponding condemnation of US and EU regulators asleep at the wheel and bureaucratic micro-managers subsidizing Asian exporters and US consumers at the expense of 2 billion poor in China and India is both disingenuous and ignorant.
But as always enjoy the views, knowledge, writing. good luck heading into 2009
Anon - while I agree what we've witnessed is as messy backroom abortion, as CPE, I do not think you can equate the two. In my view, Central Banks and governments may have been riding the horse, but horse was unbridled. As such I see it far more as a market failure. Bridling the bronco at least allows a civilized ride. Failures to the GSE experiments were in the main (again IMHO) a result of the unbridling since (as seen in the S&L crisis before) you cannot underwrite risk and at the same time deregulate for obvious reasons of moral hazard. I will grant this was as much due to ill-advised political compromising as the bucking bronco, but again I fail to see the parallel between CPEs and abnegated regulatory, fiscal, and monetary responsibility.
Please enumerate the substantial hidden costs of restraint which are not obvious to me at first sight.
Anon#2 - Since this missive primarily is Amero-centric, It has been my belief that America could only do what it can do. In this regard, more bridling (higher rates or more balanced budgets, particularly post-2000 - and here it was clearly a revenue shortfall rather than excessive expenditure) through mirroring median OECD energy-and moderate consumption-oriented taxes would have limited the mercantile trade surplus builds in Asia, by throttling growth to more balanced and sustainable levels. Needless to say this would have prevented the housing bubbles, and seen equities approach levels consistent with sustainable consumption without the attendant risk of torpedoing the financial system. OK even cutting them a break for not allowing this in 1998 for Y2K, allowing the purge in 02' would have cleansed the worst of the equity and property bubbles and allowed a rebuild from lower and sustainable levels.
I agree that Globalization has inevitable consequences that must be faced in the absence of hot war.
I am unashamedly an interventionist - but not from the view of micro-managing, but rather from the point of departure that both fractional reserve banking (and democracy) are precisely imperfect systems, but the best ones we've got, but like a petulant child, needs strict and sober boundaries to save it from itself. After all, Who doesn't want "something for nothing"?
Cass - I think we're agreeing more than disagreeing. I assert that without the enablement of CB combined with FRB the regulatory failures you cite, which were indeed disastrous, would have caused much less damage. Fire needs fuel, in this case loose money - lots of it, primarily coming from easy credit which was only possible because of the blessing of CB (explicit in the form of negative real interest rates and implicit in backstop.)
Re. the "hidden costs", money created out of thin air (even in small amounts) allows suboptimally productive people to consume more than they produce, creating imbalances. If the amounts are small enough, we'll have mild inflation and mild rolling recessions during which rebalancing takes place.
This is easier to see if you construct your own simplified Island economy in which everyone works and barters. Introduce an initially stable currency, then allow a few of the inhabitants to "cheat" only a little by counterfeiting. Even if no one else notices at first, there will be overall slightly less to go around than before.
I could go on and on, of course, and there is plenty of literature on the subject I can cite if you're interested.
BTW, I very much enjoy and appreciate the wisdom in your musings.
...Couple of beers and we'll undoubtedly be in the same dugout.
These are trying times for a seer, soothsayer, or mere Cassandra for there is no philosophical or acadmemic payback in having seen the outcome in advance. It feels like shit. And there is no schaudenfraude in seeing it unravel, no matter the justice, for the violent dislocating impacts upon lives are both real, yet mostly unnecessary. I don;t know why we find it so easy to grasp the reality of say, the benefit of dietetic control of diabetes versus amputation, yet when it comes to finance and economic policy everyone must wait for the most dire proclamation that "the limb must be removed..."
Well put. I couldn't agree more.
I accept the approach you described to Anon #2 above ("bridling") as infinitely superior to what we have had for at least 20 years (not to mention the 20s :D)
What I don't like about it is that it is very difficult for regulators to get it right. If we have 100% reserve banking and a strictly limited central bank, there will be hard constraints on abuses without the need for constant regulatory fine-tuning. Sure, there will still be fraud, but it will be much more difficult to pull off and easier to combat. "Real" productivity will again be rewarded properly.
It is indeed quite frustrating to observe the growing suffering and increasing flailing in its face and feel all but powerless to do anything about it. Maybe a few beers will help! :D
Private:
I read widely across many economic areas and I have no hestiation it saying that this column is one of the best economic journals on the web. The most interesting and thought expanding.
Well done, keep up the excellent work.
C - how we go about "bridling" the system is exactly what the regulators and politicians are pondering as we speak and what the markets must face up to in 2009. Agree that capitalism and democracy are the best modes of political organization and resource allocation we have, yet inherently flawed due to the boom-bust society inevitably must endure. And let us not forget these financial vicissitudes are not unique to the last generation of unbridled Anglo-Saxon/Reagan-Thatcher/Cowboy Capitalism (Tulips, joint-stock co's, railroads). Moderating the excesses going forward whilst still encouraging the innovation and productivity that the system provides will be instrumental in capital asset pricing and (dare i say it here) general welfare going forward. Needless to say, I have seen nothing encouraging thus far.
