Duncan’s Economic Blog

Bank Failure & Macroeconomics: Keynes, Hayek, Marx & Minsky

Posted in Uncategorized by duncanseconomicblog on August 30, 2011

At the start of this month I took part in a (highly enjoyable!) LSE/Radio 4 debate on Keynes versus Hayek (45 minute radio edit available here and ‘un-cut’ 90 minute video version available here) with Lord Skidelsky and myself representing Keynes opposed by George Selgin and Jamie Whyte..

The structure of the debate limited our opening contributions to around 4 minutes each and the format meant (rightly) that what was emphasised was the differences and disagreements. Which was entirely correct for a public debate/radio programme but the advantage of writing a blog is that allows me to be more nuanced.

I actually have a lot of time for some Hayek’s work – I usually disagree with the policy recommendations which (especially amongst Hayek’s modern day adherents) seem to be driven as much by political ideology as by economic analysis but there is something in Hayek’s analysis of the causes of financial crashes that the left cannot ignore.

So whilst I disagree with most modern day Hayekians on the supposed virtues of cutting public spending during a ‘balance sheet recession’ (Richard Koo’s term, recently used (perhaps unwittingly) by the Chancellor) I can see their point that, given how the modern financial system currently operates, a long period of low interest rates can lead to severe mal-investment and unsustainable bubbles.

The crucial word there being ‘currently’. I can also envisage circumstances in which low interest rates allow a heavily reformed financial system (more banks, more industry focussed banking, regional banks, less speculation) to actually support the productive economy.

But the question that really interests me at the moment, and what inspired this blog post, is the issue of how to deal with the failure of large banks. An issue that I hope doesn’t arise in the near future but which may well do rather quickly if the worst case scenarios come to pass).

At the debate Whyte and Selgin were keen to brand the policies pursued in 2008 (broadly put – huge central bank liquidity support coupled with direct government recapitalisation and varying degrees of nationalisation) as ‘Keynesian’. I’m not at all sure that is fair, I think Kaynes would been far more inventive – perhaps using QE to capitalise a National Investment Corporation. But, that aside, it certainly wasn’t Hayekian.

Their argument (again broadly put) was that bad banks should have been allowed to fail and that by propping them up the government is stopping money going to well functioning banks and holding bank the recovery. The ‘liquidation’ of bad assets has to be allowed to happen in order for a sustainable recovery to begin.

Back in 2008, I supported the actions taken by Western Governments, I thought large scale bank failures would have turned the recession into an actual depression as savers took large loses, payments systems broke down and cash machines actually ceased to operate. That would have been a disaster.

But bank failure in 2011 or 2012 or 2020 could be different. Back in 2008 the crisis surprised policy makers and the response was haphazard and driven by fear and confusion.

As Frances Coppola, who really knows this stuff, has recently written about ways to ‘set banks up to fail’, lessons to learn from the last crisis and argued that:

If an institution is not viable, it will fail eventually whatever steps are taken to prop it up. The problem is that when it does fail, it brings a lot of others down with it. The larger and more interconnected the failing institutions, the greater the risk they pose to the world economy – and the louder the cries of people who depend on those institutions that governments should act to prevent their failure.

If the international financial system is so fragile that it can only survive with constant infusion of mammoth amounts of public money, then IT IS ALREADY IN A STATE OF COLLAPSE. And as any mining engineer knows, propping it up is not only expensive, it is dangerous.

I would like to suggest that the international financial system should be ALLOWED to collapse. That doesn’t mean that governments should abandon their responsibility to protect the people affected and as far as possible prevent long-term damage to the economy. On the contrary, governments should be actively involved in managing the collapse of the current unsustainable system and the building of a new system that meets our needs better.

This point, which could be dubbed ‘Interventionist Hayekian’, seems right to me.

I also think it is possible to get to the same conclusion in a fundamentally Marxist way. Basic Marxist Crisis Theory says, amongst other things, that as booms expand the amount of capital employed increases, eventually the rate of profit begins to fall leading to a recession in which much of the capital stock is destroyed – allowing higher profits on the remaing capital stock and hence a resumption of expansion.

