The economy is too serious a thing to be left to the economists

A better management of the current financial crisis requires a profound analysis of its causes, a wise consideration of possible responses and a visionary view on how the global financial system could be improved to prevent, as much as possible, future problems.

This is not an easy task and is not what happens today.

Today we are seeing central bank presidents, whom we have given the responsibility to maintain a healthy national and international monetary system, and ministers of finance, whom we have given the responsibility to propose the best possible financial policies nationally and internationally, making statements that are proof of powerlessness or lack of vision, or both.

How to change this dangerous incompetence?

We, the peoples of the world who, when we are living in democracies, have vested responsibility and authority with ministers of finance and central bank presidents (to name just the highest in "authority"), are the only ones who can give the answer.

Economists should help us, with their technical knowledge and insights, to develop a vision of a global financial and economic system that would enable a fair chance and fair living for all, now and in the future.

Robert Triffin, a famous analyst of the global financial system, once said to me: “Just as Clemenceau once said that war is much too serious a thing to be left to the generals, I think the economy is far too serious a thing to be left to the economists.” (see the second para in my article "The International Monetary Crunch: Crisis or Scandal?")

Managing the crisis (1)

"Central banks have kept interest rates very low for many years. This has led many banks to seek juicy returns – to protect shareholder value, as they say – by taking unreasonable risks. This has also led to massive foreign exchange reserves accumulation all over the world. The great unwinding must now take place," said Charles Wyplosz in the Financial Times of 21 December 2007.

Yesterday, the Bank of England presented a rescue plan of 62.5 billion euros for commercial banks affected by the credit crisis, the largest rescue plan ever by England's central bank. One of the banks in trouble, the Royal Bank of Scotland, last year still celebrated its conquering of ABN Amro.

"The central banks have done everything they can to keep financial markets orderly. They have taken the risk of feeding the moral hazard beast and what did they achieve? So far, they have avoided the much feared Big Crunch, but the end of the tunnel is not yet in sight," said Charles Wyplosz in the FT of 21 December 2007.

Charles warned that "further cash injection (by central banks) will not provide the permanent solution – the return of interbank lending. For that to happen, banks need to be reassured about each other. Recapitalisation is the only solution."

He added, "If a company has suffered, or is about to suffer, heavy losses, its shareholders will have to partake in the trouble. Delaying tactics prolong the misery without solving the problem, which will not go away. We now see that the willingness of central banks to provide liquidity at reasonably low cost is only allowing the shareholders to delay the time of reckoning. (...) The message must now go out: unless banks take up their losses and raise the required amount of capital, there will be no more liquidity."

Charles saw a simple solution: let the Sovereign Wealth Funds buy the shares needed to recapitalise the banks.

Stephany Griffith-Jones and José Antonio Ocampo have written an interesting paper on Sovereign Wealth Funds (SWFs) from a developing country perspective. They observe that these funds "have helped calm fears about banks' solvency and helped contain the inevitable reduction of share prices."

"A reason why SWF investment in banks has been welcomed," they observe, "is because they tend to take relatively small shares in banks, and none of them sit on bank boards. Additionaly, SWFs are perceived as having longer term horizons (for example as compared with private equity or hedge fund investors) which makes them less sensitive to market volatility."

In a next post, I will highlight other points in José Antonio and Stephany's paper. I will also report on an insightful article, "Financial Regulation: Sending the Herd over the Cliff. Again", I just received from Avinash Persaud and of which a version will appear in the June edition of the IMF journal Finance & Development.

What do you think of the Bank of England's rescue plan? Is it good? Is it bad? Is it nor good nor bad?

Let's help the poor in the US and elsewhere

Sometimes I feel we are so busy with our own business that we forget to think about what is happening in the world. Or we think that we are dealing with what is happening in the world, but are doing so in a little effective or wrong way.

Last week I was shocked by a small article on page two of an Amsterdam journal, Het Parool, which said that 28 million people in the United States will need food stamps and that the number of people needing these stamps had increased by 30 percent since the beginning of the credit crisis.

Only in New York 1.1 million depend on food stamps. The victims are people with low-earning jobs in shops, the cleaning industry, kitchens of restaurants and workers in the construction sector. These 'working poor,' as the article observes, often spend 10 percent of their earnings on gasoline (petrol) and a substantial proportion of their income on food.

I have a revolutionary thought: let our European ministers of international development cooperation advocate a change of neoliberal policies in the United States and other countries affected by neoliberal policies, to combat poverty in the US and elsewhere including our own countries.

Doing just that our development aid industry would make a healthy turn away from too much a focus on bookkeeping of money given or lent to developing countries to, what in my view is the essence of international development cooperation, economic and social policies for the well-being of all.

The picture comes from a book I spent hours and hours looking at in my youth, "U.S. Camera 1939", Edited by T.J. Maloney, and published by William Morrow & Company, New York.

Preventing the crisis (4)

To be able to prevent a crisis one has to know its origins or possible causes. As with previous financial crises, the current crisis is generally treated in a too simple way, not taking into account more fundamental causes than the problem with mortgages and new financial instruments.

Jane D'Arista is one of those economists who have a broader and more profound view on crisis emergence and crisis prevention. Commenting on emails by John Williamson and Stephany Griffith-Jones, Jane applauds “the discussion of the yen carry trade and its role in both financing excesses and supporting balance of payments imbalances”. The yen carry trade is a topic discussed by John in his paper and Stephany suggested that macroeconomic action would be one way to curb it, but that it should be accompanied by regulatory actions, to ease the task of monetary authorities, “who if not face a wall of money, that makes their interventions more difficult and expensive.”

