Economic Dreams - Economic Nightmares

Capitalism's Fatal Flaws

In The Worldly Philosophers, Robert Heilbroner tells us that all the great economists foresaw a time when capitalism would come to an end. In Stabilizing an Unstable Economy (1986), Hyman Minsky outlines an agenda for ending capitalism as we've know it (what Heilbroner called "Capitalism as a Regime" in Behind the Veil of Economics). Minsky suggests that we replace laissez-faire capitalism (Wiki link) with a less-flawed version of Capitalism that allows for much better automatic stabilizers than found in our current system.

Minsky, following his reading of Keynes, tells us that modern financial institutions (with inherent tendencies toward monopoly) inevitably will turn into predators on other economic subsystems. Minsky also tells us that most economic theories, with emphasis on "equilibrium" while allowing only for occasional shocks to the system, are ill-equipped to deal with the systemic problems stemming from stability that breeds instability. Minsky (p.280):

In a world with capitalistic finance it is simply not true that the pursuit by each unit of its own self-interest will lead an economy to equilibrium. The self-interest of bankers, levered investors, and investment producers can lead the economy to inflationary expansions [including asset inflation] and unemployment-creating contractions. Supply and demand analysis—in which market processes lead to an equilibrium—does not explain the behavior of a capitalist economy, for capitalist financial processes mean that the economy has endogenous destabilizing forces. Financial fragility, which is a prerequisite for financial instability is, fundamentally, a result of internal market processes. …

Institutions such as the Federal Reserve, which were introduced in an effort to control and contain disorderly conditions in banking and financial markets, are now slaves of an economic theory that denies the existence of such conditions.

The "stability breeds instability" process is now well-know to complex systems theorists. As systems age, newly emergent systems first gain, then lose redundancy and therefore resilience—they become fragile, brittle, or tightly-coupled. At some point a shock to the system will cause catastrophic failure (if the system just doesn't get stuck in a "poverty trap"), setting the stage for rebirth of that system or newly emergent systems that arise in the wake of the old. (See, e.g. adaptive cycle, or more generally: Resilience Alliance.)

Minksy's dream is a hard sell in the American culture, with our new-found American values. Minsky's agenda is to relegate market mechanisms to relatively minor roles. Minsky's "solutions" which he offered up humbly, are for bigger government, smaller banking institutions, and an elimination of "welfare" via a government-sponsored "employment strategy". It is an agenda that is still being pitched by some of Minsky's disciples, although there is dissension among the disciples as is always the case with economists. Minsky also advocated for a "balanced budget" — balanced not every year, but over a reasonable time-frame so as to avoid hyper-inflationary possibilities.

Time will tell whether Capitalism will survive (and if it does, In what form?). In the meantime we all watch and wait, cuss and discuss.

For more on Minsky and more on the bankster crisis, see:
Economic Perspectives from Kansas City.
For more on monetary complex systems thought, see:
Macroeconomic Resilience

Making Sense of Economics

[Updated Mar. 7— Draft: in flux!]

Not too long ago a friend asked how to make sense of economics. After my laughter subsided, I recommended two books by Robert Heilbroner: The Worldly Philosophers:The Lives, Times and Ideas of the Great Economic Thinkers (Wiki Link) and Behind the Veil of Economics: Essays in the Worldly Philosophy (NY Times Books). I said, "Start with these, and then we can talk more." If my friend had been more inclined toward Financial Economics I might have added Peter Bernstein's Against the Gods: The Remarkable Story of Risk (my assessment) to the list.

To effectively make sense of economics one must realize that Economics is both a history of technology and development, and a study of how people in societies provide for their sustenance. Neither of these two studies necessarily relies on money, although in most cultural practice money is near center stage.

Since money is center stage in most economic chatter, it proves useful to better understand both the contributions and the blindspots in the various "schools of thought" that make up what we call economics.

Blind Men and the Elephant

Consider "the blind men and the elephant" metaphor as applied to economists. Austrians (Wiki Link) (and Neo-Austrians) emphasize market mechanisms and market cycles. Unfortunately, they tend to overemphasize the importance of markets and under-emphasize the role of government. At least they are accused of such by other economists. Often there is outright hatred of government (sometimes with the exception of National Defense) apparent in their writing.

Monetarists (Wiki Link, NS Link) focus on the role of the "money supply" on national output and longer-term price trends. Monitarists tend to focus too narrowly on money and its supposed ability to heal all social problems. At least they are accused of such by other economists.

Keynesians (Wiki Link) (and Post-Keynesians, and Chartalist cousins) emphasize the role of government in setting up mediums of exchange (currency, monetary accounting systems, credit systems, taxation, etc.) and in moderating market behavior when things get too wild. Unfortunately, Keynesians seem too often to err on the government side of the cultural power balance between government and markets. And some Keynesians, like there monetrist antagonists are prone to overplay the "money card" when faced with economic problems. At least they are accused of such behaviors by other economists.