If we then add on some of the work of modern Marxist economists on how capital has been ‘financialised’ then we get to an interesting conclusion.  Foster and Magdoff have written (in a book that I’d highly recommend despite it being somewhat to the left of my usual reading habits):

For the owners of capital the dilemma is what to do with the immense surpluses at their disposal in the face of a dearth of investment opportunities. Their main solution from the 1970s on was to expand their demand for financial products as a means of maintaining and expanding their money capital. On the supply side of this process, financial institutions stepped forward with a vast array of new financial instruments; futures, options, derivatives, hedge funds, etc. The result was skyrocketing financial speculation that has persisted now for decades.

One could then argue that if financial capital has replaced physical capital and the state is preventing financial assets from being destroyed there is no way, according to standard Marxist theory, for the ‘crisis’ to end. Which leads one into calling for revolution and the overthrow of capitalism or acknowledging that simply nationalising failed banks is unlikely to ever end the crisis.

We are in an odd place indeed when Marx and Hayek are pointing in the same direction.

Which take us to Minsky, who although he called himself a Keynesian was a far more interesting and nuanced thinker who paid as much attention to Fisher on debt –deflation as he did to Keynes (and his Keynes was far more about the Treatise and the Tract than the General Theory).

As he wrote:

As the standard interpretation of Keynes was assimilated to traditional economics, the emphasis upon finance and debt structures that was evident in the 1920s and the early 1930s was lost. In today’s standard economic theory, an abstract nonfinancial economy is analysed. Theorems about this abstract economy are assumed to be valid for economies with complex financial and monetary institutions and usages. As pointed out earlier, this logical jump is an act of faith, and policy advice based upon the neoclassical synthesis rests upon this act of faith. Modern orthodox macroeconomics is not and cannot be a basis for a serious approach to economic policy.

And this is what we need – a modern way of thinking about the macroeconomy which takes asset bubbles seriously, we looks at over-speculation and which understands how banks operate rather than assuming them out of existence.

The odd thing is that it will probably draw as much from Hayek as from Keynes.

20 Responses

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  1. Will M said, on August 30, 2011 at 1:37 pm

    On the subject of the debate – Jamie Whyte was very keen in using the typical Hayekian grenade of “we can’t bail out banks, it creates moral hazard, since it leads banks to think they have state backing” (and, as per usual, with no suggested practical alternative to rescuing the banks). This analysis completely fails to take into account the question of when the moral hazard might be said to have arisen.

    In my view, when governments fail to adequately regulate banks in respect of their size, their gross + net liabilities, and their inter-connectivity (e.g. through derivatives counter-party exposure), thus creating the different aspects of the Too Big To Fail problem, it is *at this point* that the government is creating the moral hazard. I agree with Mr Whyte entirely that this a terrible thing, but think that nevertheless having created the moral hazard of implicit state backing, the State is at least obligated to follow up on that backing.

    • JakeS said, on August 30, 2011 at 9:19 pm

      Meh.

      There was nothing wrong with AIG that Ch. 7 bankruptcy could not have solved, if coupled with unrestricted fiscal support of full employment. Yeah, it sucks to be a creditor to an insolvent institution, but that’s what you get for not performing your due diligence.

      Of course the Mellonesque suggestion that we allow the liquidation spree to commence without unrestricted fiscal support of full employment is a recipe for turning a disaster into a catastrophe. But that will be the case whether you Ch. 7 the insolvent bank or attempt to bail it out.

      – Jake

  2. Gareth said, on August 30, 2011 at 2:34 pm

    Interesting post, Duncan, thanks. Hope you enjoyed your holiday haven.

    “Which leads one into calling for revolution”

    I have seen this a few times recently, there was a Radio 4 Analysis program about “financialisation” theory which made the same call; that the bust was “not big enough” to inspire true reform of capitalism.

