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Thursday, May 20, 2010

Economists Tackle the Economic Crisis: IV

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 fourth in a series of commentaries on the views of various economic writers on the economic downturn. Zoltan Zigedy

Every budding economics student and learned professor, along with our media pundits and high ranking policy-makers, should be forced to read Why 10,000 economists Got It Wrong, a section of a series of articles written by Jack Rasmus appearing in Z Magazine (“Epic Recession: Prelude to Global Depression”, February, March, 2010). Rasmus, professor of political economy at Santa Clara University, playwright, and labor activist, constructs a tragically amusing collection of responses by prominent economists to the economic crisis. By taking these economists at their own words, Rasmus demonstrates the abject poverty of thought and shameless gall of most of the profession’s leading lights.

Among my favorites is the comment of Nobel laureate and godfather of the rational choice/game theoretical school, Kenneth Arrow, whose influence has swept through the social sciences and humanities over many decades. Skeptics have persistently challenged Arrow and his many followers to ante up and confess whether rational choice theory describes actual human behavior or rather offers a user’s guide to optimizing results, whether their results are descriptive or prescriptive. Advocates of unfettered markets have used this ambiguity to defend the infallibility of the market mechanism. According to Rasmus, Arrow’s response to the economic downturn was “that he and his fellow economists erroneously assumed the banks would act rationally and correct their growing abuses and problem. ‘We took it for granted these people protect themselves. We were wrong.’” Now we finally know: rational choice and game theory are recipes for success, but bankers do not follow the directions. It follows, of course, that Arrow’s mathematical formulae offer no support for the claim of market rationality. If financial actors act irrationally, the market cannot save their hides.

There are some other gems in Rasmus’s accounting. Laura Tyson, formerly a chief economic advisor to President Clinton, without cracking a smile, likened the economic crisis to ‘a kind of Greek tragedy.” And Paul Krugman, as Rasmus notes correctly, continues to slyly suggest that the root of the crisis may lie at the doorstep of The Peoples Republic of China for refusing to accede to the West’s demand that it devalue the yuan.

While the responses given by these learned professors may elicit some giggles, they reveal an intellectual crisis as well; no Nobel prizes should come from this performance.

Rasmus offers more than a devastating parody of the economics profession. His two lead articles promise an account of the current economic crisis – an account that goes beyond the shallow inanities that occupy so many academic economists.


Like Marx, and few others, Rasmus is explicit and conscious of his method, his framework for understanding the economy. And like very few others, he seeks “a deeper historical perspective” when pursuing answers. I think this approach is the cardinal virtue of his work and any other effort to seriously explain the current economic crisis. Without it, economic thinking is speculative and barren. He draws extensively on his study of earlier downturns, including The Great Depression. His study of the 1907-1914 crisis is particularly fresh and fertile; I confess I have overlooked this period in my own work, as have others.

On the other hand, I am surprised that he offers little on the so-called downturn, an event that I believe links up importantly to the current crisis. As the first false step of speculative capital, the collapse of 2000-2001 revealed important aspects of contemporary capitalism that foretold the current downturn and, in all likelihood, the next one.

Economic analysis is economic archeology, sifting through the shards and artifacts of previous economic activity. Rasmus does this and does it well.

Rasmus underscores a second tenet of his method: securing a theoretical framework for his analysis. Again, this is a sound and intellectually honest approach. One element of his framework is to forego the use of metaphor. I think this is too rigid. Metaphor – drawing on similarities with non-economic phenomena – enriches economic discourse and suggests fruitful paths of exploration. The problem with metaphor arises when it is both the beginning and end of economic explanation. While a metaphor suggests, it must be backed up with some theoretical muscle. At a time when few of us understood the new and opaque instruments employed by the financial sector, metaphor – “casino”, “bets”, “toxic”, etc. – was the best guide going forward. In fact, Rasmus makes good use of two rich metaphors: the imagery of “fracturing” and “fragility”.