Complexity-theory economists (Wiki Link), focus on "complex systems" and the complexity of human interaction that is sometimes framed as "wicked problems". They are accused by other economists of bringing too much information into their frames of reference, thereby disabling predictive capabilities that theories/methods from other schools of thought enable. Complexity theorists, like other economists, are often so caught up in the mathematics of their vision quest that they are accused of methodological blindness.

Behavorial economists (Wiki Link) bring psychology to center stage in talking through behavior of individual and group actors. I was particularly glad to see them emerge — so too complexity theorists —to move economics thought forward.

Information economists (Wiki Link) put information and information transfer at center stage. Some emphasize the importance of "information asymmetry" as power in both markets and government.

Finally Institutional economists (Wiki Link) focus on "institutionalist political economy", affording much space for politics and political theory in the study of economics.

But we can't stop here. These few hints just begin to explain the various schools of economic thought. See also: Heterodox Economics, which includes the "schools" where I spend much of my time.
  [ Notes: The word "hate" as used above is probably too strong. Alternates include: despise, belittle, "can't stand", etc. Also, there are practitioners in all of the economic schools of thought who are much better than the caricatures I present. Still, when I wander through the blogs, I'm struck by how nearly the term "hate" fits. I should mention that there is a strong tendency toward turf protection among economists — many spend much time dishing dirt on other schools of thought, and on prominent economists not from their school. This is understandable, since economics sits just behind much of the power money in the world today.]

Too often economists fail to adequately embed political and psychological reasoning into their arguments. In every case they so fail, their reasoning ought to fall on deaf ears. But it doesn't. Witness the mess we are in today and the impact too-blind economic reasoning — pontificating really — has had. Audiences listen too well to half-blind (or worse) economic reasoning. Such arguments are amplified by the media, and continue to befuddle and enrage. This proves true whether we look to the so-called general public or to the halls of legislative, administrative and judicial governments around the world.

Learning from Economists

Despite the chaos of economics, the nastiness of politics, and the aberrant nature of the human psyche, there is much we can learn from economists. Austrians help us to better understand the creative destruction (Wiki Link), to use Schumpeter's words, of market cycles. They help us understand information theory: the use and transmission of knowledge via market mechanisms. [ What else? both here and in other schools] They also help us to be wary of moral hazard (Wiki Link) . Keynesians help us better understand important roles for automatic stabilizers (Wiki Link when market cycles tend toward "irrational exuberance" and "irrational pessimism". Monetarists help us better understand that if we are going to base a social system around money, we had better damn well understand the plumbing of the system. Institutionalists help us better understand that we had better understand much beyond money when we are dealing with political economy. Behavioralists and information theorists help us better understand that there are bounds on individual and group rationality (Wiki Link). Complexity theorists help us better understand the chaos/order balance of the world we live in — i.e. complex systems — and the added individual and group psychological "systems effects" that are inherent in social system.

Other schools of thought add spice, nuance, and sometimes insight to discussions within any school. And remember that many economists don't fit well within any "school".

Policy makers need to better understand the ideological/methodological roots of economics reasoning. They need to better understand, as do we all, the "frames" that economists use to bound their discussions — frames that sometimes blind those who work and talk within them.

[Need to add something about The Shock Docrtine, The Wrecking Crew, etc. and the havoc that half-blind ideology and power can unleash.]

Financial "Rock, Paper, Scissors"

Let the rock be gold, the paper be money, and the scissors, a shredder. We have a stage set for "financial rock, paper, scissors". From a historical perspective, we can easily trace the most recent path from gold to paper money (or fiat currency) as it has played out on the world stage—officially beginning in 1971 when President Richard Nixon officially declared the US to be off the gold standard. Numerous books have been written on the matter. Here is a very short history that begins in 1913 titled "Privatize the Gains, Socialize the Losses", by Peter Treadway. Paper covers rock! {Note: Treadway's paper isn't the best short history around, and may replace it with something else, but I do like the title.}

What is just now playing out is the predicted credit bust that predates the shredding of the paper money when market cycles turn ugly. Or maybe it doesn't precede shredding (partial shredding via inflation really), but someone will have to explain to me just how we get out of this mess otherwise. Oh, I almost forgot Mosler's Law: "There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it." I'll post more on the "Chartalist fix" soon.

Numerous blogs are now tracking the debt bubble that is still building (and shifting from "private" to "public") in the wake of the credit bubble. Few are offering acceptable resolutions to the debt problem. At least I'm not finding them—or accepting them. Here are a few places that track the problem: Doug Noland's Credit Bubble Bulletin, Steve Keen's Oz Debtwatch, Edward Harrison's Credit Writedowns.

Paul Krugman, among other Keynesian economists, advocates higher inflation to create more space for interest rate cuts in times of stress. Of course "higher inflation" for awhile would help the government out from under some of the debt burden too. But at the expense of those on fixed incomes, unless tax policy or other means were used to make "fixed incomes" types whole again.