    The parallel with the “Shock Doctrine” is irresistible!

  3. charliemcmenamin said, on August 30, 2011 at 3:14 pm

    Given it is essentially a spatchcocked together series of previously published magazine articles I do agree that the Foster and Magdoff book is very good indeed. But then, they’re really the ‘heirs of Paul Sweezy’, as I argued when I reviewed on my blog it when it came out – and that’s a pretty imposing intellectual legacy to be carrying. As a non economist I thought they did a good job of integrating Minksy’s (or Minskian, anyway) ideas into their account, but that’s a statement made on the basis of having never read him in the original so subject to change if Someone Who Knows What They’re Talking About corrects me.

    But there is a mismatch between the depth and plausibility of their economic analysis and the sketchiness of their political solutions which, to be frank, seem to be little more than slogans (albeit ones I’m sympathetic too) rather than worked out strategies.

  4. liminalhack said, on August 30, 2011 at 3:39 pm

    Duncan, we just need to be able to have properly negative nominal interest rates to allow excess capital stock to be safely retired with the market as the ultimate arbiter of the rate at which the stock should be reduced, and with every holder of excess claims allowed to decide what oven to stick their head in.

    Anything else is far to complex, and worse, doomed.

  5. jomiku said, on August 30, 2011 at 3:56 pm

    I haven’t had time to listen to the debate. Thanks for the link. In the US, this thing happens at universities only.

    As for Austrians, I have little patience for them. Their analysis is interesting, but then many are, including thinking about how this would work in the Klingon Empire. My problem with them is they act as though they are speaking for God. This comes from their ancestry in natural law, in Church thinking which sought to apply Christian views of creation to economic activity. They presume a set of absolutes and then argue that what they say flows from these premises. These are not absolute at all. As a non-Christian, I find them manifestly offensive in many ways, given how they presume to speak about creation and God’s intent.

    Austrians, like all believers, tend to lie a lot. I’m not sure why believers need to distort what other people think, do or say. I suppose it comes from the heresy arguments implicit in this kind of thinking: you’re a heretic, what you think is heretical and it doesn’t deserve treatment which casts it as less than heretical. I find it nearly impossible to engage Austrians because their minds are blinkered by belief.

    What they are arguing is that God wants destruction: of lives, of wealth, of happiness. The reason: we did not adhere to the structure God imposed on reality, which the Austrian school has discovered and determined in its details. (The similarity to Marxism is obvious, with the latter relying on pseudo-science as its absolutism.) Since you used an expletive in a post, here’s mine: who the fuck are they to know the mind of God? Who the fuck are they to decide that wrecking lives and causing vast chaos and ruin is God’s plan? Their belief system, rooted in late medieval Catholic thought, says that some things are natural, that some things are meant to be this way, and that deviation from them not only brings ruin but that we should embrace the ruin as punishment for our deviation. What a load of nonsense.

    It’s important to look at where a person and an ideology comes from. Austrian thinking is inescapably the imposition of a religious set of assumptions about what is God given and thus what is God’s will and thus what God hates. How dare they.

  6. metatone said, on August 30, 2011 at 4:19 pm

    Isn’t the fundamental problem with Hayekians (and possibly Hayek himself) that for them an “interventionist Hayekian” is an anathema to them?

  7. Leigh Caldwell (@leighblue) said, on August 30, 2011 at 6:26 pm

    metatone: “Isn’t the fundamental problem with Hayekians (and possibly Hayek himself) that for them an “interventionist Hayekian” is an anathema to them?”

    I think this is the distinction between Hayek’s underlying theories and Hayek’s politics; modern Hayekians tend to follow both, but they can be separated.

    As I understand Duncan’s point (with which I agree) the underlying non-political Austrian arguments, partly due to Hayek and more so to von Mises, are about the limits of knowledge and cognition. These limits imply that certain kinds of central planning can’t work, and so a strict authoritarian regime will never be able to deliver the benefits of an open market.