By contrast, Rasmus argues for causal explanation, specifically explanation that distinguishes between fundamental, contributing, and participating causes. Certainly, these distinctions are not new; one finds similar distinctions as far back as the works of Aristotle. But, sadly, his point is a needed reminder to the multitude of academic economists who have lost their way in the thicket of mathematical models, game theory, and rational choice theory. Today’s academic economist fails to look beyond correlation, spinning connections that hang in the air absent a supportive theoretical web. Mainstream (bourgeois) economics decries theory and relies on correlative relationships. An example is the famous Phillips curve – the inverse relationship between unemployment and inflation - which served as a foundation for Keynesian economics until the 1970's when a period of stagflation burst that particular correlation. This provided an opening to Friedmanites who postulated that federal spending to reduce unemployment resulted in an only marginal shrinkage of the rate of unemployment at the expense of galloping inflation. Though it won a Nobel for its proponent, Edmund Phelps, the basic idea was consigned to the dustbin, supplanted by neo-liberal dogma.

The Theory

For Rasmus, leading fundamental causes of the current global downturn were “the forces behind the massive accumulation of excess global liquidity in recent decades, as well as the network of speculator-investors, shadow banks and institutions, and the new speculative instruments and markets they have spawned.” This is correct, but there is much more to say, much more to explain about the “forces behind…” Indeed, I wrote of this enormous pool of global liquidity in November, 2005 (Capitalist Surplus, Marx, and Crisis”), but I also sought to explain why this posed a particular problem at that time.

Thus, capital continues to accumulate at an accelerating rate, filling the coffers of the capitalist class. As the Wall Street Journal article [cited in my original article] notes, this has created considerable consternation with the capitalist class: the ability to make further money is now impeded. Capitalists are finding fewer and fewer investment opportunities. And when they find them, they offer at best modest returns. Higher returns are attainable at great risk, greater risk than most investors are willing to take. The WSJ quotes Gerd Häusler of the International Monetary Fund: “The search for yield has been the defining factor in financial markets for roughly the last two years.”

In my view, this search for yields prompted riskier and riskier investments – a point well made by Rasmus – though it is important to understand why. The growth of global liquidity is an instance of what Marx called “accumulation” – in this case hyper-accumulation. It defies the simple “savings=investment” depiction of conventional economics since this massive surplus can find no home that will promise greater return than that which is conventionally gained. In fact, its engagement with existing, relative safe, investment opportunities necessarily will exert downward pressure on the rate of return on all investments – the cost of capital will fall. Thus, the very existence of this enormous pool of liquidity challenges the growth of accumulation, exerting a downward pressure on its rate. As I argue in my article, “…this is an instantiation of the much misunderstood Marxist law of the tendency of the rate of profit to fall. This much maligned tendency towards crisis reflects the effects of capitalist exploitation upon unlimited growth, demonstrating how the drive to accumulate greater profit ultimately retards the ability to do so.” It is this tendency – prompted by hyper-accumulation – that motivated and drove “the network of speculator-investors, shadow banks and institutions, and the new speculative instruments and markets they have spawned”, the “fundamental cause” that Rasmus identifies.

Further, it is important to ask and answer: what is the source of this” massive accumulation of excess global liquidity”?

I offered a tentative answer:

The vast accumulation of capital noted in The Wall Street Journal has been generated from several factors, all part of a conscious program of the wealth-holding elites—the capitalist class. Fundamentally, the world-view of neo-liberalism—open, unfettered commodity markets, private ownership, the dismantling of the welfare state, and making human labor completely subject to the market—has been elevated to an article of faith, a world-view not only unchallenged, but unchallengeable. As a result, the class struggle becomes one of not denying these tenets, but accommodating them, by challenging “unfair” competition, by “rationalizing” the last bastions of public ownership, by “reforming” the welfare state to include market forces, and by “humanitarian” concerns for the most egregious work conditions.

The role of the state has been critical: both political parties in the US have joined to re-militarize the economy around a bogus “war on terrorism” while attempting to enlist the rest of the world into a reprise of the Cold War. This tactic has opened new, and vast, opportunities for transferring wealth to parasitic corporations that inflate costs, under perform, and invite corruption.