Agree that artificially low rates contributed in no small part to this crisis and the fiscal policies of most Western countries, particularly the US, have been deplorable. Still, I don't see how you can be unabashedly interventionist and pro-regulation when many of the distortions and unintended consequences flowed directly from misguided government policies. The US government has policies in place to discourage saving via income tax of 40%, a mortgage interest deduction, and negative real interest rates for much of this decade. How can you blame consumers for indulging when the proverbial punch bowl never goes away, particularly when another interventionst, mercantilist government lends you long-term money at inflation whilst the Jones' levered assets go up 10% per annum? I neither indulged in the party nor espouse the policies in place, but from a certain vantage point it's justifiable and for many, too seductive to pass up. The point here is that many of the distortions of the last decade are directly attributable to government intervention and ample yet terrible regulation of the agents making economic decisions in accordance with the policies. This is not something you will read in the mainstream media or Barney Frank/Chris Dodd's reelection literature, but I can assure you when the history books are written on this crisis, government intervention will have played no small part. Look at any spread product out there, all are downgrading credit via higher rates and yet the governments again throw the kitchen sink at Libor-OIS, ABS, CP, etc. Have we learned nothing?
(I am banging this out quickly so please forgive atypos and relative coherence in advance)
Let's begin with some definitions. Bad Policy what you might term "Positive Micromanaging" since it screws with incentive to achieve typically some plausible result, but ultimately has at its core some concentrated self-interest which is often the result of some pathetic form of rent seeking.
Bridling on the other hand is as apolitical as financial Calvinism can be though it isn't entirely free from it since its inherently imbued with some political values. It sees expenditure beyond the essential including the moderate redistribution - particularly inter-generational -(whose objectives I happen to agree with) as wholly political, and safeguarding reasonably sound money and prudent credit-growth as its primary objectives.
The difference is obvious: if as a society you wan't to increase home ownership, or housing availability, build social housing directly, fund housing charities (housing associations) or collect the money subsidise down-payments directly (demand low income people put up 5 of the requisite 25% deposit and require gainful employment. This is an inherently conservative approach, amazingly eschewed by conservatives who should be natural supporters of such a taxonomy. Yet it is likely that they fear they will lose the political battles for their parochial (non-redistributive agendas) hence have a better of succeeding when they are entwined.
In the financial realm (as with medicine) modern complexity IS overwhelming and while its fine (in principle) for free-marketeers to demand more personal responsibility, the complexity remains daunting in both spheres, even for the educated. Thus from a regulatory point of view, I think its useful for the State (where ideally the state is uncompromised by trade associations and rent seeking) to set some/most of the boundaries (i.e. "no money-down, teaser rates, negative amortizing mtgs, etc) in the spirit of prudence. Some may view this as state nannying but I view it the same way I view such restriction the same way I do dumping wastes (toxic or otherwise) into rivers: the financial system is a common good, and should be safeguarded as such. "Voluntary restraint", "self-regulation", "long-term self-interests", "common good" (the very tethers - OK maybe not that last one - Mr Greenspan was surprised to see broken).
I do not argue that what some may term micromanagement, but which in actual fact was corruption and crony-capitalism at its worst created distortions that were often root to causation and perverted incentive. But just as yelling shouldn't be confused with discipline, so to should bad policy enacted by a comprised State be confused with what I might propose should be archetypical boundaries enacted and enforced by uncompromised state in the public's interest (at least according to its stated role of safeguarding the integrity of the coin and the financial system of the realm.
We must not throw out the Hayekian truth that markets and market price signals are the best way to allocate resources just because a particular generation of Panglossian central bankers - and economists - took it in their heads to salivate over whatever "sophisticated" instruments market participants cooked up in the pursuit of profit. Their intellectual blindness has proved the old adage that cleverness does not connate with wisdom. The central banks and others in the policymaking field are there to act as referee over the markets not to act as scantily dresseed cheerleaders. So what is the best policy now? Do nothing. Absolutely nothing. Just wait and let current forces work themselves out over the next six months or so. Let the markets respond to the price signals. Face the debt and take the losses. Clear the debris. People learn by suffering and fear, not through the palliatives and promises of politicians. Of course, it will not happen.
I take it they left out the bold and decisive action of bringing back the guillotine. We optimists can aim for 2009 on that one. I'm especially intrigued about the irrational exuberance the public may have for the Masters of the Universe when sharper management tools are available.
Adrem- I am unsure of the value of price signals in an economy where financial speculation dwarfs actual economic activity. How does one manage a business with the oil price signal in July at $150 and going to the moon, and December @ $42 and going lower??
This isn't a fully formed thought, but the price volatility is such that one must take EVERYTHING in the markets with a grain of salt in thinking through policy implications. While the market nastiness might take care of some of the excess funds in the system, isn't the larger problem for the past 10 years the obese size of finance capital compared to real products?
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