Many on the "right" seem to want to blast Krugman for advocating that we inflate our way out of the crisis, as if that were (1) true, and (2) the only tool Krugman advocates for. Yet the Feb 12 IMF paper, "Rethinking Macroeconomic Policy" (pdf) Krugman points to in a recent post, talks through various tools to try to find a path forward, including

• Raising the Inflation Target
• Combining Monetary and Regulatory Policy
• Higher Inflation Targeting and Foreign Exchange Intervention
• Providing Liquidity More Broadly
• Creating More Fiscal Space in Good Times
• Designing Better Automatic Fiscal Stabilizers

Neo-chartalists, at least some of them, advocate what I'll call an "modern-day alchemy fix" to the debt problem, remember: "There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it."

In any supposed "fix" there will be winners and losers, with the government in the middle of the mess. Scary times ahead! Both the Keynesian and the Chartalist approach suggests inflation. But how much? Scissors cut paper! Out come the shredders, figuratively, to cut up the paper. Inflation to counter deflation? Or runaway inflation? What other ideas are worth looking at? Maybe it is as simple as re-regulation — as if that were simple — but I doubt it.

If the "scissor act" is too flagrant, as it may well be given the size of the debt we are dealing with, we will see a substantial loss of faith in US currency. Such could trigger wide-spread panic and subsequent worldwide Depression. At minimum we would see at least some countries try to mimic the US move, which might set a stage for hyperinflation. What China and the Arab states might do in response is an open question, particularly if we repudiate the debt outright apply Mosler's Law as some Neo-Chartalists advocate.

The point of this little note is to suggest that in the wake of inflationary actions to deal with the debt bubble, we will likely see — already are seeing, e.g."We are All Austrians Now" — calls for a return to what might be called 21^st century gold standard. If that were to become a political necessity, we will have come full circle: Rock crushes scissors!

I hope that we can stay with fiat currency and find means to deal with the mess at hand. But I am outclassed by most of the economists and finance experts I follow. So I watch and read, and occasionally comment. The "mess" is once-again center stage as the PIIGS threaten default. And California and other messes closer to home will prove interesting to watch as this year unfolds. This is a Wicked Problem of global proportions. But that is a story for another day.

Why I Still Believe in Team Obama

For quite some time I have been giving Ben Bernanke and Tim Geithner passes, every bit as much as I did not give passes to Alan Greenspan. I believe that Team Obama—Larry Summers, Christina Romer, Ben Bernanke, Tim Geithner—see the error of their past ways, AND are savvy enough to guide us, in concert with others, however painfully into the next era of regulated finance.

I am not yet ready to declare capitalism dead. Still, I am very glad to see the gleeful "free market screech-monkey" chatter quieted.

But I just watch this stuff. I'm no expert. I glean advice and seek wisdom from post-Keynesian and other economists, from financial historians, and from those who dabble in complex system theory. I am first to recognize that what I hope to be true will likely not be—In this case trusting my (and your) fate to Team Obama.

If Paul Krugman is right, then I'm wrong to trust in Team Obama. If Jamie Galbraith is right, then I will be most certainly proven wrong if only for this reason:

…The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. There is no chance that the banks will simply resume normal long-term lending. To whom would they lend? For what? Against what collateral? And if banks are recapitalized without changing their management, why should we expect them to change the behavior that caused the insolvency in the first place?

End Note on Free Market Fundamentalism: While looking for a good source on Free Market Fundamentalism, I found this note (5/23/2007) I dropped into Yves Smith's naked capitalism:

[W]e Americans have gravitated to a faith-based society/culture. And a big part of that "faith" transfers directly from religious fundamentalism to free-market fundamentalism (Wiki link): Government sucks, markets do it best/right.

If that thesis is correct, then American politicians (whether pandering to the religious right or themselves "true believers" in free-market fundamentalism) tend to shy away from redistributive policies/practices.

What will shake the faith, I don't know. I've been a believer for quite some time that we've got a hell of a problem here in the US with theological Millennium fever. Free-market fundamentalism is symptomatic of the bigger problem.

See also Market Fundamentalism v. Sustainable Development and my Economic Fundamentalism: Too Many False Prophets.

{Update, 3/24/07}: Better Still, read Steve Keen's recent Neoclassical Economics: Mad, Bad, and Dangerous to Know

None Dare Call it Fascism: Moyers and Galbraith

Last Friday, Bill Moyers sat down with Jamie Galbraith to talk about The Predator State and our current mess relative to 1929-. Galbraith says that like 1929-,

The situation today is very similar to the moment of panic and collapse that we saw in 1929. And for very similar reasons. An abandonment of the supervisory responsibility that should have been applied to keep the speculation and the fraud and the abuse from getting out of control. So there's going to be a major period of correction. And dad, [John Kenneth Galbraith, The Great Crash 1929 writing] in 1955, talks about how memory fades and how eventually, although so long as people remembered '29 it wouldn't be repeated, eventually it would be forgotten and the underlying speculative impulse would come back.