Today, I would add a more measured answer – one with “a deeper historic perspective”. In the first place, the disappearance of an entire alternative economic bloc – the European socialist community - opened enormous new markets and opportunities for profit from low-wages and bargain-basement acquisition of the means of production. Also, this development freed Cold War capitalism from its paternalism, its public relations competition with the Soviet Union. Without the competition, ruling elites felt no political obligation to tout the living standards of Western workers and began to intensify the class war and the rate of exploitation. While workers wages were stagnant during the 1970’s and 1980’s, wages lagged even further behind the growth in productivity after the fall of European socialism. Maintaining a modest standard of living became, for most working class families, a matter of assuming more debt, a further incentive for capital to pursue opportunities of financial speculation.

In addition, the expanded, and increasingly unregulated, global market encouraged a global capitalist division of labor, assigning production to low-wage, unregulated labor markets and finance to the most mature capitalist countries: principally, the US and the UK. Thus, by the moment before the world-wide crisis struck, financial activity accounted for nearly half of all profits in the US.

Rasmus writes of the “global money parade” and the $20 trillion that “sloshes around from one speculative investment opportunity to another…” I would only add the roughly $220 trillion notional value of credit default swaps that layer onto this total and further fuels the huge speculative orgy. Yet he leaves open the question of why this affliction strikes when it does.

He offers little to explain the roots of the system’s appetite for speculation, beyond hyper-accumulation, Federal Reserve policy, and investment innovation. One wishes he would say more.

Rasmus relies upon a business cycle model to explicate his theory of crisis. He sees the boom phase of a business cycle as generating debt accumulation and financial asset inflation. This seems generally reasonable. He goes on to argue that with the addition of hyper-speculation, the business cycle occurs more frequently and more severely, creating the possibility of a pernicious “feedback” mechanism that will send the economy into a spiral of “debt, deflation, and default”. “A vicious, downward spiral occurs in which all three feed upon and exacerbate each other.” This account, to my mind, is a vivid narrative, but theoretically spare. Hyper-speculation, as Rasmus acknowledges, began well before the 2000-2001 downturn (indeed it helped precipitate this event). Moreover, the trajectory of debt accumulation had a life independent of the 2000-2001 decline and recovery and, certainly when we include federal debt, the 2008-2009 collapse. And the asset deflation associated with both 2000-2001 and 2008-2009 was selective and not generalized throughout the economy. In short, I don’t think viewing the current crisis as an aberration of the business cycle is adequate or reflective of deeper fundamental causes located in the mainspring of capitalism; the current crisis does not emerge from a renegade sector of capitalism, but from capitalism itself.

I fully endorse Rasmus’s adamant refusal to place events like deregulation, Fed policy, or the personal actions of economic policy-makers center stage. While they played a role in intensifying the current crisis, deeper mechanisms are at play.

Historical Research and “Epic Recessions”

Rasmus distinguishes between “ordinary” recessions (type I) and more severe, system-threatening recessions (type II, “Epic recessions”). His taxonomy is useful and he defends the distinction with clarity and a command of historic data. For Rasmus, the 1907-1914 recession typifies a type I recession with an initial shock, policy adjustments (the creation of the Federal Reserve and the introduction of federal income taxes), followed by a longer period of stagnation interrupted by a war-induced recovery.

The early years of The Great Depression (1929-1931), on the other hand, typify a type II recession (Epic Recession). Distinguishing it from a type I is its severity and intractability. Rather than stagnation, a type II recession proceeds in fits and starts, but generally tracks downward. Rasmus shows a good grasp of the history of that era, a fact that separates him from the herd of commentators who either center matters on Roosevelt’s embrace of Keynesianism (Keynes had yet to write his opus) or posit a train wreck from bad monetary policies. As Rasmus understands, matters are a bit deeper than that simplified picture. On the other hand, Rasmus neglects the role of mass movements in ameliorating the harshness of The Great Depression for millions of people and in succeeding to stabilizing the decline to a great extent (see my: The Real Lesson of the New Deal for the US Left, ). His account is far too structural and policy-oriented and, therefore, misses the central lesson of the era: mass action makes a difference. And if Rasmus is correct – and I believe he is – that there are great similarities between The Great Depression and our current crisis, then this lesson is urgent for today.

