Yves here. This Real News Network interview with Yilmaz Akyüz, chief economist at the South Centre and former director and chief economist at UNCTAD, focuses on the conundrum of the Fed’s need to exit from QE from an international perspective, and layers in the further complication that China is not going to keep up its investment spending at the same level. Akyüz argues that “….we have problems at the end of the crisis which are as big as the ones during the crisis, and these problems are largely due to mismanagement of the crisis, particularly in the U.S. and Europe.”
But I’m not sure it’s as simple as mismanagement. I’ve believed we are at the end of an economic paradigm, and the way out of those in the past has been breakdown. In ECONNED, I listed four theories, and I believe the last was the most problematic:
Cognitive regulatory capture, meaning the regulators have adopted the industry worldview, which makes them reluctant to act.
Extortion, meaning that the financial services industry controls infrastructure that is essential to capitalism, and cannot be displaced except at very high cost. Think of what happened to the civilization at Ur when the king shut down the overly powerful lenders.
State capture, meaning the financial services industry now has the status of oligarchs in third world countries, having used its economic clout to buy so much political influence that they largely dictate policy regarding its interests.
Paradigm breakdown, meaning key elements of the current system are no longer viable, but that is a possibility that no one is prepared to face, since the old system seemed to work well for a protracted period. Thus the authorities reflexively put duct tape on the machinery rather than hazard a teardown.
All these factors play a role in the hesitance to impose tough reforms, but the most intractable and least recognized is the last, the difficulty of seeing that the failings of the current system are deeply rooted and not amenable to simple remedies. Any resolution of the major problems facing the financial system would take a good deal of time, care, and persistent effort, and would simultaneously be highly politicized. That makes it very likely that the financial services industry will derail or blunt reform efforts. That in turn means the current paradigm will be patched up and restored to service only to fail again. This pattern will replay until the breakdown is beyond repair…
One of the troubling features of the discussion of the crisis has been the recognition of the role of so-called global imbalances as a factor in the debt binge in the U.S. and other advanced economies, and the widespread attitude of resignation towards that problem. The tacit assumption is that the United States cannot act unilaterally. The US first took a posture of benign neglect, but the administration is taking a slightly different tack. The focus of the G20 discussions has shifted from banking reform to the nebulous notion of creating a framework for addressing global imbalances. Ironically, the financial crisis has led to miraculous progress. The US trade deficit has fallen sharply because scarce credit has strangled consumption and trade financing. But exhortations to meet medium term goals, far enough away that no one will be held accountable for failing to meet them, is simply another way to kick the can down the road.
Similarly, the policy of the authorities in the United States has been explicitly to try to shore up asset values, out of the belief that we discussed earlier, that the markets are simply wrong about the need for housing prices and other financial assets to correct. Yet numerous analyses have found that residential real estate price in many markets, including the United States, the UK, Ireland, Spain, Australia, the Baltics, and much of Eastern Europe, rose to levels well out of line with historical relationships to income and rentals. There was also pervasive underpricing of credit risk, as noted in the Bank of England’s April 2007 stability report.
Yet the strategy of the powers-that-be has been to try to restore status quo ante. Albert Einstein defined insanity as “doing the same thing over and over again and expecting different results.” It is one thing to try to patch up what you have on an emergency basis due to the need to respond quickly, and quite another to regard that as a viable long-term solution.
The situation we are in now echoes that of the Great Depression. Although scholars still debate its causes eighty years later, a persuasive view comes from MIT economics professor Peter Temin. Temin, in his Lessons from the Great Depression (1989), first sets forth the prevailing explanations and explains why each falls short. He argues that the culprit was the impact of the World War I on the gold standard.
Recall that starting roughly in 1870s, major European economies increasingly adopted the gold standard, and a long period of prosperity resulted. The regime was suspended in the UK and the major European powers during the war. Afterwards, they moved to restore it, sometimes at considerable cost (England, for instance, suffered a nasty downturn in the early 1920s). But the aftereffects of the war meant the Edwardian period framework was unworkable. The deflationary forces they set in motion could have been countered by countercyclical measures after the Great Crash. But that was impossible with the gold standard. Indeed, as Temin notes, “Holding the industrial economies to the gold-standard last was about the worst thing that could have been done.”
Now readers may have trouble with that comparison, particularly since the conventional wisdom is that our policy responses have been so much better than those of the early 1930s. But the key point here is that the institutional framework locked the major actors into a particular set of responses. They were not able to see other paths out because they conflicted with an architecture and a set of beliefs that had comported themselves well for a very long time. It’s hard to think outside a system you grew up with. And remember, the gold standard did not break down overnight; the process took more than a decade.
Back to the current post. So it’s not surprising that experts like Akyüz see only grim outcomes and no ready way out. The incumbents are simply unwilling to risk, both politically and economically, the degree of intervention needed to come up with or even ease the way to a new set of institutional arrangements. Ideas like a jobs guarantee, which would be far more salutary than a lot of other alternatives, are dismissed as too far out to even get a serious hearing. The authorities have done an impressive job of keeping a badly impaired system limping along, and it might even have periods of credible-looking improvement. But as Herbert Stein said, “If something cannot go on forever, it will stop.” So the end game seems inevitable, even if the timing is unclear.