Economists Tackle the Economic Crisis: III

A good, old-fashioned crisis of capitalism – a disruption that rocks the whole system – produces one salutary result: wiser heads, serious students begin to re-examine widely held assumptions and popular theories of political economy. For those few, this may mean dusting off old copies of the works of Keynes, Schumpeter, or Minsky, and – only too rarely – Marx. For the honest observer, the crisis is an opportunity for a deeper understanding of the capitalist mechanism and its direction.

But others cling to the comforting views of infallible markets and perfect rationality that prevailed until recently, while amending their theories with warning labels touting the current crisis is a special case falling outside of the economic canon. Most economists, pundits, and policy makers fall into this latter category. They got it wrong and they continue to get it wrong. They have too great of an investment in the ideologies, careers, and honors of the past.

There is now a long list of books and papers offering explanations, in part or wholly, of what went wrong with the global economy. The worst of these offer simple and immediate answers: evil bankers, irrational borrowers, lax regulators, etc. The best offer longer and deeper views that locate problems in the evolution of capitalism and its inner mechanisms. They contest the too human urge for simple answers and easy solutions. This is the third in a series of commentaries on the views of various economic writers on the economic downturn. Zoltan Zigedy

Paul Krugman, a Nobel laureate, is most likely the best known living academic economist in the US. His column in The New York Times is widely syndicated and often cited. A recent profile in The New Yorker touted his popularity and near celebrity status. Krugman represents, like Stiglitz, Shiller and a few others, a trend in academic circles skeptical, to various degrees, of the strict market fetishism increasingly dominant over the last three decades.

Along with his wife, Robin Wells – thought by some to be the more iconoclastic of the two – Krugman recently authored an article in The New York Review of Books (“Our Giant Banking Crisis – What to Expect” 5-13-10). The piece reviews a current book (This Time Is Different: Eight Centuries of Financial Folly p, Carmen M. Reinhart and Kenneth S. Rogoff), draws on IMF publications, and develops some of their own views of what lies ahead for the economy.

In light of the recent developments in Greece, Krugman and Wells cannot resist drawing Greek debt into the forefront of their account. They recite the charge, now largely taken for granted, that the current panic is induced by “excessive” debt: “The risks seem obvious: Greek government debt is at levels that have historically signaled deep trouble for middle-income nations…” Yet economists have struggled with giving any precise divide between high debt and excessive debt. What may “seem obvious” after the fact may well not have seemed obvious just months ago. This is especially true in light of the fact that Portuguese debt is even higher, Ireland’s three times greater, Spain’s four times greater, and Italy’s over five times greater. Why Greece? And why now?

Similarly, they summarize Reinhart and Rogoff’s findings: “In a nut shell, it is that too much debt is always dangerous.” But “too much” debt has as little explanatory power as “excessive” debt. In the run up to the crisis, economists had been warning of too much debt in different sectors of the economy for most of the decade. Why is debt “too much” for some and not for others? When is high debt transformed into “too much” debt? These questions go unanswered.

Part of the problem – unaddressed by professors and pundits – is the one- sided view typically proffered. Abundant scolds take the borrowers to task, hectoring them for “living beyond their means” or “profligate” spending. Little or no attention is paid to the lenders. Krugman and Wells note that “Greece has been in arrears on its debt for half its modern history.” But who loaned them the money? And why did they loan them the money given the notorious history and high debt load?

The answer is simple: banks and other institutions loan the money in order to make more money. In the confined world that Krugman and other economists theorize in, the omnipotent market should retard Greek borrowing well before the debt reaches the level of “excessive”. But that is not what happened.

Instead, the Greek debt grew until other financial institutions and figures attacked this debt, betting against its full repayment or resolution. They did not sit down with Greek policy-makers and argue for some adjustment for the good of the EU or the global economy. They did not meet with the European central bankers who had loaned the Greeks roughly two-thirds of Greece’s outstanding debt and suggest that this debt might strain the EU and the global economy. That is not what speculators do. They make money. Of course their bets – their purchase of credit default swaps against the Greek debt – affected the financial markets, driving up interest rates, lowering bond and credit ratings, and dramatically increasing the value of their bets. A crisis ensued.

Certainly there is nothing new in this course; it is precisely the scenario that amplified the capitalist crisis as it unfolded in the US three years ago. And like the earlier raid on banking, the elite policy decisions forced on the Greek people are aimed at bailing out banks and not the people. It is not Greece that is being saved, but lender banks throughout the world.

We know that speculation drives this crisis thanks to a little noticed correction by the Bank of International Settlements – the organization that keeps score on international debt – on April 22. On that date, the BIS downgraded Swiss bank exposure to Greek debt by 95% -a drop of $74.9 billion. One would have expected that this news would have, at least temporarily, slowed the mounting attack on Greek solvency. It didn’t.

