15th September, 2008.
To address this very grave global financial crisis effectively, one needs to analyse it correctly. A wrong analysis results in wrong conclusions and solutions, just as a wrong medical diagnosis can lead to wrong, often life-threatening treatment. Orthodox economists, who have for so long turned a blind eye to the finance sector, to privatised credit creation and its role in fuelling asset bubbles, do not understand this crisis. They did not predict this crisis. And their deeply flawed economics mean they cannot therefore resolve this crisis. Indeed they are supremely irrelevant to this crisis.
Tonight a group appeared on Newsnight. (‘Nightmare on Wall St.’). They included a woman economist whose name regrettably escaped me, and who is not listed on Newsnight’s website, Anatole Kaletsky of the Times, and Derek Scott, previously economic adviser to Tony Blair.
They argued firstly that the crisis was caused by Greenspan’s low interest rates/loose monetary policy/low policy rates after 2001. Many orthodox economists are asserting this, for two reasons: to pin the blame for the crisis on interest rates, not de-regulation of credit creation; and to pin the blame on central bankers, not the private finance sector. Focusing on interest rates diverts debates away from proposals for re-regulation of the finance sector. Focusing on government civil servants, which is what central bankers are, diverts attention from the privatised finance sector.
They are wrong in analylsing Greenspan’s low interest rates as a fundamental cause of the crisis. Because if low interest rates are the cause of the crisis, then as the rather unwise Derek Scott suggested the ‘cure’ is and I quote: ‘higher interest rates’. This is a truly deranged solution to the crisis facing banks, individuals and whole economies buried in mountains of debt, and threatened by the intractable crisis of deflation as these mountains of debt are de-leveraged. (De-leveraging by the way, means paying off/writing off the crazy amounts borrowed on the back of tiny amounts of real money. The $1 million borrowed (or leveraged) say, on the back of $1,000 of real, sound collateral. De-leveraging that would mean paying off/writing off $999,000. You can see why de-leveraging leads to bankruptcy, and why in the wider economy it is deflationary. Many householders are de-leveraging/paying off/writing off/re-financing the huge loans taken out on the back of inflated prices for properties – whose prices are now falling.)
Debtors – official debtors, individual debtors, corporate debtors – are struggling to repay at current high real rates of interest. That is why we have a debt crisis or a credit crunch. Treating this crisis with higher interest rates would plunge individuals, companies and banks into an even deeper mess. We must be grateful Derek Scott no longer advises the government.
Yes, its true that Greenspan lowered interest rates, and tried to keep them low after 2001 – but that was only as a reaction to a grave crisis – the bursting of the dot.com bubble – a bubble that like the property bubble was one fuelled and inflated by easy, unregulated and privatised credit creation. Furthermore, the low interest rates of the early years of the 21st century were more a function of unregulated global capital markets, than of the powers of central bankers to set low rates.
Because de-regulation (i.e. ‘globalisation’) means that capital can flow untrammelled around the world; and because the collapse of the Bretton Woods system (which had mechanisms for curtailing the growth of imbalances between nations) led to the growth of large imbalances (massive deficits for the US and UK and surpluses for Japan and China) – China (and other countries in surplus) exported surplus capital to the US. This flood of capital lowered rates of interest in the US and puzzled Greenspan, who was trying to raise rates. (He called it a ‘conundrum’.) If Greenspan had wanted to tackle these low rates, he would have erected barriers to the movement of capital – capital controls – and thereby prevented China’s surplus capital from affecting and lowering US rates. He had no intention of doing so, and instead pretended that his lack of control over rates was a mysterious ‘conundrum’.
With capital controls, Alan Greenspan or any other central banker would exercise control over a key lever of the economy: the rate of interest. Not just the ‘policy rate’ or official rate (often known as the Bank rate) – but all rates – safe and risky, short and long. Without capital controls, and by delegating powers over interest rates to private bankers (see Libor rate discussions below) central bankers are impotent in the face of capital movements that affect the yields on bonds, and therefore interest rates within their domains.
Second, our panel of orthodox economists suggested that the crisis was caused by an absence of transparency. Sure, secrecy and outright deception about the true facts relating to balance sheets, assets and liabilities played a big part in this crisis. Secrecy and deception undermined trust in the banking system and triggered the ‘debtonation’ of 9 August, 2007. Secrecy and deception are endemic to un-regulated financial systems.
So will requirements that banks become more transparent solve the crisis? Absolutely not, because making their liabilities more transparent -at a time of crisis - will only exacerbate the crisis. Of course, transparency should have been demanded in the first place. But demanding transparency now in the midst of the perfect storm, is a bit like asking a patient to walk out of the hospital into the hurricane stark naked just as s/he is undergoing a stem cell transplant.
Its orthodox economics, but its crazy.