Summary: Two bright lights shine amidst the torrent of bad economic news. First the G20 meeting. Second, President-Elect Obama’s new team at the Treasury Department. I suggest that we avoid disappointment by expecting little from either. We are far “off the map”, with little in history or economic theory to guide us. Only time and much work can reveal the path we should take. Politicians and the public will demand immediate solutions; quacks will provide them.
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There is no why here
Few people realize the oddness of recent economic events. The current hot jargon calls these black swans — Nissam Taleb’s term for a “large-impact, hard-to-predict, and rare event beyond the realm of normal expectations.” But after months of such events, one after another, some observers have declared that these days all swans are black (see “Black Swans Become Norm, Instead of Exception” by William Pesek at Bloomberg, and Envast Gold’s poem “All Swans are Black“).
The bizarre strangeness of current events suggests that we have moved into the “twilight zone.” The Twilight Zone is that place where there is no why. As in Primo Levi‘s Survival in Auschwitz:
Driven by thirst I eyed a fine icicle hanging outside the window, within hand’s reach. I opened the window and broke off the icicle but at once a large, heavy guard prowling outside brutally snatched it away from me. ‘Warum?’ I asked him in my poor German. ‘Hier ist kein warum’ (there is is no why here), he replied, pushing me inside with a shove.
This quote is used far out of its original context, but captures the feel of today’s events. In this strangeness is a key to the situation: we are “off the map”, outside of the precedents of history and conventional economic theory.
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- Our situation is largely unlike anything previously experienced: a global deflationary event. This has some similarities to the 1930’s, but the world has changed too much since then for those to tell us much.
- It is a paradigm crisis for the dominant paradigm of economics. This collapse in a sense results from us traveling to the boundaries of Keynesian theory, which does not adequately deal with unsustainably large aggregate debt levels.
Implications
The easy analysis is to blame Ben Bernanke and Hank Paulson for their in adequate or wrong response to the crisis. This site has many posts doing exactly that. While justified, there is (as always) another perspective.
Bernanke and Paulson were the A-team, by any objective criteria. Their failure indicates more than two individuals pushed beyond their limits. This is a systematic failure, much like the Hoover Administration’s failure — and that of FDR’s Administration (they mitigated the downturn, but only WWII ended it). The economic paradigm of 1929 was inadequate (Keynes published The General Theory of Employment, Interest, and Money in 1936). Almost anyone in their chairs might have failed. Even FDR — as seen in his warnings about inflation during the 1932 election and attempts to balance the budget during 1933-1938.
My conclusions:
- Let’s not expect too much from Obama’s new team.
- Their only “new” knowledge is that their predecessors’ programs failed. They bring no magic to the game.
- We can expect aggressive use of fiscal and monetary policy. What else can they do?
- I doubt these will do more than slow the decline and mitigate the damage.
I discuss this in more detail at “The new President will need new solutions for the economic crisis.”
The G-20 conference, and the many conferences to follow
Expectations were high for last month’s IMF and G-7 conferences. Ditto for this weekend’s G-20 conference. The Economist explains the reason for the excitement, and the inevitable disappointment (“After the Fall“, 13 November 2008 — bold emphasis added).
THE leaders arriving in Washington, DC, for this weekend’s economic summit are being presumptuous. If they want what they are calling Bretton Woods 2 to live up to the original, which took place in New Hampshire overshadowed by war and the Depression, it will have to establish a new economic order for the capitalist world. In 1944 that meant creating the IMF, the World Bank and a body to oversee world trade. Imagine Hank Paulson, America’s treasury secretary, as John Maynard Keynes; or picture Gordon Brown, Britain’s prime minister, as Winston Churchill (as Mr Brown himself secretly may), and you get a sense of the task ahead.
The Bretton Woodsmen of 2008 are grabbing the credit before they have earned it – rather as all those subprime householders did. More than two years of gruelling technical work laid the ground for the wartime conference of officials and finance ministers (prime ministers and presidents had other things to deal with). By contrast, the leaders gathering this weekend from the G20, a mix of industrial and emerging countries, plus the European Union, have cobbled together an agenda in a few frenetic weeks. They will doubtless produce no shortage of promises. Just what these are worth will depend on sweat and summits yet to come.
The summit is sure to stir up a debate about the institutions that oversee the international economy. By convening the G20 rather than the closed, rich club of the G7, the old order has in effect acknowledged that the rest of the world has become too important to bar from the room. But what new order should take its place? Answering that question has been a parlour game for economists since long before the crisis. By encouraging them to dust off their pet ideas, the summit will at the very least create a bull market in new schemes for global economic governance.