These events underline how little has been done to reign in speculative capital. They also point to the likelihood that financial turmoil will be with us until policy-makers look to make serious structural changes in the world of finance capital. Nationalizing the 900 pound gorilla is an obvious answer, but one that most public figures - especially pundits and opinion-makers - don’t want to hear.

Studying History?

Krugman and Wells praise Reinhart and Rogoff for drawing on the long history of financial crises to both enrich and enlighten our perspective. They contrast their historical approach to those who “…take the easy road… [tending]… to focus their efforts on times and places for which numbers are readily available, which basically means the recent history of the United States and a few other wealthy nations.”

I would agree wholeheartedly that an historic approach is not only commendable, but essential to unraveling present economic events. Though it is not only the narrative and numbers that are essential, but the connections between economic events - the logic behind capitalism’s course.
One does not find these threads in the Krugman and Wells article or, I suspect, the work of Reinhart and Rogoff.

If there is a far-reaching, global financial crisis, then surely it cannot be separated from a crisis of capitalism. Creating an artificial barrier between financial behavior and systemic behavior a priori limits disclosing any connections between financial capital and other sectors of the economy. Such a narrow focus forbids, without argument, an examination of the role of the global division of labor, the explosion of trade, political changes in the balance of power, privatization, radical income redistribution, technological change and a host of other factors that may be deeper-seated causes of the financial expression of the current crisis.

Likewise, a truly historical approach to the downturn would explore the links between the dot-com downturn at the beginning of the decade and the current economic difficulties. When an entire decade exhibits little job growth, escalating income and wealth dispersion, expanding consumer debt and other ominous indicators, there may well be some common causes lurking in the shadows.

This refusal to look for explanation beyond a self-imposed intellectual enclosure is typical of modern academic economics and in sharp distinction from the method of classical political economy. If you don’t look for deeper and broader answers, you won’t find them.

Out of the Crisis

“History says that the next few years will be difficult. But can anything be done to improve the situation? This Time is Different says little on this score.” But Krugman and Wells have much to say.

Indeed, they make a strong, persuasive case for deficit spending as the way out of the crisis, an argument that would seem to be at odds with their finger-pointing at Greek deficit spending. In fact, they make a strong case for discounting the Reinhart and Rogoff stand against “too much debt”; where Reinhart and Rogoff find high debt causing low growth, they argue, conversely, that slow growth more likely generates high debt. Thus, they excise the principal theoretical basis for avoiding growing debt.

I would maintain that these seemingly paradoxical views coexist only because all parties in this debate subscribe to patch work economics, spinning conclusions from snap shots of economic events. They suffer from a dogmatic aversion to “grand” theories of the evolution or development of capitalism. While grand theories can take us well into the realm of speculation and fantasy, some sense of the structure and logic of capitalism can save us from the dead-end of disconnected events with disconnected causes.

In fairness to Krugman and Wells, they distinguish between “middle-income” nations like Greece and a large economy like the US, though they never tell us why that difference is decisive with respect to debt and deficit spending. We are left to guess why scale matters with two countries bearing potentially comparable relative debt obligations and deficit spending habits, but requiring different policy prescriptions.

In the US, no one was surprised that financial irresponsibility sent shock waves through the global economy. But how does a “middle-income” economy with far less debt than the cost of the CITIGROUP bailout create such an international panic as we are now witnessing? Surely some grander theory of speculative capitalism, a theory that would emphasize the role of new and more predatory modes of speculation, would be useful.

Without some further clarification, Krugman and Wells seem content to consign Greece to economic hell while rescuing the US economy with deficit spending.

It would be a mistake, however, to ignore Krugman and Wells’ case for deficit spending. They rehearse a host of examples –well known to serious economic historians and ignored by deficit hawks – that show dramatically that recovery from severe downturns occur when and only when policy makers intensely prime the pump with government deficit spending. While this is not a new observation, it demonstrates how discredited Keynesian thinking became after economists embraced the tenets of neo-liberalism after the economic experiments of the Thatcher-Reagan era. Today, Krugman’s principled and persistent advocacy of deficit spending often seems like a cry in the wilderness.

The Krugman and Wells prescription for avoiding future crisis is completely in step with current liberal orthodoxy: financial regulation. Certainly, regulation is preferable to no regulation or de-regulation. Like their colleagues, Krugman and Wells are fully aware of the seeming immunity to the global crisis enjoyed by The People’s Republic of China. During the global upheaval, the PRC economy perked along merrily with capital flowing freely from the banking spigot. In this regard, Krugman has often pointed to the immediate and intense stimulus that the PRC employed to sustain growth, a powerful buttress to his argument in support of deficit spending. On the other hand, he and most other economists conveniently ignore the essential role of the publicly owned banks, a critical factor in sustaining the growth. For ideological reasons, nationalization of the banks, rather than regulation, never enters the discussion.

One has to ask how many times you have to be bitten by a snake before you find a different pet.

Zoltan Zigedy
zoltanzigedy@gmail.com