Galbraith differs from many who blame our current mess on"the deficit", on the US Government living beyond its means:

BILL MOYERS: But even Barack Obama's website calls the deficit America's "Domestic Enemy." Even he's aware of the fact that the deficit's beyond sight.

JAMES GALBRAITH: Well, the deficit isn't beyond sight. The deficits in the Bush administration in relation to the size of the economy were never all that large. They were certainly larger than they were under Clinton, but that was in part necessary because of the changed economic situation, the collapse of the dot-com bubble in 2000.

The United States government's credit is good. The deficit is a financial number that people are going to have to get used to because there is no way in these circumstances of avoiding an increase in the deficit. One of two things can happen. The government can take action and help stabilize the economy in which case we will have more spending but also more employment.

Or the government cannot take action and let the economy collapse in which case we will have much less tax revenue. The deficit is going to be larger either way. There is no way of avoiding that. The only question is do you work to have a good economy or do you accept a terrible economy?

BILL MOYERS: What are the negative effects of a soaring deficit?

JAMES GALBRAITH: Well, the one thing I would have worried about is that we might not find lenders who are willing to provide funds to the U.S. government, that the Chinese or the Japanese might decide that they would rather be in some other currency and that we'd then have trouble with inflation. But that's not going to happen. It's not going to happen because, as it turns out, the major alternative, the euro, simply isn't viable as a reserve asset for the rest of the world. It's the dollar or nothing. So the United States basically can finance itself to the extent necessary to deal with this crisis. And I'm right now quite sanguine about that, quite confident that we won't face a problem.

At the end of the interview, Moyers gets to Galbraith's new book, The Predator State, and how some like Steve Forbes are already beginning to blame the mess on reformers like Galbraith. Here's a snip

BILL MOYERS: [T]here are capitalists like Steve Forbes, … of "Forbes Magazine," who argue that people like you are going to go too far and that it was actually the government's excesses and failures in the '80s and '90s that contributed to what began to happen in 2007 with the meltdown. And that if you have your way, people like you have your way, you will criminalize business. You will raise taxes and dry up the economy. You will take government unchecked into the same kind of catastrophe that unchecked Wall Street has carried us. How do you answer a Steve Forbes?

JAMES GALBRAITH: Well, first of all, I very much agree with him, that it was failures of government that were responsible for this. It was the actual failure, the abandonment, the neglect of the supervisory regulatory responsibility. That's at the root of this.

Just as you cannot prosper without a private economy, you cannot prosper without an effective autonomous government capable of thinking for itself, capable of balancing things out, of standing for other interests, of standing for labor and consumers and for the public interest as a whole. If you don't have that, you're going to get these pyramids, these bubbles, these epidemics of fraud and abuse, and ultimately the collapse of trust and the collapse of the economy itself. That's what's happened in the predator state.

I agree with Galbraith on much, including the fact that both private (e.g. so-called "rating agencies") and public regulators (e.g. government agencies, the US Congress, and US Adminsitrations dating back to Ronald Reagan) were asleep at the wheel. I hope Galbraith is right about the US dollar's non-endangered "reserve currency" status for the near term. I also hope he and other reformers are able in the next few years to restructure the world's financial systems to set a stage for thoughtful investment rather than unbridled speculative excess.

Note: My title might better have been written "None Dare Call it Corporatism." Here is a Wikipedia link to Corporatism. See also Wikipedia on The Economics of Fascism.

Chris Dillow: Taleb vs Economists

Over at Stumbling and Mumbling Chris Dillow asks important questions: "Were banks risk managers really that bad? Are bosses an order of magnitude stupider than even I had thought? Or is something else happening?" The answers seem to be, some risk managers likely were "really that bad" others were just playing the game, knowing that when the music stopped they hopefully will have a sack of cash piled up that will tide them over until they can find another game. Same true for managers. Same true, by the way, for politicians and government agency heads and subordinate bureaucrats. What else is happening? Part of this mess is brought about by herd effects, people being squeezed, or believing they are, then selling out of (earlier "buying in to") hedge funds, 401Ks, IRAs, etc thus forcing fund managers to do what they wouldn't do in normal times. Beyond that, you tell me. To Dillow:

Taleb vs Economists, Chris Dillow, Oct 14: Everyone seems to be hailing Nassim Nicholas Taleb as the man who saw the crisis coming. I have a problem with this. It's not that what Taleb says about risk is wrong. Quite the opposite. It just strikes me as trivially true.

We've known for ages that returns are non-Gaussian, that extreme events are more common than a normal distribution predicts, and that risk can't be quantified simply, if at all. The Black Swan, then, was just an entertaining if a little egocentric way of telling us what we already knew.

So, when I read in it (p43) that bankers "are not conservative at all; just phenomenally skilled at self-deception by burying the possibility of a large, devastating, loss under the rug" I thought: "But surely they've learnt from statistics and experience by now. Their risk management can't be as terrible as Taleb claims. I know bosses are stupid, but they can't be this gibberingly, imbecilically, carpet-chewingly, moronically cretinous, can they?" I suspect most economists thought my way.

