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.]

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

Obama's Big Gambles

Last week's financial news was once-again grim. The Dow sits at 12-year lows, having fallen nearly 2500 points since the beginning of the year. Worse, the index has fallen over 50% in one year, making its worst performance since the Great Depression. Obama and Co. are just beginning the biggest Keynesian stimulus ever seen, that many believe will ultimately run in the three to five trillion dollar range. One BIG gamble! Another gamble will be to see if this and subsequent Administrations and the US Congress can then claw back enough money — new taxes — to cover the near-term push.

Two other gambles are in play. First, US President Barack Obama seeks to do what has proven impossible for many other Administrations: to reform the US health care system, and simultaneously to reform and green-up US energy policy. Second, Obama seeks to end Bush's Iraq war, which Tomas Ricks believes history will record as "the biggest mistake in the history of American foreign policy". Obama also seeks to do something positive relative to the rest of the Middle East, especially focused on Afghanistan and Pakistan. We will leave the latter two gambles for later posts and will today focus on the stimulus gamble. Some stage-setting:

Borrow and Spend

Not many years ago Republicans railed against a Democrat-dominated US Congress for what they believed to be highly wasteful and dangerous Tax and Spend Liberalism. That day is gone. Now we fear Borrow and Spend tactics from both sides of the political aisle. This borrow and spend era began in earnest with Ronald Reagan. It was revisited, mimicked really, with George W. Bush's three trillion adventure into Iraq (See, e.g. Stiglitz and Bilmes, Washington Post, Mar 9, 2008) and the beginning salvos of a bailout in the wake of our recent financial meltdown. (For more see Wikipedia, Public Debt).

Now Barrack Obama intends to lead us further down the Borrow and Spend road into a massive Keynesian Fiscal Stimulus that could cost up to to 5 trillion dollars. (Wikipedia, Keynesian Economics).

The end of capitalism or just the end of Laissez-faire capitalism?

The Obama Administration claims they are doing only what is needed. Maybe. I don't know. My biggest fear is that no matter what "stimulus" is thrown at the problem, we simply can't create enough high paying jobs fast enough to innovate our way out of this crisis. When you listen to pundits telling us how we are going to grow our way out of this crisis — more jobs, more wealth — remember what is happening around us with computerized robotics and networked information systems. And the threat isn't just "manufacturing", but "professional practices" in medicine, law, accounting, and so on. Remember too, that the latest-greatest fad, new jobs in financial engineering just failed too.

The winds of Joseph Schumpeter's creative destruction (Wiki link) might this time blow away capitalism as we've known it. You tell me where the jobs are going to come from. I know that prediction is always flawed, and that historically we've "creatively" come up with jobs whenever our capitalist systems were threatened. But I keep hearing echoes from all the great economists, fearing an end to capitalism. Is it near? In any case I just can't see what these new jobs are going to be shaped from. Likely I'm just being short-sighted and frightened. Amidst it all, the Republican right howls about Obama and socialism (put those two word into Google and see what pops up).

If indeed the end of capitalism is not near then I side with the majority of economists that this rediscovered Keynesian is the way forward. If capitalism is indeed dead, we will have given a gift to the banking community that is largely resposible for getting us once again into this mess. And, maybe set a stage for hyperinflation. Scary thought! In either case, I remain angry about the fact that we really didn't have to get into this mess again. The lessons from the 1920s and 1930s should have kept us from allowing the massive bubbles to form this time around. But prevailing Friedmanite economic ideology (Wiki Link) that has only recently been debunked — for how long? — pretty much silenced dissenting voices and reasoning that might have prevented all. That is, prevented politicians, CEOs, brokers, "quants", lenders, borrowers, from drinking the Kool Aid this time around. Serious students of Keynes know that not only do you have to stimulate big economies sometimes, but you also have to "stabilize" by cooling over-heated economies. On that front, we all need to read more Minsky as Financial Times' Martin Wolf recently noted.

This transition, no matter where it takes us will be difficult and many people are going to be hurt, distressed, disgusted, and so on. Doug Noland says

… Today's Post-Bubble Facts of Life [Feb 12] create a serious policymaking dilemma. Unimaginable wealth was shifted to "Wall Street" and their client base during the boom, while millions of regular folk were saddled with unmanageable debt and, now, negative net worth. Those on the right side of the inflationary boom accumulated historic wealth, while millions on the wrong side destroyed their financial health. The runaway boom inflated expectations — and now comes the depressing phase of disappointment and growing despair. Of course the populace is ticked off, spurring politicians to vilify and seek amends and wealth redistribution. In this regard, there are no surprises today to those of us that have studied the post-1929 landscape. …

At minimum, historians are going to have a field day with this moment. For the rest of us, we have to hope that somehow we can find a reasonable path forward.

