As the U.S. (and global) economy teetering on the brink of a meltdown, Act III of the Modern Economic Crises was formally unveiled on Thurs evening, Sept 18, 2008 as Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson Jr. made an unusual visit to the Congress; see e.g. the New York Times report of the event. Two weeks later, on Oct 3rd, after much fanfare and drama as well as backroom arm twisting and deals, Congress passed a $700 Billion dollars rescue package and President G.W. Bush quickly signed it into law. In the last 20 days since Sept 19, the Dow Jones Industrial Average (DJIA) stock market index of 30 of the largest and most widely held public companies in U.S. has dropped by over 2,000 points or nearly 20%. In comparison, the stock market crash of 1987 (for different reasons) brought the DJIA down by over 30% in 6 days starting from the black Monday, Oct 19, 1987.
Why Act III? After the Panic of 1907 over 100 years ago, the structure of the system guided by the Classical Economics that were developed initially by Adam Smith, the father of the modern economics, was found insufficient. Federal Reserve System, a version of the Central Banks found in Europe, was subsequently established to provide government an additional significant tool to intervene and to alter the behavior of the market when needed. Since then, we have witnessed two historical and trajectory changing episodes: Act I - Great Depression of 1929-1941 that ushered Keynesianism that believes in active government intervention using principally fiscal policy (through controls of government spending and taxation) and monetary policy (through control of money supply by Federal Reserve).
Act II began 40 years later when Keynesianism met its own limitation and was discredited in 1970s as its framework failed to address stagflation, a simultaneous occurrence of economic stagnation and inflation. For the last three decades, the synthesis of Keynesian on macroeconomics and neoclassical on microeconomics – so called Mainstream Economics emerged as the dominating framework with monetarism being the principal guide and monetary policy being the principal instrument of intervention as Alan Greenspan aptly demonstrated for almost 20 years from 1987 till 2006.
While economists continue the debate and analysis about how and why we get to where we are, and Presidential candidates are busy convincing us they are the right person to lead us out of the crisis, I can’t stop wondering am I one of those blind men in the Indian fable of Blind Men and an Elephant 瞎子摸象? Or worst yet, are we, the blind men, also parts of this continuously transforming elephant as well?
Let us pause for a moment to examine the basics if there is any hope for average person like me to begin to comprehend something as complex as economy. Before we explore further, Let us keep in mind that in practice there is no pure form of any ideology so we don’t get distracted by political terms and labels like “socialism and redistribution”, “tax and spend”, “fiscal conservative”, “de-regulation”, “free-market”, etc.
In 1978, Libertarian Vienna School economist and writer Henry Hazlitt added a new chapter “Lessons After Thirty Years” and published the new edition of his popular 1946 book Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics. Now another thirty years has passed, have we learned and done anything differently? The short answer is no.
In his 218 pages book of 1978, Henry Hazlitt first summarized the single lesson of the whole of economics in one sentence: “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.” He then went on to illustrate, with 23 easy-to-understand examples, most popular economic fallacies.
The main take-away for me was that we, the blinds, are so easily confused by the half-truths that flood all channels that, intentionally or not, make us forget the fundamental law of economics “There is no free lunch” and the fundamental law of physics “Conservation of the Total”. The simple cruel reality is that the only possible real growth is to increase our collective economic outputs with more efficient production, delivery, and use of resources (that determine the Total in the conservation law). Everything else is a matter of when and who gets which part of the pie and how. As Gretchen Morgenson of NY Times noted in her 8/19 interview with Bill Moyer about this current crisis “…this is privatizing gains and socializing losses. So when things are going well, the managements make out, the shareholders make out, the counter-parties are fine. All the private sector people do well. But when something goes wrong, when decisions are made that turn out to be bad decisions, the U.S. taxpayer has to take on the problem…” There is no denial that we are all participants of this game, willingly or not, and there are no completely innocent but only ignorant bystanders. There are those who cleverly ate others’ lunches of the future before our very eyes and we don’t even see it! Remember the “trickle-down theory”? Have you ever wondered who got the crumbs and who got left out at the end?
Few experts did see and had warned us that we were approaching a cliff, noting several indicators and trend; see for example articles by NYU Professor Nouriel Roubini on his Global EconoMonotor. However, many of us including myself could not comprehend nor judge the intricate principles and operations, nor knew of crucial indicators of credit market such as TED spread. At the end, many of us fell back to wait-and-see and leave it to the “experts”. However, being wonderful social beings, we take cues and learn from each other; we “follow the herd” when fear erodes our confidence, shake our beliefs, and challenge our judgment at the most critical moments. Some tough it out and many caved in to validate the self-fulfilling prophecy. Then the cycle repeats itself again.
Is it really that hard to understand what is going on at least at an intuitive level? There appear to be inevitable oscillatory dynamics at various time scale due to the delayed actions-reactions. There are familiar examples in other systems such as the familiar alternating congestion of roadways due to reported congestions of one and the subsequent mass reroutes of affected drivers. Other examples can be found in Internet, chemical plants and so on. Indeed, it is well understood that inherent time-lags in these systems can cause oscillations and instability of the system. And ad-hoc well-intended but ill-designed and flawed monitoring and control attempts will only exasperate and worsen the situation. I am convinced that this is the basic nature of the system for which we are an integral part of it. I would challenge our smart economists please explain to us if this is true and why can’t we figure out alternate and more stable frameworks instead of arguing about how to tweak and fine-tune an inherently unstable and flawed system?
Of course, I might sound a little too critical of economists who are not really the ones to be blamed. As Henry Hazlitt pointed out at the end of his new chapter of the book: “the main problem we face today is not economic but political”. 30 years later, nothing had changed since what we have is still a fundamentally unstable political economical system. What we did manage to accomplish beyond incremental adjustments is the nuances of accelerated globalization and creation of “virtual capital”.
One of the things globalization did is to enlarge the system to include an increasingly larger part of the populations on earth, thereby allows us tapping into more resources and further leveraging more capitals. It effectively allows us pumping more air into a bigger balloon, sharing risks among more entities, and thus delaying the (louder) bursting of the bubbles and subsequent contraction. What made it worse was the creation and leverage of what I would call “virtual capital” whose excessive growth in forms of credits and risks pushed us over the edge. Do you know unlike traditional banks, investment banking companies like the bankrupted Lehman Brothers, the acquired Merrill Lynch, and the re-registered Goldman Sachs and Morgan Stanley were not required to have any reserves to operate? By the way, the best explanation of the word “virtual” I have ever heard was from Internet pioneer Bob Kahn a long time ago. He once said “virtual is something you can see but it is not there (and transparent is something you can’t see but it is there)”. So, there you go.
It is tempting for us to believe that we can change and control the world. It is too convenient for us to have the wishful thinking that interventions by government through hands and mouths of politicians and experts can solve the problems and save us all. Democracy and Free Market ideals seem no longer compatible not to mention the market was never “free” to begin with. We expect multinational corporation maneuvers and government interventions on behalf of us by democratically elected politicians whenever things don’t quite work the way we’d like. We reward our politicians by electing and re-electing those who can benefit MY community and MY interest most, and then we complained about other “special interest groups”. We entrust our assets and savings and reward Wall Street with outrageous compensation as they are finding bigger and bigger stake tables globally, hoping that we all get rich fast.
There is an old saying, “Fool me once, shame on you. Fool me twice, shame on me.” How many more times do we want to get fooled? American philosopher and aphorist George Santayana had also said in his work The Life of Reason, 1905. “Those who cannot remember the past are condemned to repeat it.” How many more times do we have to repeat it? It is time to change the fundamental structure of our political economical system.
Talk to you soon!
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