It looks like we were wrong and Taleb right.

But this isn't because Taleb had any great insights into the nature of risk. It's because he thought banks' risk managers were idiots, whilst economists didn't think so - not even me.

In doing this, however, we were just following economists' standard procedure - of assuming that agents were if not rational then at least not wholly stupid.

For me, all this is very troubling.  It suggests that what we economists have to learn from Taleb has nothing to do with the nature of risk – we've all known that - but about others' rationality. We should ditch the assumption - which in a sense is mere courtesy - not only that others are rational but even the weaker assumption that they are nearly so. Perhaps we should indeed regard them merely as "empty suits."
But this is a vastly greater departure from standard practice than anything Taleb has suggested about the nature of risk.

All of which leaves me genuinely puzzled. Were banks risk managers really that bad? Are bosses an order of magnitude stupider than even I had thought? Or is something else happening? Help me.

More on Taleb: Taleb Outsells Greenspan as Black Swan Gives Worst Turbulence, Bloomberg, Stephanie Baker-Said, March 27

Speculative Orgy Gone Bust: Bogle and Noland

This morning on NPR, John Bogle, founder of The Vanguard Group, said that we have a "Speculative orgy like nothing we've ever seen before in the history of the United States. … We've become a market dominated by speculators not by investors.

"I don't know if [the bailout] can succeed. I mean Goldman Sachs collecting deposits from investors, putting an ATM on every corner. I can't imagine it. … I worry about mixing banking — commercial banking — and investment banking, just like they worried about when they put in the Glass Steagall Act back in1933 or 1934."

Meanwhile, Prudent Bear's Doug Noland weighs in, particularly on the over-leveraged nature or our system:

The Wall Street Bust, 10/02: … It is today impossible to comprehend the full ramifications from The Bust in Wall Street Finance. Yet we can be rather certain that for the foreseeable future much less Credit and liquidity will be directed to the asset markets. And, at the same time, there will be significantly less Credit Availability for riskier loans of all varieties — for the household, business, financial and the government sectors. Few appreciate that these dynamics are extremely problematic for the U.S. Bubble Economy — an economic system that had come to a large extent to be governed by asset-based and high-risk lending. These dynamics are at the heart of today's Acute Financial and Economic Fragility and the resulting imploding markets.

The leveraged speculating community played such an integral role in the overall Credit Bubble and, more specifically, to the Bubble in Wall Street Finance. They were instrumental in both spurring financial sector Credit creation/leveraging, while directing this Flood of Finance to the asset markets. And the more the leverage and the greater the Flow to inflating markets, the higher the returns generated by this expanding pool of speculative finance. And the greater the returns, the more robust the "investment" flows into the hedge fund community — spurring more leverage and more potent fuel for additional self-reinforcing asset inflation. Well, this historic speculative Bubble is now in the process of blowing up. One of the greatest manias ever — surely The World's Greatest Episode of "Ponzi Finance" — is absolutely coming apart. And the wreckage is accumulating in all markets — everywhere.


Here at home, our maladjusted economic system will only be sustained by somewhere in the neighborhood of $2.0 TN of new Credit. It's simply not going to happen. The $700bn from Washington would seem like an enormous amount of support. In reality, it's nowhere even close to the amount necessary for systemic stabilization. To the $2.0 TN or so of new Credit required this year (and next) add perhaps as much as several Trillion more necessary to accommodate speculative de-leveraging (liquidations forced by huge losses). Importantly, the Bust in Wall Street Finance has ensured that insufficient liquidity will be forthcoming to maintain inflated asset prices and sustain the Bubble economy — creating catastrophe for the leveraged speculating community.

The "Freidmanites" thought they understood the (post-crash) policy mistakes that led to The Great Depression. They believed the "Roaring Twenties" was the "Golden Age of Capitalism." The great bust could have been avoided with a simple ($5bn or so) banking system recapitalization. As we are witnessing today, the issue is not some manageable amount of new "capital" to replenish banking system losses. Instead, the predicament is the massive and unmanageable amount of new Credit necessary to, on the one hand, sustain a mal-adjusted Bubble Economy and, on the other, the Trillions more required to accommodate a gigantic speculative de-leveraging. I have a very difficult time seeing a way out of this terrible mess.

I too have a difficult time seeing a way forward. It looks like we will have to do what Sweden did, but on a far larger scale — nationalize our financial system for a time — that either will bring hedge funds under the regulatory umbrella along with commercial banks, kill hedge funds outright, else ensure that hedge funds individually or collectively can't themselves be the next too-big-to-fail excuse for yet another government bailout. And let's hope that we get rid of the idea of Government Sponsored Enterprises (GSEs) and either keep Fannie Mae and Freddie Mac as government entities, else (not my preference) privatize them.