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."

Gas Prices Not 'Outrageous'

On mainstream news this morning I heard our Utah Governor declare US gas prices "outrageous". Memorial Day national news coverage labeled them "sky high." Wrong! Gas prices only seem outrageous to we Americans who George W. Bush correctly noted are "addicted to oil".

Europeans, by contrast, have lived with high gas prices for years, using proceeds to fund social programs, re-build infrastructure, etc. In addition, as noted in a May 21 Senate-side Congressional hearing Exploring the Skyrocketing Price of Oil (3 hrs), Europeans used gas tax differentials to correctly steer transportation systems toward diesel and away from gasoline, which proves ever-more important now that clean diesel is available. And to steer transportation system toward mass transit and away from single-vehicle transportation. Meanwhile we Americans sat around watching TV and partying until world market forces pushed prices upward, allowing most of the recent 'surplus' to be captured as record profits, record CEO compensation, etc. by what I'll call the Petrochemical Industrial Complex. Finally, Europeans are now beginning to look toward a future free of dependence on petrochemicals and their commingled carbon-loading propensities.

Even though we Americans are just now beginning to face the reality of high gas prices, the prices themselves are not the problem. In fact "sky high" prices are finally getting us to pay attention, however feebly, to alternative sources of energy that are compatible with global climate systems and human survival. As noted in the Congressional hearing, planet Earth is not in jeopardy, rather it is we humans (along with myriad other species) who are at risk. The Earth has worked its way through five Great Extinctions in the past and arguable done remarkably well. But it is in no way clear that we humans will survive the Sixth Great Extinction. Tragically, we humans may be contributing to our collective demise by clamoring for lower gas prices.

This is not to say that all is well in petrochemical industrial complex, medical industrial complex, financial industrial complex, military industrial complex America. But that is a story for another post (or several hundred posts). In the meantime 3 hours are well-spent viewing the hearing. If you want a sneak peak, go to 2:15 in the videocast and watch Senator Charles Schumer (D-NY) in action, followed by others as the hearing winds up.

Note: cross posted at Ecological Economics

Soros: Financial Crisis Stems from Super Bubble

Like me, George Soros is no believer in "equilibrium economics". Rather he believes that sometimes we will see an equilibrium, but that it will be short-lived. Like Hyman Minsky, Soros argues that stability will itself sow the seeds of the next instability. Soros says we are in a unique place with our current crisis, experiencing both inflation and a recession at the same time. Hear/read more from Soros on today's NPR Morning Edition, Financial Crisis Stems from Super Bubble:

… Soros blames what he calls a "super-bubble" that started about 25 years ago. That's when a less-is-more philosophy became popular with economic regulators. That allowed Wall Street to invest increasing amounts of money in credit.

"The idea was that regulators always make mistakes, state interference in the markets just messes things up," Soros says. "And that was a false idea .... Regulators are human and bound to make mistakes, but markets are also human and they are also bound to make mistakes. Instead of markets always being right, they're actually always groping at trying to find out what the facts are. But they never get it right." …

Soros says there's a "super-bubble" in the economy that's bigger than just the recent housing crises, and he blames exotic financial instruments for helping cause it.

"The markets have introduced financial instruments with fancy names — CDOs and CLOs and all these strange instruments that are traded in very large volumes. And they were all constructed on the belief deviations are random.

Soros also has a new book out. Here is a snip from the introducion:

A New Paradigm for Financial Markets, Introduction, George Soros: We are in the midst of the worst financial crisis since the 1930s. In some ways it resembles other crises that have occurred in the last twenty-five years, but there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process; the current crisis is the culmination of a super-boom that has lasted for more than twenty-five years.

To understand what is going on we need a new paradigm. The currently prevailing paradigm, namely that financial markets tend towards equilibrium, is both false and misleading; our current troubles can be largely attributed to the fact that the international financial system has been developed on the basis of that paradigm.