Jane adds, “Leverage, too, was a critical ingredient in the crisis”, and notes, “national regulators completely ignored the BIS and IMF warnings about the amount of speculation in the global financial system and the threat it posed for a systemic meltdown.”

Jane disagrees with Stephany's view “that there is no link between (global) imbalances and the financial crisis and that US budget deficits were the cause of the inflows that funded the consumption spree. The inflows were particularly strong during the period of the budget surpluses in the late 90s when the spending spree was shifted from the government to the household sector and took off from there. Policy was part of the problem - including the strong dollar policy supported by the Fed's attention to the interest rate differential between the dollar and other major currencies in that period - but the capital flows problem has been a mixture of many contributing factors.”

Jane stresses, “So far, the IMF has contributed good analyses of developments and has - like the BIS - called attention to both macro and financial excesses but without effect. Bill White and the BIS have also offered prescriptions for a macroprudential framework (including in the FONDAD volume) that need further exploration. The need to redirect central banks is, in my view, key to reviving stability and I am working on a paper for the Minsky conference at the Levy Institute (April 17-18) that deals with that issue.”

I look forward to seeing Jane’s paper, which should be ready by now, April 17, and hope to report on it in a next post.

I hope Bill White and others (Mark Allen? Charles Wyplosz?) will join the discussion.

There are more papers I will discuss on the blog like the ones I received from Jan Kregel, José Antonio Ocampo (co-authored by Stephany) and Rob Vos.

Preventing the crisis (3)

One possible way to prevent crisis is regulation. It is the regulator’s hope that good regulation will prevent trouble.

In response to John Williamson’s paper Stephany Griffith-Jones said in an email that she particularly liked John’s emphasis on “regulatory failure and need for improved regulation, including the possibility of forbidding certain transactions or activities.”

Stephany added, “This sounds radical, but if the social benefits are clearly below the social costs of certain activities, it seems the role of regulators should be to curb them.”

With “certain activities”, she referred to new financial instruments such as collateralised debt obligations (CDOs) and asset-backed commercial paper (ABCP), which lay at the heart of the crisis that erupted in 2007. Would better regulation of these new financial instruments have prevented the crisis?

This is difficult to say. With hindsight, it’s always easy – compare marital conflict and war. But if the rules had been different, would a crisis not have happened?

I don’t know if Stephany thinks that with better regulation of “certain activities” a crisis would have been prevented. There are other causes as well, I think. Anyway, I will ask her what she thinks.

Stephany reported that Joe Stiglitz and others are advocating an agency that would review financial instruments from this perspective: its social benefits and costs. She compares the job to one of an agency that reviews medicines “to check before they are released that they have no unintended negative effects that would outweigh their positive impacts.”

This is an interesting thought. Can it be but into practice?

Stephany went on saying that it would be interesting to discuss in a planned FONDAD workshop the regulatory implications of the current crisis. She suggested that we should look at more accepted ideas that need a strong push for something to happen. For example, we might consider regulating rating agencies, and modifying Basle 2 “to eliminate procyclicality of capital requirements, or even postpone Basle 2 introduction so it does not deepen the current slowdown (an idea mentioned briefly at a recent G24 meeting and hinted at in the Financial Times).”

This all sounds very interesting. I will ask Bill White what he thinks.

The question remains whether good regulation can prevent crisis.

(to be continued)

Preventing the crisis (2)

Every crisis between men can be prevented, be it a marriage crisis, a strike, a war, or a financial crisis.

Yesterday I read that someone considered the current international credit crisis "man-made". A non-sensical statement, because it could not be otherwise.

How could the current crisis have been prevented? That's a more difficult issue. It requires analysis, and opinion. Yes, without opinion, no explanation. And, usually, there is not one explanation but several.

Some people assume that facts explain. You need them, but you should never believe you have them all. There is always more.

Explaining requires reduction or abstraction, that's what makes it attractive and convincing – up to a certain degree.

Complex matters can be made crystal clear but sometimes the beauty (aesthetics) of explanation obfuscates reality, particularly in social sciences (economics) and politics where reality is subject to opinion and willingness of change.

The current financial crisis is complicated and simple at the same time. Not because it’s about numbers, figures – as I said before – but because it is man made. All made by men is simple and can be understood, even though it sometimes seems complicated.

But preventing a crisis remains difficult.

In the next post we will see what some of you say about it.

Preventing the crisis (1)

Those who suffer from a crisis wish the crisis would have been prevented. This applies to the debt crisis of the 1980s and all other crises that preceded (e.g. the crisis of the 1930s) and followed it (e.g. the Mexican crisis and the Asian crisis of the 1990s).

So the question is: could a crisis have been prevented?

Thousands, if not millions, of pages have been written about crises of the past to answer this question. On the current crisis, less has been written about its possible prevention. Many observers seem to find this hardly an interesting question, but I think that in five or ten years the literature on the possibility of preventing this crisis will be equally voluminous.

In the previous posts both John Williamson and Andrew Sheng have spoken explicitly or implicitly about the question of whether the current crisis could have been prevented. In a next post, I will highlight their thoughts and that of others.

Many of you have sent me their thoughts and it is high time that I include them in this blog, which is mine but aims to be yours as well.

Early this morning, at about 5am, I thought I should have on the blog a series of thoughts about (1) explaining the crisis, (2) preventing the crisis, (3) managing the crisis, (4) reforming the system.

The first series (explaining the crisis) has started already and will continue. This post starts the second series.