Minsky on 'Flawed Capitalism', 'Flawed Economics'

I am a fan of Hyman Minsky's work, but have not read — until now — any of his books. I am currently reading Stabilizing an Unstable Economy. Here is a timely quote, from Chapter 12, "Introduction to Policy", emphasizing our current plight both as to our political economy and misguided economic ideology/methodology. It could have been written yesterday but was first published in 1986:

… We need to embark on a program os serious change even as we need to be aware that a once-and-for-all resolution of the flaws in capitalism cannot be achieved. Even if a program of reform is successful, the success will be transitory. Innovations, particularly in finance, assure that problems of instability will continue to crop up; the result will be equivalent but not identical bouts of instability to those that are so eviedent in history.

Political leaders and the economists who advise them are to blame for promising more than they or the economy can deliver. The established advisers have failed to make the political leadership and the public aware of the limitations that economics processes and the the ability to administer impose on what policy can achieve. … [O]ur economic leadership does not seem to be aware that the normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciations, unemployment, and poverty in the midst of what could be virtually universal affluence—in short, that financially complex capitalism is inherently flawed.

Economic advisors, whether liberal or conservative, believe in the fundamental "soundness" of the economy. Finding fault with one thing or another, they may advocate policies such as changing Federal Reserve operating techniques, tax reforms, national health insurance, and wars on poverty, but all in all they are satisfied with the basic institutions of modern capitalism. According to today's gospel [extant faults] are due to secondary, not to fundamental, characteristics.

[T]he economists of the policy-advising establishment differ about details: some propose to fine-tune the economy by fiscal tinkering, others want to achieve a natural rate of employment through steady monetary growth. Neither, however, sees anything basically wrong with capitalism as such. The credit crunch of 1966, the liquidity squeeze of 1970, the banking crises of 1974-75, the inflationary spiral of 1979-80 and the distress, national and international, of 1981-82 are, in their view, aberrations, due to either "shocks" or "errors." Since nothing is basically wrong, they also hold that incisive corrective measures are not needed.

The truth of the matter is that something is fundamentally wrong with our economy. As we have shown, a capitalist economy is inherently flawed because its investment and financing processes introduce endogenous destabilizing forces. The markets of a capitalist economy are not well suited to accommodate specialized, long-lived, expensive capital assets. In fact, the underlying economic theory of the policy establishment does not allow for capital assets and financial relations such as exist. The activities of Wall Street and the inputs of bankers to production and investment are not integrated into, but are added onto, the basic allocation-oriented theory.

Economic policy discussions in recent years have centered on how much more (or less) on the one—fiscal policy—and how much less (or more) of the other—monetary policy—is necessary for economic stability and growth. If we are to do better in the future, we must launch a serious debate that looks beyond the level and the techniques of fiscal and monetary policy. Such a debate will acknowledge the instability of our economy and inquire whether this inherent instability is amplified or attenuated by our system of institutions and policy interventions. ….

Today's economic crisis is as profound … as that of the 1930s. … There is no consensus as to what we should do. Conservatives call for freeing up the markets even as their corporate clients lobby for legislation [to] institutionalize and legitimize their market power…. [C]orporate America pays lip service to Adam Smith, while striving to sustain and legitimize the very thing that Smith abhorred—state-mandated market power.

Liberals, instead of articulating and incisive critique of our capitalism as such and pioneering innovative experimentation and change, are wedded to the past. They support minimum-wage increases without questioning whether these laws have served any real purpose since the Great Depression, when reflation was the policy objective. Liberals are unwilling to face up to the shortcomings of policies inherited from the past and are, fundamentally, timid about setting forth in new directions.

As a consequence, instead of analysis and ideas, we get slogans: free markets, economic growth, national planning, supply-side, industrial policy—imprecise phrases that face up to neither the what nor the how of policy objectives. The various programs for change are based on misconceptions of both the strengths and the weaknesses of market processes. One of the reasons for the intellectual poverty of policy proposals is that they continue to be based on ideas drawn from neoclassical theory. Although economic theory is relevant to policy (without an understanding of how our economy works we cannot find cures), for an economic theory to be relevant what happens in the world must be a possible even in the theory. On that score alone, standard economic theory is a failure; the instability so evident in our system cannot happen if the core of standard theory is to be believed.

Today's economic policy is a patchwork. Every change designed to correct some shortcoming has side effects that adversely affect some other aspect of economic and social life. Every ad hoc intervention breeds further intervention. If we wish to improve upon what we now have, we must embark upon an age of institutional and structural reforms that will check the tendencies toward instability and inflation. Standard theory, however, offers us no guidance on that score; for the problems are outside the domain of relevance of the theory. A new era of reform cannot be simply a series of piecemeal changes. Rather, a thorough, integrated approach to our economics problems must be developed; policy must range over the entire economic landscape and fit the pieces together in a consistent, workable way: Piecemeal approaches and patchwork changes will only make a bad situation worse.

