GLOBAL FINANCIAL CRISIS: by Patrick J. ByrneNews Weekly
Fundamental change is needed, but probably won't happen
, June 13, 2009
The Global Financial Crisis is set to become a prolonged slump, because vested national interests and narrow ideological convictions are likely to stifle necessary reforms, argues Patrick J. Byrne.Describing the behaviour of the banking system, Martin Wolf, associate editor and chief economic commentator at the Financial Times, has said, "The UK has a strategic nightmare: it has a strong comparative advantage in the world's most irresponsible industry." (Financial Times, May 21, 2009).
Certainly, the UK and US banks have to wear major responsibility for the worst crisis ever to beset capitalism.
It was the US banks that first persuaded its government to allow them to use a new form of complex derivative to sell debt off their books to other financial institutions, allowing them to slash their capital adequacy ratio well below what was considered a safe minimum of 8 per cent. When Lehman Brothers went broke, for each $40 it loaned, the bank held only $1 dollar in reserve.
These derivatives were sometimes called "sausages" - because you never quite knew what was in them. The worldwide derivatives market, which peaked at $600-$700 trillion and was based on grossly inflated asset values, is now unwinding.Gambling habits
The banks deserve harsh judgment; but it was the huge imbalances in the world trading system that created the trillions of dollar in "hot money" flows, which fed the gambling habits of the banks.
What do all the countries with big trade surpluses, the big savings economies, have in common? They all engaged in the most powerful form of protectionism known; they manipulated their exchange rates, keeping them low in order to give themselves massive trade advantages with the rest of the world.
This resulted in the wholesale transfer of industry and jobs from the US, UK, Australia and many EU nations to China and Japan.
Logically, then, to overcome the Global Financial Crisis, the supply of gambling money should be cut by restoring balances in world trade. This would mean that the debtor nations, such as the US, UK and Australia, should rebuild their industries and rely less on imports; and nations like China, Japan and Germany should export less, import more and focus on developing domestic consumption rather than exports.
Consequently, some countries would have much lower trade surpluses and others much more manageable trade deficits. The need for "hot capital" to flow from the big savings to the big debtor countries would diminish. The gambling money of casino capitalism would dry up.
Governments are saying that re-regulation of the banks is the solution. However, as Dr John Hewson recently pointed out, regulation alone won't work. So long as the temptation of hot capital flows is there, the banks will find a way around new regulations.
All the more reason why rebalancing world trade is the necessary solution to the Global Financial Crisis. But will it happen? Can sweet reason prevail?
It seems unlikely, for two reasons.
First, most of the high savings, emerging countries will conclude that their export-based capitalism works best. As Martin Wolf warns, they will be convinced that "accumulating massive foreign currency reserves and limiting [their] current account deficits is a sound strategy. This is likely to generate another round of destabilising global 'imbalances'" that created the problem in the first place.
"This seems an inevitable result of a defective international monetary order. We do not know how globalisation will survive all such stresses. I am hopeful, but not that confident." (Financial Times
, May 19).
Second, in the big debtor economies - the US, UK, Australia and much of the EU - there is no willpower to change from the economic ideology of globalism (the radical free trade theory) that created this fundamentally flawed trade and financial system.
The renowned Robert (Lord) Skidelsky is emeritus professor of political economy at Warwick University, author of the definitive three-volume biography of the distinguished 20th-century economist, John Maynard Keynes, and a member of the British House of Lords.
Skidelsky describes how Western economic thinking is dominated by an outdated ideology.
A "fundamental reason" for the economic crisis is "the dominance of the Chicago school of economics, with its belief in the self-regulating properties of unfettered markets. This belief justified the deregulation of financial markets in the name of the 'efficient-market hypothesis'. It led to the spread of financial risk-management models, which grossly underestimated the amount of risk in the system.
"John Maynard Keynes wrote that 'practical men who believe themselves to be quite immune from intellectual influences are usually the slaves of some defunct economist'.
"Most of today's economists are not defunct, but work in the ideological vicinity of Chicago. Their assumptions should be ruthlessly exposed, for they have come close to destroying our world." (Project Syndicate
, April 2009).
Skidelsky adds that most economists are hidebound by this outdated ideology. "A few geniuses aside, economists frame their assumptions to suit existing states of affairs, and then invest them with an aura of permanent truth. They are intellectual butlers, serving the interests of those in power, not vigilant observers of shifting reality. Their systems trap them in orthodoxy.
"When events, for whatever reason, coincide with their theorems, the orthodoxy that they espouse enjoys its moment of glory. When events shift, it becomes obsolete. As Charles Morris wrote: 'Intellectuals are reliable lagging indicators, near-infallible guides to what used to be true'." (Project Syndicate
, September 2008).
So if neither the big exporting savings nations nor the ideologically-driven economists steering Western economies are prepared to consider restructuring the world trading system, what will this mean for the floundering world economy?
After Japan's grossly inflated property market collapsed in the late 1980s, its economy staggered from one crisis to another and stagnated for 20 years. Without a major restructure of the world trading system, the Global Financial Crisis is set to follow the Japanese example and become one prolonged recession, in which we stumble from one financial crisis to another.
How the global political order will evolve under these circumstances can only be guessed at, but the China-US relationship will be pivotal.
Capitalism, in a multitude of forms, will continue because it has no rival; but, given the bitter legacy this crisis will leave for the world, it's by no means sure how the democracies will fare.- Patrick J. Byrne is national vice-president of the National Civic Council.REFERENCES:
Martin Wolf, "This crisis is a moment, but is it a defining one?", Financial Times
(London), May 19, 2009.
Martin Wolf, "Why Britain has to curb finance", Financial Times
(London), May 21, 2009.
Robert Skidelsky, "Farewell to the neo-classical revolution", Project Syndicate
(Prague), September 2008.
Robert Skidelsky, "The treason of the economists", Project Syndicate
(Prague), April 2009.