    Many modern Hayekians would make a stronger statement – that price signals are the only workable way for information to be transmitted around a society, and that government intervention is always counterproductive because it does not make decisions based on price information. However, Minsky showed that markets are also subject to collective errors; prices alone do not provide sufficient controls or stability to guarantee good outcomes.

    I would suggest that the cognitive constraints highlighted by von Mises imply that pure markets cannot work, just as they imply the same about pure central planning.

    Minsky’s and von Mises’ (and implicitly, Hayek’s) theories leave open the possibility that some other kinds of institutions can be designed, which would result in more stability and/or better outcomes for individuals and society than either pure free markets or pure government. They don’t, however, say what those would be. Some have suggested, inspired by the traditional Labour movement, that some form of cooperatives might be a solution – I’m open minded but not convinced.

    While I agree with Duncan on all this (if I have understood him rightly), I think there’s a flaw in this quote from Foster and Magdoff:

    “For the owners of capital the dilemma is what to do with the immense surpluses at their disposal in the face of a dearth of investment opportunities. Their main solution from the 1970s on was to expand their demand for financial products as a means of maintaining and expanding their money capital. On the supply side of this process, financial institutions stepped forward with a vast array of new financial instruments; futures, options, derivatives, hedge funds, etc”

    Financial institutions are not actually on the “supply side” of these instruments; they are intermediaries only (putting aside the cases where they trade on their own account, which are not the point here). For each owner of capital who wants to get a return from a derivative, there must be a counterparty who is willing to accept the capital and offer a return on it.

    Capital owners cannot generate these returns on their own, or only with the help of banks; they can only do it by persuading someone on the other side to become a user of capital. This in itself is not a process of pure financialisation; it is a change in the destination of surplus capital.

    This may well be why the use of consumer debt has risen significantly in the last 20 years. Although we could equally argue that consumers borrowing from holders of capital is the natural state of things, and this demand was artificially suppressed in previous decades, leaving business investment as the only outlet for capital surpluses.

    • JakeS said, on August 30, 2011 at 9:46 pm

      Capital owners cannot generate these returns on their own, or only with the help of banks; they can only do it by persuading someone on the other side to become a user of capital. This in itself is not a process of pure financialisation; it is a change in the destination of surplus capital.

      This may well be why the use of consumer debt has risen significantly in the last 20 years. Although we could equally argue that consumers borrowing from holders of capital is the natural state of things, and this demand was artificially suppressed in previous decades, leaving business investment as the only outlet for capital surpluses.

      This is a cute story, but it is not how bank lending actually works: As long as the bank has access to a solvent customer who is prepared to pay the prevailing risk-free rate, plus appropriate risk premium, plus whatever overhead the bank incurs, the bank can lend to said customer. Depositors are not required, because the central bank always has the power to fix the risk-free yield curve in any odd shape it might care to. To speak of “capital surpluses” being “intermediated” by banks into loans is to engage in the loanable funds fallacy.

      (As an aside, discussion of these matters is not aided by the persistent confusion between (real) capital and financial assets. The two are only tangentially connected, and the industrial society that fails to keep the distinction at the forefront of its mind when shaping economic policy will soon cease to be an industrial society.)

      In fact, the causality goes the other way: Beginning around 1980 (give or take five years depending on where in the OECD you are looking), wages stopped tracking productivity. There is a variety of more or less interesting reasons for this, but the term “neoliberalism” provides a catch-all that is adequate for the present purposes.

      Since wage-earners were also the principal consumers in the Fordist political economy, this posed a serious problem: Suppressing wages would send demand into a tailspin, which would kill profits deader than the dodo. This problem was resolved by separating the role of consumer and the role of wage-earner, by creating a series of credit bubbles (real estate, common stock, revolving credit, real estate again) that permitted the citizens to consume out of money they had not earned in wages and had no realistic prospect of ever earning in wages.