Poverty in the midst of plenty and joyless affluence are but symptoms of a profound disorder [Tibor Scitovsky, The Joyless Economy (New York: Oxford University Press, 1976)]. As we have pointed out, persistent financial and economic instability is normal in our capitalist economy. The commitment to growth through private investment—combined with government transfer payments and exploding defense spending—amplifies financial instability and chronic inflation. Indeed, our problems are in part the result of how we have chosen, inadvertently and in ignorance of the consequences, to run the economy. An alternative policy strategy is needed now. We have to go back to square one — 1933 — and build a structure of policy that is based upon a modem [modern?] understanding of how our type of economy generates financial fragility, unemployment, and inflation. [pp. 319-23]

Note: whereas in Minsky's day inflation tended to be more self-grown, today's inflation tends to wander the globe accompanying unfettered capital mobility. Note further that Minsky was careful to introduce his policy 'remedies' with this caution: "Even as I warn against the handwaving that passes for much policy prescription I must warn the reader that I feel much more comfortable with my diagnosis of what ails our economy and analysis of the causes of our discontents than I do with the remedies I propose."

James Galbraith on the 'Collapse of Monetarism'

Hyman Minsky, John Kenneth Galbraith and John Maynard Keynes take center stage as James Galbraith throws down the gauntlet to contemporary mainstream economists. Speaking at the 25th Annual Milton Friedman Distinguished Lecture at Marietta College, Marietta, Ohio, Jamie Galbraith asks Fed Chair Ben Bernanke and a host of others to embrace the " intellectual victory of John Maynard Keynes, of John Kenneth Galbraith, of Hyman Minsky." — else to explain "why not". We will search and update on any "why nots" if and when they surface. To Galbraith:

The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus [PDF], by James K. Galbraith, March 31, 2008 : … I come to bury Milton [Friedman], not to praise him. But I would like to do so on the terrain that he favored, where he was strong, and over which he ruled for many decades. This is monetary policy, monetarism, the natural rate of unemployment and the priority of fighting inflation over fighting unemployment. It is here that Friedman had his largest practical impact and also his greatest intellectual success. It was on this battleground that he beat out the entire Keynesian establishment of the 1960s, stuck as they were on a stable Phillips Curve. It was here that he set the stage for the counter-revolution that has dominated academic macroeconomics for a generation, and that – far more important — also dominated and continues to influence the way in which most people think about monetary policy and the fight against inflation.

What was monetarism? Friedman famously defined it as the proposition that "inflation is everywhere and always a monetary phenomenon." This meant that money and prices were tied together. But more than that, Friedman believed that money was a policy variable — a quantity that the Central Bank could create or destroy at will. Create too much, there would be inflation. Create too little, and the economy might collapse. There followed from this that the right amount would generate the right result: stable prices at what Friedman came to call the natural rate of unemployment.

The intent and effect of this line of reasoning was to defend a core proposition about capitalism: that free and unfettered markets are intrinsically stable. In Friedman's gospels government is the lone serpent in Eden, while the task of policy is to stay out of the way. Just as this was the vulgar lesson of "Free to Choose" so it turns out it was also the deep lesson of the larger structure of Friedman's thought. Friedman and Schwartz's Monetary History for all its facts and statistics carried a simple message: the market did not fail; the government did.

Friedman succeeded because his work was complex enough to lend an aspect of scientific achievement to his ideas, and because the ideas played to the preconceptions of a particular circle. As Keynes wrote of Ricardo:"The completeness of [his] victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely…to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority."

Friedman's success was similar to Ricardo's but not in all respects. Yes he also explained away injustice and supported authority. But the logical superstructure was not vast and consistent. Rather Friedman's argument was maddeningly simple, yet slippery. He would appeal to short run for some effects and to the long run for others, shifting between them as it suited him. … His money growth rules promised stable employment without inflation. Their promise was not austere, but happy. Ricardo was Scrooge. Friedman was more like the Pied Piper.

Naomi Klein on: 'Shock Doctrine' and Greenspan

{Updated 9/30}

Naomi Kleins' book, The Shock Doctrine: The Rise of Disaster Capitalism is nothing if not controversial. So is Klein. Commentary surrounding Klein's book is raising important questions as to what effect activist economists have on politics. Those familiar with Robert Heilbroner's works, e.g. The Worldly Philosophers, Behind the Veil of Economics already know well what impact the most well-known and powerful economists have on politics.

In The Shock Doctrine Klein takes on Milton Friedman and "the Chicago boys", blaming them for planting the seeds of so-called free-market capitalism in the minds of disciples, paving the way for alleged "crony capitalism" that followed. William Grieder's appraisal of Friedman is also damning. So is Joseph Stiglitz's, in his "Bleakonomics" review of Klein's The Shock Doctrine. Here's Alexander Cockburn's review , which views Friedman in a slightly less evil light. Yesterday, Klein took on Alan Greenspan:

Greenspan and the Myth of the True Believer, Naomi Klein, The Nation,Sept. 27: … Since I began touring with my book The Shock Doctrine, I have had a number of exchanges like this, revolving around the same basic question: When hard-right political leaders and their advisers apply brutal economic shock therapy, do they honestly believe the trickle-down effects will build equitable societies--or are they just deliberately creating the conditions for yet another corporate feeding frenzy? Put bluntly, Has the world been transformed over the past three decades by lofty ideology or by lowly greed?