The new paradigm I am proposing is not confined to the financial markets. It deals with the relationship between thinking and reality, and it claims that misconceptions and misinterpretations play a major role in shaping the course of history. …

Let me explain briefly how the theory of reflexivity applies to the [current] crisis. Contrary to classical economic theory, which assumes perfect knowledge, neither market participants nor the monetary and fiscal authorities can base their decisions purely on knowledge. Their misjudgments and misconceptions affect market prices, and, more importantly, market prices affect the so-called fundamentals that they are supposed to reflect. Market prices do not deviate from a theoretical equilibrium in a random manner, as the current paradigm holds. Participants' and regulators' views never correspond to the actual state of affairs; that is to say, markets never reach the equilibrium postulated by economic theory. There is a two-way reflexive connection between perception and reality which can give rise to initially self-reinforcing but eventually self-defeating boom-bust processes, or bubbles. Every bubble consists of a trend and a misconception that interact in a reflexive manner. There has been a bubble in the U.S. housing market, but the current crisis is not merely the bursting of the housing bubble. It is bigger than the periodic financial crises we have experienced in our lifetime. All those crises are part of what I call a super-bubble—a long-term reflexive process which has evolved over the last twenty-five years or so. It consists of a prevailing trend, credit expansion, and a prevailing misconception, market fundamentalism (aka laissez-faire in the nineteenth century), which holds that markets should be given free rein. The previous crises served as successful tests which reinforced the prevailing trend and the prevailing misconception. The current crisis constitutes the turning point when both the trend and the misconception have become unsustainable. …

Martin Feldstein: 'Severe Recession' Dead Ahead

US Faces Severe Recession, Yahoo News, March 14: The United States is in a recession that could be "substantially more severe" than recent ones, National Bureau of Economic Research President Martin Feldstein said on Friday.

"The situation is very bad, the situation is getting worse, and the risks are that it could get very bad," Feldstein said in a speech at the Futures Industry Association meeting in Boca Raton, Florida.

"There's no doubt that this year and next year are going to be very difficult years." …

Don't Trust 'The Press'

Dean Baker tells us that we ought not trust the media. In this case it's because they seem to have bought into the 'economy is sound' story for too long, missing the housing and stock bubbles and instead cheering on the ongoing American-led consumption party. On that latter note, Robert Reich tells us that the party is over—the American consumer is tapped out. Worse, the power brokers (including the media) don't yet see it:

The US economy, Pravda style, Dean Baker, The Guardian, Jan 28: … Just as the Soviet press [in the bad old 'cold war' days] wanted the public to trust the wisdom of the party bosses, … pillars of the [American] elite media want the public to believe that the experts who are the insiders on the decision-making process in Washington are uniquely qualified to craft policy. …

Misunderstanding the economy's weakness earlier this month is trivial compared to the much more grandiose mistake of failing to recognize the $8 trillion housing bubble, or before that, a $10 trillion stock bubble. If performance mattered, then the experts who got things so hugely wrong would no longer be the ones shaping public policy. Instead, with the Washington Post style beautification process, experts can jump from policy disaster to policy disaster and never have their failures affect their standing.

If we are ever to have an open debate on economics, or any other area of public policy, we will need media that honestly discuss policy failures and that hold those in charge accountable. In the current situation, the economic disaster facing the economy was entirely preventable, but the Federal Reserve and the rest of the inside crew were either too incompetent to recognize the housing bubble or felt the short-term benefits outweighed the costs that the country would inevitably face when the bubble burst. … [Most] major news outlets chose to hide any serious debate on the problems posed by the bubble on the way up, and they would like to prevent any discussion of this massive policy failure even in retrospect.


The Real Recession Problem: Consumers Are at the End of Their Ropes, Robert Reich, Jan. 28: … [Business tax breaks exemplify] the illogic of what’s called supply-side economics. If you reduce the cost of investing, so the thinking goes, you’ll get more investment. What’s left out is the demand side of the equation. Without consumers who want to buy a product, there's no point in making it, regardless of how many tax breaks go into it.

Which gets us to the real problem. Most consumers are at the end of their ropes and can't buy more. Real incomes are no higher than they were in 2000, while food and energy and health care costs are all rising faster than inflation. And home values are dropping, which means an end to home equity loans and refinancing.

Most of what's being earned in America is going to the richest 5 percent, but the rich devote a smaller percent of their earnings to buying things than the rest of us because, after all, they’re rich — which means they already have most of what they want. Instead of buying, the rich invest most of their earnings wherever around the world they can get the highest return.

