Three Cheers for Nothing

An article by James De Long (ET, July 26) praises the ‘historical minded economists’ like himself, Joseph Stiglitz, Paul Krugman, Carmen Reinhart, etc., Who ‘got it right’ and also mentions that there are economists, who according to him did not ‘get it right’.

The ‘right’ here refers to the financial and economic crisis of the last four years and the response to it. According to De Long, theyunderstood that ‘rapid run up of housing prices and extension of leverage posed macroeconomic dangers’. They understood that ‘large bubble driven losses held by leveraged financial institutions would cause a panicked flight to safety’.

A key feature of this crisis was that it came as a shock to the general public catching most people unaware. We only know of Nouriel Roubini predicting the dimensions of this crisis in early 2008 and loud denials, at that time, by many in the financial industry and government. It is difficult to understand why preventive actions were not taken if all this was so well foreseen by a group of economists.

He says that they understood that “preventing a deep depression required active official intervention as a lender of last resort”. This insight has led to rounds of government paid bailouts  and stimulus packages, in Europe and USA, it has blown fiscal deficits to proportions unimaginable even five years back, and the result has been  developed countries being put on extended ventilators. The point is that there has been no significant success to celebrate so far, leave alone assigning credit for the success.

Europe teeters from crisis to crisis, even after four years, and floods of government dole outs, and the USA is in the new normal of 8%+ unemployment and 1-2% growth. The economic crisis causes the deepest anxiety and foreboding for governments, households and institutions across the world even today. The crisis deepens every day, and therefore it is presently difficult to cheer for the ‘right’ response to the crisis.

The article also says, that ‘monetarist cures were likely to prove insufficient; that sovereigns need to guarantee each other’s solvency; and that withdrawing support too soon implied enormous dangers.’ This is surprising, because ‘monetarist cure’ is in fact the mainstay of the response that has been offered by this group. Unprecedented increases in money supply across the world have been tried as a way of flushing out the unregulated misdeeds of the financial sectors of a few countries. If this is not a monetary response, what is? The point also is that this infusion of liquidity is not only continuing, but seems to be the only lame solution that is being tried again and again. Thus we get a sequence of QE1 followed by QE2, and if that does not work, then there is QE3!

Sovereigns guaranteeing each other’s solvency, is  nothing but a concerted increase in money supply across G20 countries, leading to export of inflation to countries like India and China, who by the way had no financial crisis to start with.He says that withdrawing support too soon implied enormous dangers. This line of thinking perhaps explains why we are stuck with support in one form or the other, from Angela Merkel to Bernanke, to hold up the imploding financial system. The global financial system has failed to build any latent strength, or eradicate its weaknesses, and is surviving on fire fighting measures in country after country.

Fiscal deficits have reached a proportion where, continuing unaffordable support for too long may be a bigger worry than ‘too soon’ because of the ‘enormous dangers’ of crippling the entire government sector of developed nations. Of course, their argument is that deficits do not matter, because it is debt you owe yourself. However, in this transfer game, the government becomes severely disabled from undertaking the requisite expenditure for public goods, nation building and even defence.

More basic question that needs to be asked is what is being supported and why? Lack of regulation in the financial sector, compounded by conflicts of interest between agencies, regulators and government, leading to ‘toxic asset accumulation’ should not and need not be supported. Bankruptcy of large banks and institutions were anathema because, firstly they were ‘too big to fail’ and secondly ‘it would lead to a Great Depression’. Regarding the first anxiety, the bailout of banks too big to fail is crippling governments across the world, and the health of public finances should be considered as ‘much too big and important to fail’. Regarding the second fear, instead of a Great Depression (sharp plunge in GDP growth) we are now stuck with the “Eternal Recession” (anaemic growth hugging zero rates) where after four years, we still cannot foresee any return to healthy growth rates in the coming five years. A whole generation is facing bleak prospects of unemployment or poorly paid jobs, less security, higher taxes and greater difficulties of building their financial equity. Again, the point is, the future seems bleak and the cheering has not started.

De Long says that they knew “attempts to achieve long term fiscal balance would worsen the short term crisis and thus be counterproductive in the long run”. Assuming that he is Keynesian, given his liking for fiscal intervention, we should all well heed the famous dictum, “In the long run we are all dead.” Keeping that aside, it is important to clarify when exactly the long term balancing should start.

Four to five years arealready passing, and we still do not know what exactly is meant by the long run when budgets may be balanced. May be in ten, twenty, fifty years there comes a time when economic growth balances out not only the deficit but the ballooning interest payments? Debt traps born of interest payments rising faster than tax growth is probably not applicable to this long run? It is well that these questions are clarified,  because the elected representatives and the executive, is surely having a hard time defining this long term and this is causing various rifts and conflicts to arise in the government. If these economists have the answer they should share it with the government budget office.

They also knew that ‘unemployment is caused by cyclical rather than structural changes’. Accumulation of toxic assets based on artificially low interest rates can hardly be called a structural problem. Lack of corporate governance and even some criminality may be implied, but it is hardly a change in structure. It is something that should have been dealt with by holding agents accountable through the regulatory agencies and the law. Instead a bubble was allowed to develop.A bursting bubble creates cyclical unemployment, is not a profound insight.

The moot question is persistence of unemployment. Why is unemployment in the US persisting above 8% and in double digits in Europe? Repeated monetary and fiscal intervention is water down the drain, since it is unable to bring down stubbornly high unemployment rates.

If a group of economists want to congratulate themselves for foresight and effective response, should they not wait until unemployment falls to 3-4% and growth rates rise to 3-4%? The fact of the matter is, for the 99%, there was a spectacular failure of foresight, cowboy attitude to regulation, failure of government stimulus packages and failure of monetary flooding as far as economic growth and employment is concerned. So what should we cheer for? Yes, the ‘too big to fail’ organisations have been saved from bankruptcy and their purpose has been served.

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