demandside

Plus Idiots of the Week — the Economist Magazine and the nation of China .

Idiot of the Week, featuring, on a grand scale, first the Economist magazine and the apologists for China, and second, the snide and cynical observations of that magazine’s Daniel Frnaken.

We end with commentary from Joseph Stiglitz, abbreviated from his Vanity Fair article this month, addressing one of the most crucial debates in the current economics.  In order for the free market ideologues to rescue their failed system, it is becoming necessary for them to rewrite history, which they are doing with ever more energy.  Stiglitz establishes the facts.

First, from the economist podcast entitled “From the Paper” for the week ending December 13.

ECONOMIST

Surprise about the imminent demise of China is misplaced.  Nouriel Roubini and indeed all the no-decoupling school have been quite prepared for an economy — China’s — which depends on selling to the U.S. consumer to be affected with that consumer is no longer able to buy.

We suggest that the referenced imbalances between exports and imports in China reflect the slowing need for and price of commodities, 2% v. 18%, and the 7% drop in energy usage reflects the true state of affairs.

One can also imagine that a population sold on the benefits of state capitalism may become disgruntled with the state when the capitalism falls into its inevitable funk.  After all, they have sacrificed their environment for a pro-growth fever that has only generated corruption.  We suggest, as we have before, a New Deal for China, as suggested here.  The infrastructure spending so appropriate for America is only redundant in China.

Now. Daniel Franken of the Economist and Michael Moran of CFR dot org from the Economist’s “World Next Week” podcast of December 12.  Beginning with Daniel Frnaken.

FRANKEN-MORAN

Franken’s pinched view of the world says a president Obama is lucky to have the excuse of an economic collapse, it is “convenient,” to cover the necessary need to disappoint his constituents.  This is very far away from the true need, which is for the public sector to step into the breech with all barrels of the Obama agenda.  We do not need the snide and cynical Mr. Franken to apply the screws now when he was unwilling to do anything but applaud for half a decade of headlong debt expansion.  If there was a time for prudence, that was it.  Instead the market shot itself in the foot, repeatedly.  Now that two-thirds of the economy has been lamed, it is no time for the public sector to sit down. What caused the crisis? Joe Stiglitz says it was “system failure” based upon a single, incorrect belief:

Capitalist Fools, by Joseph E. Stiglitz, Vanity Fair: There will come a moment when the … task before us will be to chart a direction for the economic steps ahead. … Behind the debates over future policy is a debate over … the causes of our current situation. … So it’s crucial to get the history straight.

What were the critical decisions that led to the crisis? Mistakes were made at every fork in the road—we had what engineers call a “system failure,” when not a single decision but a cascade of decisions produce a tragic result. Let’s look at five key moments.

No. 1: Firing the Chairman: In 1987 the Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. … Volcker … understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing… Greenspan[’s] flood of liquidity combined with the failed levees of regulation proved disastrous. …

No. 2: Tearing Down the Walls: The deregulation philosophy would pay unwelcome dividends… In November 1999, Congress repealed the Glass-Steagall Act… The most important consequence … lay in the way repeal changed an entire culture. Commercial banks are … supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally … take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risk-taking.

There were other important steps down the deregulatory path. One was … to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher)… As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives. … Nothing was done.

No. 3: Applying the Leeches: Then along came the Bush tax cuts… The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches. The tax cuts played a pivotal role… Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. … The flood of liquidity made money readily available in mortgage markets… And, yes, this succeeded in forestalling an economic downturn; America’s household saving rate plummeted to zero. But it should have been clear that we were living on borrowed money and borrowed time.

The cut in the tax rate on capital gains contributed to the crisis in another way… [T]he decision encouraged leveraging, because interest was tax-deductible. … The Bush administration was providing an open invitation to excessive borrowing and lending…

No. 4: Faking the Numbers: …[I]f you can’t have faith in a company’s numbers, then you can’t have faith in anything about a company at all. Unfortunately, in the negotiations over what became Sarbanes-Oxley a decision was made not to deal with … a fundamental underlying problem: stock options. …[A] problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.

The incentive structure of the rating agencies also proved perverse. Agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings…

No. 5: Letting It Bleed: The final turning point came with the passage of a bailout package… As America’s banks faced collapse, the administration veered from one course of action to another. Some institutions … were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not.

The original proposal by … Henry Paulson … didn’t address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction …—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted… When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. …

The other problem not addressed involved the looming weaknesses in the economy. …

Without quick action by government, the economy faced a downturn. …

Was there any single decision which, had it been reversed, would have changed the course of history? … The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal.

… The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

Joseph Stiglitz

And from a recent Project Syndicate post:

“Keynes was worried about a liquidity trap – the inability of monetary authorities to induce an increase in the supply of credit in order to raise the level of economic activity. US Federal Reserve Chairman Ben Bernanke has tried hard to avoid having the blame fall on the Fed for deepening this downturn in the way that it is blamed for the Great Depression, famously associated with a contraction of the money supply and the collapse of banks.

“And yet one should read history and theory carefully: preserving financial institutions is not an end in itself, but a means to an end. It is the flow of credit that is important, and the reason that the failure of banks during the Great Depression was important is that they were involved in determining creditworthiness; they were the repositories of information necessary for the maintenance of the flow of credit. ”

One of the things that is both amazing and revolting about the current policy response is the actions of the Fed. With more than a year’s lead time and with confidence born of years of study, Bernanke applied his monetary remedies …. to no effect. The crash occurred. The only change in the Fed chairman has been an increase in the fever with which he applies the wrong medicine.

As Keynes said, paraphrasing, expansionary monetary policy is like buying a larger belt in hopes of getting fat.

His ass-backwards means of stabilizing housing was for too long attempting to create a credit environment which would somehow reflate the housing bubble. Too late he came to the table of stabilizing housing markets by stabilizing housing prices.

But the main point is that he, as you point out here, attempted to prop up the banks in hopes the banking function would be stabilized. It is not these decrepit and defunct institutions that are needed, it is the function of banking. We need a new bridge, not a multi-trillion dollar prop up of the broken one.

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