Because everyone agrees that something big needs fixing and that the world expects action, calling the summit Bretton Woods 2 could yet come to be seen as a rallying cry for reform. And yet there are lots of reasons to see it as vainglory. The agenda is vague and sprawling. With so many of the world’s political leaders sitting around the table, it will be hard to escape platitudes and hypocrisy. There may be disagreements-especially where sovereignty or competitiveness is threatened. And most of all, the recent international financial collaboration is fraught with in-fighting and complexity.
Bretton Woods’ epochal results were built on
- Four decades of searing events, war followed by inflation followed by depression followed by war,
- decades of profound theoretical work in economics, along with the data from the Depression, and
- a unique historical moment of absolute hegemony, America leading the Allies to total victory in WWII — along with the devastation of every other major nation.
Bretton Woods closed an era of massive, rapid, and painful change. Agreement for a new era was not easy even then, but possible. None of these preconditions exist today.
A historical note
Are we ready for reform, to give up the vices which have brought us to this point and adopt often unpleasant new ways? This is a common situation in history. Titus Livius (aka Livy) wrote about such a time in the Preface to his History of Rome:
The subjects to which I would ask each of my readers to devote his earnest attention are these – the life and morals of the community; the men and the qualities by which through domestic policy and foreign war dominion was won and extended. Then as the standard of morality gradually lowers, let him follow the decay of the national character, observing how at first it slowly sinks, then slips downward more and more rapidly, and finally begins to plunge into headlong ruin, until he reaches these days, in which we can bear neither our vices nor their remedies.
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp relevance to this topic:
- about the Candidates for President of the USA
- about America – how can we reform it?
- about the Military, political, and strategic theory
- some Good News about America!
Posts discussing some solutions:
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
- Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
- How should we respond to the crisis?, 24 September 2008
- A solution to our financial crisis, 25 September 2008
- A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
- The Paulson Plan will buy assets cheap, just as all good cons offer easy money to the marks, 30 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008
- Prof Roubini prescribes first aid for America’s economy, 4 October 2008
- Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
- Dr. Bush, stabilize the economy – stat!, 7 October 2008
- The new President will need new solutions for the economic crisis, 9 October 2008
- Results from the IMF meeting – just thin gruel, 12 October 2008
- The G-7 meeting was the last chance for action before the global recession, 12 October 2008
- A brief note about our financial system: Intermediation, disintermediation, and soon re-intermediation, 16 October 2008
- New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
- A look ahead to the end of this financial crisis, 30 October 2008
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If you step back and admire the last, say, 100 years from a distance, could you not build a strong argument that “the oddness of recent economic events” is just another step in the direction of a unified world government?
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Fabius Maximus replies: That’s an interesting idea, and worth some thought!
Paraphrasing Livy, we can still bear our vices but cannot yet stand their remedies. Americans still want things to be the way they’ve been for a generation: easy credit, big domestic automakers providing cushy union jobs, suburban motoring, etc. The nation is not ready for severe austerity because our leaders haven’t prepared us, starting with their rhetoric.
I appreciate the bit of history, thanks for that.
I do however think you give way to much credit to those who got us to here. I think Primo Levi’s quote, while poignant, distracts from those at fault and prompted me to look up the spelling for “shyster” – From Websters:
shy·ster — Etymology: probably from German Scheisser, literally, defecator (1844): a person who is professionally unscrupulous especially in the practice of law or politics. From wikipedia: Shyster is commonly misspelled. Common variants include schister, scheister, sheister, schyster, shister, shaista, shiester and schiester.
Back to the quote, clearly in our current situation there is a “why”, but we need to ask some simple questions first. They go like (I am sure every can remember them) – those 5 W’s: Who, what, where, when, and then… why.
I think we all know or have a clue about first four, I am not sure why you give up on the last one. I can only conclude that the answer is unpalatable you would just choose to move on, change as it were. To close, and provide my answer to “why” another definition – From Websters:
heist — Etymology: variant of hoist (1865); chiefly dialect : hoist a: to commit armed robbery or steal.
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Fabius Maximus replies: I too have written similar things, such as Slowly more voices are raised about the pending theft of taxpayer money (21 September 2008). But as a complete explanation for a global event of this magnitude “shyster or heist is grossly inadequate.
The root cause, or one of them, is the excessive accumuation of debt, as seen in A picture of the post-WWII debt supercycle (26 September 2008). Nobody forced American households to borrow on such a scale over so long a period. Let’s try something different and accept some responsibility for our actions! It might be a step back on the right the path going forward.
Debt is the problem, both private and public.
As for one world government idea, at this point of human history we do not have enough incommon to bind a world government together. The only option would be use a model very similar to original United States. Since, we have become nannies and must tell others what to do, it is also not likely.
“Sometimes it is said that man cannot be trusted with the government of himself. Can he, then be trusted with the government of others? Or have we found angels in the form of kings to govern him? Let history answer this question.”