Rasmus writes “By the summer of 1933, unemployment was 25-30 percent, production down by more than half, more than 15,000 small banks had failed, the stock market had declined 89 percent, and the Great Depression was at its low point.” In fact, the summer of 1933 was the peak of a false recovery - a factual correction, when made, which actually bolsters Rasmus’s claim of the intractability of the Great Depression and its historic uniqueness. I cite the following important history of the New Deal:

The index of production rose from 56 in March [1933] to 101 in July. Improvement was particularly marked in the steel, automobile, construction, and textile industries. The index of farm prices rose from 55 to 83 during the same period. Retail food prices rose from 59.8 to 71. Wall Street staged a bull market in industrial stocks which rose in price from an average of 63 in March to 109 in July. Monthly stock sales… which had been less than 20,000,000 in January and February rose to 125,000,000 in June.

These portents of prosperity were widely interpreted as proof that the new administration had already routed the depression. Wiser heads pointed out that no change in fundamentals had as yet been accomplished by the administration, except a slight fall in the value of the dollar. Employment rose between March and July from 58.9 to 71.5, and payrolls from 37.1 to 50.8, but purchasing power lagged far behind production and the rise in prices. The boom was compounded of speculation based on cheap credit and expectation of inflation and future profits, expansion of inventories as a hedge against rising prices, and the manufacture at prevailing wages of surpluses which could be sold at higher prices… Manufacturers, merchants, and investors hurried to change money, which had already begun to fall in value, into goods, which were rising in value. The “recovery” which resulted was false because it was speculative and without sufficient foundation in expanded purchasing power. It left the mass of consumers, who had no surplus funds to exchange for goods, worse off than before, because rising prices reduced the value of their income.

The most speculative elements of the boom were liquidated by the stock market crash of July. A more serious handicap on the administration’s recovery program was the decline of production from 101 to 71 in November. My italics (The History of the New Deal, Basil Rauch, p.93, 94)

If this reads ominously like the late spring of 2010, it is because the parallels are there for all to see. While this may conflict with Rasmus’s historical claim, I believe it vindicates Rasmus’s view– and my view – that we are far from shedding the deep flaws in the system that fueled the crisis. Once again, “cheap credit”, “expectation of inflation”, “expansion of inventories”, and “speculation” have generated an illusory recovery not unlike that reported by Rauch in revisiting The Great Depression.

Rasmus draws the right lesson from his historical survey: the only policy answer (short of socialism) to a crisis of the magnitude of the Great Depression or the current global crisis is massive government spending. That was the answer to the Great Depression and, as he points out, the recession of 1907-1914. In both cases, it was only a war that provided the political will to accept the level of deficit spending necessary for full recovery. But, as he notes, war is not the only answer. The PR of China sailed through the downturn relatively unscathed thanks to a stimulus program that far exceeded the scale of any other economy in the world. He might have noted the role of the publicly-owned banks in lubricating the flow of this massive stimulus. He might also have noted that most of the PRC stimulus was not diluted by public-private partnering as was the US Administration’s program.

Rasmus’ summary of where we stand is ominous, but accurate:

Having blown trillions of dollars bailing out banks and big companies…, consumer and household debt levels still remain at dangerously high levels. Meanwhile, the average household’s real disposable income continues to fall in general due to unresolved massive unemployment, continuing wage and earnings cuts, progressive benefits declines, deteriorating retirement income, various negative wealth effects, and a host of other forces…

[R]ecovery is not simply stabilizing the banking system. Nor is it even a return of GDP levels to positive growth… Normal fiscal policy responses… are likewise insufficient in generating a sustained recovery…
Obama and his administration, Congress, and the welfare of tens of millions are thus at a crossroads in 2010.Does Obama have the strategic foresight to make a turn to an FDR-like populist program? Or will he continue with another token jobs program, a tweaking of an already timid housing recovery program, and a lot of tough talk about bankers but little else?

These are questions we should all be asking and, more importantly, demanding of the current administration.

Rasmus’s new book, Epic Recession: Prelude to Global Depression (Pluto Press/Palgrave-Macmillan) should be available now and I look forward to reading about his insightful views in greater detail. I only hope that he gives some attention to the socialist option, an option that would put these concerns behind us once and for all.

Zoltan Zigedy

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