      The problem is that the holders of this bogus debt want it to be paid back. Without corresponding increases in wages or sovereign outlays, to match the income that this drains from the system. Which is, of course, a mathematical impossibility.

      – Jake

      • Leigh Caldwell (@leighblue) said, on August 31, 2011 at 1:49 pm

        Hi Jake

        We are talking about opposite sides of the balance sheet.

        Your explanation is of course quite right with regard to the process when a bank wants to lend money out to someone else (subject to reserve requirements).

        But Foster and Magdoff are talking about banks borrowing – or equivalently, the owners of capital lending to banks.

        Banks cannot generate real returns out of nowhere to pay these capital owners; they must earn it by somehow lending the capital back out again, or investing it.

        • JakeS said, on August 31, 2011 at 8:38 pm

          Your explanation is of course quite right with regard to the process when a bank wants to lend money out to someone else (subject to reserve requirements).

          But Foster and Magdoff are talking about banks borrowing – or equivalently, the owners of capital lending to banks.

          No, what they are talking about is banks pretending to be brokerage firms. The banks do not borrow from the private sector in order to make loans – the private sector can never compete with the discount window in that respect.

          What banks occasionally do is perform brokerage roles – that is, they sell securities to non-bank customers. Broadly speaking, this can be either because the bank is acting as market maker, which is usually fairly innocuous, or because it is doing something that would be illegal if it did not dance a kabuki around it.

          Legalised, systemic criminality in your financial system is not caused by low interest rates, or a surfeit of private sector cash holdings. It is caused by your financial regulator not doing its job.

          – Jake

  8. Dave Holden said, on August 30, 2011 at 6:27 pm

    Nice piece. Short of time so I will need to re-read but I highly recommend another excellent piece from John Hussman’s here http://www.hussman.net/wmc/wmc110829.htm.

    “On this note, it is critical to remember that nearly all financial institutions have enough capital and obligations to their own bondholders to completely absorb restructuring losses without customers or counterparties bearing any loss at all. So keep in mind that the debate here is not about protecting customers or counterparties – it is really about whether the stockholders and bondholders of banks and other financial institutions should bear a loss.”

  9. Robbie said, on August 30, 2011 at 6:54 pm

    Really interesting post Duncan.

    It immediately reminded me of something Nassim Taleb said on Newsnight recently; that we perhaps need to conceptualise banks less as rational (!) economic actors and more as Utilities -with consequential shifts in regulation and governance around what they can do.

    The fickleness with which energy suppliers and water companies are portrayed as treating their customers aside, a central theme in the rationale for bank bail out(s) was the special role they play in ensuring liquidity in the economy (as important as electricity or a reliable water supply for companies who actually make things aka the real economy).

    I wonder then if a pertinent issue is not whether to bail out so-called zombie banks but the role authorities should (can?) play in redefining their role, status and activities post bail out.

  10. charliemcmenamin said, on August 30, 2011 at 7:50 pm

    @ Leigh Cauldwell

    “Financial institutions are not actually on the “supply side” of these instruments; they are intermediaries only (putting aside the cases where they trade on their own account, which are not the point here). For each owner of capital who wants to get a return from a derivative, there must be a counterparty who is willing to accept the capital and offer a return on it.”

    Well, sort of. In a way this is the workings out , in a vast more complex form, of what Marx was on about when he spoke of ‘fictitious capital ‘:

    “the capital-value of such paper is…wholly illusory… The paper serves as title of ownership which represents this capital. The stocks of railways, mines, navigation companies, and the like, represent actual capital, namely, the capital invested and functioning in such enterprises, or the amount of money advanced by the stockholders for the purpose of being used as capital in such enterprises… But this capital does not exist twice, once as the capital-value of titles of ownership (stocks) on the one hand and on the other hand as the actual capital invested, or to be invested, in those enterprises.” The capital “exists only in the latter form”, while the stock or share “is merely a title of ownership to a corresponding portion of the surplus-value to be realised by it”

    Which I take to mean that ownership title to all or part of current and future earnings is traded away and in the process confuses and divides the concept of ownership of capital.