Thomas Jefferson
Many of our own citizens feel as Angels able to tell others what to do, yet they can’t even manage their own lives. Until we overcome this mentallity, actually arrogance, we will be stuck in this loop. McCain and Obama are a reflection of being in that loop. I am not expecting anything different.
Another great analysis on this. You might be interested to see a note David Steven and I did on BW2 over at Global Dashboard (which quotes an earlier post of yours about BW1) – see “A Bretton Woods II worthy of the name“.
I think the one substantial point we’d add is the importance of integrating energy security (and climate change, assuming you accept the case for anthropogenic global warming – David and I do, but I know we differ with you on that).
Given that no transformation in the underlying supply or demand fundamentals on energy is taking place (a point reinforced last week by the IEA (see our analysis)), it looks as though commodity prices are set to go straight back up as soon as we emerge from the downturn (whenever that may be – we agree with you that policymakers and media still haven’t internalised how long this will take). Over the longer term, limiting greenhouse gas concentrations to 450-550ppm will necessitate a monumental transformation of the global economy too (regardless of whether or not you think such limiting is actually warranted).
Bottom line: it’s just not credible for policymakers to talk about major reform of global financial and economic systems without having the energy and climate dimensions (and associated ‘scarcity issues’, like rising food prices) front and centre on their agenda. At the moment, though, the multilateral system is extremely badly placed to cope with such an integrative agenda.
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Fabius Maximus replies: I disagree on all counts.
The “cost” of broadending the agenda is decreased liklihood of getting a meaningful agreement. That is why powerful international agreements tend to be focused. The time and effort probably increase geometrically as the domain of the discussion is widened; the odds of agreement and utility of the result probably decrease geometrically.
This is esp so as the case for AGW is in such flux, with much of the underlying foundation being washed away as data is dragged into public view and more attention is directed at the analysis.
Obtaining agreement on energy issues might be even more difficult. First, most of the solutions directly conflict with efforts to control carbon, widespread oppositon to atomic power, or both. Second, some of the key global players are energy producers and have interests to some degree opposed to those of energy consumers.
Japan economists call for ‘Obama bonds’
TOKYO – Japanese economists, increasingly concerned that the United States might seek to pay its enormous and growing debt obligations in a weakened US dollar, are looking to the possibility of US Treasuries being issued in yen.
Fabius –
While it is fair to expect those in the 40 and over crowd to accept responsibility for their HELOC abusing mannerisms, those in the US who are between 25-39 have been essentially forced to borrow absurd amounts of money for their education (in order to secure an income)and then been positioned to borrow maximally to gain entry into the housing market. Finally, because real wages have not kept up with inflation, was it ridiculous to expect them to make up the shortfall with HELOC’s?
I do not condone this behaviour, but also do not see how anyone under the age of 39 would be able to avoid debt without placing themselves into the lower proletariat class and becoming a permanent renter. Its one thing to entice people into reckless borrowing by tricking them with shiny baubles (SUV’s) and appealing to their greed (McMansions). It is another thing to force them to do so in order that they may earn an income (college education) or provide for their families and themselves by purchasing in to assets at inflated prices (home market).
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Fabius Maximus replies: Great point, that’s for bringing this up!
(sorry if dup?)
Reducing the tax incentives for debt, especially the deduction for mortgage interest, should be high on the agenda — but nobody seems to mention it. It’s too popular — I’m sure there needs to be an alternative help for homebuyers before it can be modified.
[My suggestion: 35% tax credit, up to max $50 000/year, for house payments, interest AND equity.
With $500 000 lifetime maximum, and linked to the $50k yearly to rise with average reported income.] The biased support for debt over equity in the home needs to stop.
Despite getting to this crisis thru over-spending and excess debt, the main way to minimize short and mid-term pain involves more consumer spending. The solution would probably add more debt, too, although it might be time to try the printing press alternative. Print cash and spread it. Give printed cash away to folks who will: spend it (good for short term!) or invest it (good for savings rate!) or pay off debts (good to reduce!). As long as inflation is not a problem, due to the huge deflationary drop in velocity, printing cash to reduce debt might well be the least costly gov’t response.
There is no fair way to selectively distribute gov’t benefits; the bank bailout for AIG but not Lehman was possibly a Paulson Goldman Sachs victorious! moment.
The reality of ‘need’ is that those who were most irresponsible before are most needy now, and rewarding irresponsibility is one of the main things NOT to do. Send everybody who filed a tax form $5000, or $10000 (or $5000 now, with an expectation of more if unemployment continues to go up). All citizens are, for such macro-economic purposes, equal.
Even more than construction (which has already reduced employment), the financial industries have too many people. Citi- just laid off, or is about to, some 50 000 soon-to-be ex-bankers.
There won’t be too much big agreement from this summit, nor from future ones — unless the crash gets much worse.