A definitive answer would require reading the minds of men like Dick Cheney and Paul Bremer, so I tend to dodge. The ideology in question holds that self-interest is the engine that drives society to its greatest heights. Isn't pursuing their own self-interest (and that of their campaign donors) compatible with that philosophy? That's the beauty: They don't have to choose. Unfortunately, this rarely satisfies graduate students looking for deeper meaning. Thankfully I now have a new escape hatch: quoting Alan Greenspan.

His autobiography, The Age of Turbulence, has been marketed as a mystery solved: The man who bit his tongue for eighteen years as head of the Federal Reserve was finally going to tell the world what he really believed. And Greenspan has delivered, using his book and the surrounding publicity as a platform for his "libertarian Republican" ideology, chiding George W. Bush for abandoning the crusade for small government and revealing that he became a policy-maker because he thought he could advance his radical ideology more effectively "as an insider, rather than as a critical pamphleteer" on the margins. Yet what is most interesting about Greenspan's story is what it reveals about the ambiguous role of ideas in the free-market crusade. Given that Greenspan is perhaps the world's most powerful living free-market ideologue, it is significant that his commitment to ideology seems rather thin and perfunctory--less zealous belief, more convenient cover story.

Much of the debate around Greenspan's legacy has revolved around the matter of hypocrisy, of a man preaching laissez-faire who repeatedly intervened in the market to save the wealthiest players. The economy that is Greenspan's legacy hardly fits the definition of a libertarian market but looks very much like another phenomenon described in his book: "When a government's leaders routinely seek out private-sector individuals or businesses and, in exchange for political support, bestow favors on them, the society is said to be in the grip of 'crony capitalism.'" He was talking about Indonesia under Suharto, but my mind went straight to Iraq under Halliburton. Greenspan is currently warning the world about a dangerous looming backlash against capitalism. Apparently, this has nothing at all to do with the policies of negligent deregulation that were his trademark. Nothing to do with stagnant wages due to free trade and weakened unions, nor with pensions lost to Enron or the dot-com crash, or homes seized in the subprime mortgage crisis. According to Greenspan, rampant inequality is caused by lousy high schools (which also has nothing to do with his ideology's war on the public sphere). I debated Greenspan on Democracy Now! recently and was stunned that this man who preaches the doctrine of personal responsibility refuses to take any at all.

Yet ideological contradictions are only relevant if Greenspan really is a true believer. I'm not convinced. Greenspan writes that as a student he had no interest in big ideas. Unlike his classmates who were in the thrall of Keynesianism with its promise of building a better world, Greenspan was simply good at math. He started doing research for powerful corporations; it was profitable, but Greenspan made no claims to a higher social contribution.

Then he discovered Ayn Rand. "What she did…was to make me think why capitalism is not only efficient and practical, but also moral," he said in 1974.

Rand's ideas about the "utopia of greed" allowed Greenspan to keep doing what he was doing but infused his corporate service with a powerful new sense of mission: Making money wasn't just good for him; it was good for society as a whole. Of course, the flip side of this is the cruel disregard for those left behind. "Undeviating purpose and rationality achieve joy and fulfillment," Greenspan wrote as a zealous new convert. "Parasites who persistently avoid either purpose or reason perish as they should." Was it this mindset that served him well as he supported shock therapy in Russia (72 million impoverished) and in East Asia after the 1997 economic crisis (24 million pushed into unemployment)?

Rand has played this role of greed-enabler for countless disciples. According to the New York Times, Atlas Shrugged, her novel that ends with the hero tracing a dollar sign in the air like a benediction, stands as "one of the most influential business books ever written." Since Rand is simply pulped-up Adam Smith, her influence on men like Greenspan suggests an interesting possibility. Perhaps the true purpose of the entire literature of trickle-down theory is to liberate entrepreneurs to pursue their narrowest advantage while claiming global altruistic motives--not so much an economic philosophy as an elaborate, retroactive rationale.

What Greenspan teaches us is that trickle-down isn't really an ideology after all. It's more like the friend we call after some embarrassing excess so that they will tell us, "Don't beat yourself up: You deserve it."

For more Shock Doctrine (and commentary) see:

The Guardian, Shock Doctrine minisite

Joseph Stiglitz's NY Times review, "Bleakonomics",Sept 30:

… Some readers may see Klein's findings as evidence of a giant conspiracy, a conclusion she explicitly disavows. It’s not the conspiracies that wreck the world but the series of wrong turns, failed policies, and little and big unfairnesses that add up. Still, those decisions are guided by larger mind-sets. Market fundamentalists never really appreciated the institutions required to make an economy function well, let alone the broader social fabric that civilizations require to prosper and flourish. Klein ends on a hopeful note, describing nongovernmental organizations and activists around the world who are trying to make a difference. After 500 pages of "The Shock Doctrine," it's clear they have their work cut out for them.