    Now, of course I’m not arguing that Marx was right in the sense that he wrote a Holy Book in which all answers can be found. (Indeed, I’m not even enough of an economist to make such a case, even if I wanted to). But a degree of scepticism about the very existence of financial market and to what extent, if any, they actually add to the development of an efficient, productive or humane economy seems to me to a very helpful thing.

  11. JakeS said, on August 30, 2011 at 10:15 pm

    So whilst I disagree with most modern day Hayekians on the supposed virtues of cutting public spending during a ‘balance sheet recession’ (Richard Koo’s term, recently used (perhaps unwittingly) by the Chancellor) I can see their point that, given how the modern financial system currently operates, a long period of low interest rates can lead to severe mal-investment and unsustainable bubbles.

    This is actually one of the signal weaknesses of Hayekian “theory” (and I use the term loosely): Bubbles are not caused by low interest rates. Interest rates were not low during the 1920s. Interest rates were not low during the South Sea Bubble. Interest rates were not low during the Tulip bubble. Or indeed under most historical bubbles.

    In recent times the origin of bubbles has happened to coincide with low interest rates. But this is because blowing a bigger bubble is the only solution to recession that neoliberal dogma will permit, given its well known hostility to fair wages, full employment and industrial development. Thus, most bubbles over the last three decades have their origin in recessions. And – surprise, surprise – interest rates are low during recessions.

    But high interest rates are very nearly completely ineffective (and in fact often counterproductive) at crowding out speculative ventures. A pyramid scam can always match or beat any interest rate demand made of it, however ludicrous, as long as it keeps running. And when it stops running, the proprietors intend to skip town anyway. Honest businesses, on the other hand, are constrained by having to actually create a real return on investment that justifies taking on the debt. It is not difficult to see which will be crowded out first by rising interest rates.

    In short, bubbles are caused by a deterioration of lending standards, coupled with a demand for credit to fund ventures that do not have a prayer of a chance of ever creating real, tangible returns (be that speculation in common stock, or an attempt to use your house as an ATM to make up for the gap between wages and productivity that neoliberal policy creates). Since the latter is almost always present in some volume or anther in any economy, bubbles indicate mainly a failure of the private financial sector to exercise its due diligence.

    Hayekians, naturally, do not like to hear this. In fact, they produce a quite impressive (even by the standards of pseudoscientists) ratio of invective to substantive criticism when you point it out.

    – Jake

  12. dev71_m (@dev71_m) said, on August 31, 2011 at 3:00 am

    I also think it is possible to get to the same conclusion in a fundamentally Marxist way. Basic Marxist Crisis Theory says, amongst other things, that as booms expand the amount of capital employed increases, eventually the rate of profit begins to fall leading to a recession in which much of the capital stock is destroyed – allowing higher profits on the remaing capital stock and hence a resumption of expansion.

    It’s also possible to just take what Marx wrote on credit crises (Capital Vol. III, Ch 30). It’s developed out of his observations about ‘fictitious capital’ (i.e. financial stocks, bonds, deriviatives) in Ch 29 quoted by charliemcmenamin above:

    In a system of production, where the entire continuity of the reproduction process rests upon credit, a crisis must obviously occur — a tremendous rush for means of payment — when credit suddenly ceases and only cash payments have validity. At first glance, therefore, the whole crisis seems to be merely a credit and money crisis. And in fact it is only a question of the convertibility of bills of exchange into money. But the majority of these bills represent actual sales and purchases, whose extension far beyond the needs of society is, after all, the basis of the whole crisis. At the same time, an enormous quantity of these bills of exchange represents plain swindle, which now reaches the light of day and collapses; furthermore, unsuccessful speculation with the capital of other people; finally, commodity-capital which has depreciated or is completely unsaleable, or returns that can never more be realised again. The entire artificial system of forced expansion of the reproduction process cannot, of course, be remedied by having some bank, like the Bank of England, give to all the swindlers the deficient capital by means of its paper and having it buy up all the depreciated commodities at their old nominal values. Incidentally, everything here appears distorted, since in this paper world, the real price and its real basis appear nowhere, but only bullion, metal coin, notes, bills of exchange, securities. Particularly in centres where the entire money business of the country is concentrated, like London, does this distortion become apparent; the entire process becomes incomprehensible; it is less so in centres of production. […] It follows from the above that commodity-capital, during crises and during periods of business depression in general, loses to a large extent its capacity to represent potential money-capital. The same is true of fictitious capital, interest-bearing paper, in so far as it circulates on the stock exchange as money-capital. … This fictitious money-capital is enormously reduced in times of crisis, and with it the ability of its owners to borrow money on it on the market. However, the reduction of the money equivalents of these securities on the stock exchange list has nothing to do with the actual capital which they represent, but very much indeed with the solvency of their owners.

    http://www.marxists.org/archive/marx/works/1894-c3/ch30.htm#r8

    Now fiat currency allows central bankers to try to defy this and prop-up the “entire artificial system of forced expansion of the reproduction process”, I’d say that’s crude monetarism (increasing the supply, and reducing the cost of money to the banks.

    If Hayek has something useful to say, can someone point it out? If anyone cited Hayek in warning of this crisis, can that be pointed out? As far as I recall it was generally Friedman and Hayek were more often cited by those who arranged the economy that led to the credit crisis, even if it was later inherited by 3rd Way new left who thought the market and access to it (largely through debt) would resolve their contradictions . Nil points.

    http://www.atimes.com/atimes/Global_Economy/HA11Dj01.html

    Jan 11, 2006
    Of debt, deflation and rotten apples
    By Henry C K Liu
    Deflation is a problem that looms over the horizon when the US debt bubble bursts to slow down the economy. …Mounting debt levels have enabled the United States to celebrate sky-high productivity increases by simply working less. To keep consumer demand up, the public is taught to trade off wage income for dividend income, which has been boosted by tax cuts and exemptions on dividends, augmented also by one-time cash-out refinancing of ever bigger home mortgages reflective of ballooning price appreciation. Instead of moving to a bigger house made affordable by rising income, the same house is providing consumers with windfall cash to support consumption even as income stagnates.

    This unsustainable bloodletting cure for a sick economy is celebrated by neo-liberal economists as a happy boom from free trade. The trade apple is kept shining on the outside by sucking nutrients for a slowly depleting, rotting core, eaten away by a growing debt worm, turning a sick economy into a terminal case. […] Although Greenspan never openly acknowledges it, his great fear is not inflation, but deflation, which is toxic in a debt-driven economy. “Price stability” is a term that increasingly refers to anti-deflationary objectives, to keep prices up rather than down. […]

    For the US, even when the Fed can print dollars at will, it will be unable to ward off a debt crisis; in fact the more dollars it prints, the more seriously it adds to the crisis. […] As shown by the Japanese example, deflation is damaging to the financial health of the banking system. An operative central banking regime depends on functioning links between monetary policy and banking policy. With deflation, interest rates are forced to become very low – close to zero, or even negative – below neutral. Yet near-zero interest rates only postpone, not eliminate, the need for banks to deal with problem loans, because, notwithstanding Milton Friedman’s famous pronouncement that inflation is everywhere and anywhere a monetary phenomenon, deflation, the reverse of inflation, is not everywhere and anywhere just a monetary phenomenon. Deflation is a problem that cannot be cured by monetary measures alone, as Japan has found out and as the United States is about to. Global deflation can only be cured by reforming the international finance architecture to allow international trade to be replaced by domestic development as the engine for growth. […]

    In March 1999, about a month after the adoption of the zero-interest-rate policy, major banks were recapitalized by injection of public funds. But the “convoy system” of bank mergers shelters the weakest banks at the expense of the strong. Moreover, fiscal spending was increased significantly to stimulate economic activity. But the yen money supply did not expand because of a recurring trade surplus denominated in dollars. The zero-interest-rate policy masked the symptoms, but it did not address the disease.

    There is visible evidence that something similar will happen to the United States when deflation hits. Many US companies would in fact be walking dead in a deflationary environment even if interest rates were set at zero. […] Under conditions of excess capacity, failure to deal with NPLs will lock in excess capacity, worsening deflationary pressures. But solving the NPL problem in the wrong way, through massive layoffs for example, will only add to deflationary pressure. The solution requires more than simply reducing or writing off debt. Over-indebted borrowers are almost always overextended businesses, having expanded into activities with little economic benefit or prospect of payoff. […] Addressing the problems of distressed borrowers requires substantial restructuring in order to identify a profitable business core, and in some cases liquidation of the borrower is the only alternative. […]

    The fact is that Japan, and really the whole world, cannot solve its financial problems without facing up to the reality that no free market or deregulated markets exist now for foreign exchange, credits or even equity anywhere. Arbitrary, secretive and whimsical intervention on a massive scale hangs as an ever-present threat over the global system of financial exchange. Individual self-preservation moves and short-term profit incentive will bring the global system crashing down some Tuesday morning. This is what Alan Greenspan means by the need of central banks to provide “catastrophic insurance”.

    Roubini and now Magnus have cited Marx’s analysis of capital crisis, overproduction and capital’s onslaught against labour to increase it’s share of the wealth generated in production. However, their Keynesian prescriptions then fail to match the quasi-Marxist analysis. Steve Keen seems to be the one economist drawing upon Marx, Fisher, Keynes and Minsky to synthesise useful economic models.

  13. James Doran said, on August 31, 2011 at 2:31 pm

    On the Marxian approach, two interesting writers are, separately, Harry Shutt and Rick Wolff. Both have more detailed reforms than revolutionary rhetoric, particularly centred on corporate governance.

    Interesting on the Keynesian/Hayekian synthesis. What’s curious is the thinking of some Hayek-inspired people on the question of financial reform – Positive Money being one campaign group that is striking in this regard (http://www.positivemoney.org.uk/). When you have Tory MPs like Douglas Carswell effectively advocating the nationalisation of the money supply, you know something a little unusual is occuring….

    All of this brings me to Paul Derrick, whose 1948 work “Lost Property” manages to fit in both the reforms to corporate governance advocated by Shutt and Wolff with the monetary reforms advocated by Positive Money and Carswell. It’s like a lost predecessor of Blue Labour’s economic thinking…?

  14. Carol Wilcox said, on August 31, 2011 at 9:17 pm

    “And this is what we need – a modern way of thinking about the macroeconomy which takes asset bubbles seriously, we looks at over-speculation and which understands how banks operate rather than assuming them out of existence. The odd thing is that it will probably draw as much from Hayek as from Keynes.”

    What about adding a bit of George? Extract the land rent for public benefit and you take away the banks’ dummy and force them to do a proper job of assessing risk and lending for real investment.

    • Barry Thompson said, on September 1, 2011 at 7:54 am

      There are economists who do include a proper understanding of the bank credit system and central bank operations and think seriously about speculative bubbles. These include post-Keynesian ‘circuitists’ like Steve Keen and ‘chartalists’ like the Modern Monetary Theory crowd (Cullen Roche, Randall Wray, Stephanie Kelton, James Galbraith, etc).

      Richard Koo’s concept of balance sheet recession, Rogoff’s great contraction and Krugman’s liquidity trap are all attempts at making up for what has been a big failure of modern macroeconomic theory to explain the current malaise (and also Japan’s malaise). They are all on the right track, but Steve Keen and the MMTers are way ahead.

  15. Greg Ransom said, on September 4, 2011 at 1:25 am

    BIS chief economist William White combined the work of Minsky, Hayek & Selgin in his famous BIS papers warning of the artificial boom and coming bust in the early and mid 2000s.


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