Add all this together and there's just not enough consumer demand out there to keep the American economy going. We're finally reaping the whirlwind of widening inequality and ever more concentrated wealth. Supply-siders who want to cut taxes on corporations and the rich just don’t get it. Neither does most of official Washington.

Politics of an Economic Nightmare

I have to pass along:

The Politics of an Economic Nightmare, Robert Reich, Jan. 22: A possible economic meltdown is worrisome enough, but a possible meltdown in an election year is downright frightening. For months now, Republicans have been pushing the White House to take some action that looked and sounded big enough to give them some cover if and when things got worse. President Bush has now responded with a stimulus package more than twice as large as the one Bill Clinton briefly entertained at the start of 1993 but couldn't get passed.

Not to be outdone, Democrats want to appear at least as bold, which means they'll suspend pay-go rules and throw fiscal responsibility out the window. In other words, hold your noses, because the "bipartisan" stimulus package that's about to be introduced could be a real stinker, including tax cuts for everyone and everything under the sun -- except, perhaps, for the key group of lower-income Americans. …

Meanwhile, Fed chairman Ben Bernanke and Co. have surprised everyone with a rate cut larger and sooner than expected. The three-quarters of a percentage point ("75 basis points" in biz-speak) cut announced Tuesday morning may not sound like much, but it's bigger than any rate cut in decades. The politics here are more subtle because Bernanke and his Federal Reserve governors are supposed to be independent of politics. … Expect lots and lots more Washington activity -- enough seemingly bold strokes to convince voters that our nation's capital is doing whatever is necessary to stop whatever seems to be going wrong with the economy.

The problem is, people have different views about what's going wrong. Wall Street sees it as a credit crisis -- a mess that seems never to reach bottom because nobody on Wall Street has any idea how many bad loans are out there. Therefore, nobody knows how big the losses are likely to be when the bottom is finally reached. And precisely because nobody knows, nobody wants to lend any more money. A rate cut won't change this. It's like offering a 10-pound lobster to someone so constipated he can't take in another mouthful.

Main Street sees it as a housing crisis. As I've noted, homes are the biggest assets Americans own -- their golden geese for retirement and their piggy banks for home equity loans and refinancing. But home prices have been dropping quickly. It's the first time this has happened in many decades -- beyond the memories of most Americans, which is why they never expected it to happen, why they bought houses so readily when credit was so easily available, and why so many people bought two or more of them, speculating and fixing up and then flipping. But now several million Americans may lose their homes, and tens of millions more have only their credit cards to live on and are reaching the outer limits of what they can spend. As consumer spending shrinks, companies will reduce production and cut payrolls. That has already begun to happen. It's called recession.

How much worse can it get? As I said before, the housing bubble drove home prices up 20 to 40 percent above historic averages relative to earnings and rents. So now that the bubble is bursting, you can expect prices to drop by roughly the same amount, and new home construction to contract. The latter plunged last month to its lowest point in more than 16 years. A managing partner of a large Wall Street financial house told me a few days ago the scenario could get much worse. He gave a 20 percent chance of a depression.

Even if a stimulus package were precisely targeted to consumers most likely to spend any money they received, the housing slump could overwhelm it. …

In reality, the crisis is both a credit crunch and the bursting of the housing bubble. Wall Street is in terrible shape and Main Street is about to be in terrible shape. And there's not a whole lot that can be done about either of these problems -- because they are the results of years of lax credit standards, get-rich-quick schemes, wild speculation on Wall Street and in the housing market, and gross irresponsibility by the Fed, the Treasury and the Comptroller of the Currency.

As a practical matter, our only real hope for avoiding a deep recession or worse depends on loans and investments from abroad -- some major U.S. financial firms have already gotten key cash infusions from foreign governments buying stakes in them -- combined with export earnings as the dollar continues to weaken. But this is something no politician wants to admit, especially in an election year. …

Meanwhile Paul Krugman opines that the recession is likely to be deep and long. And, the Fed may not have enough ammunition to properly play out its role. He hints that a Japan-style Liquidity Trap may await us. Finally, Krugman remembers Greenspan's 2001 surprise inter-meeting rate cut:

On January 3, 2001 the Greenspan Fed announced a surprise, inter-meeting rate cut (50 basis points, compared with 75 yesterday.)

The markets went wild with joy. The Nasdaq rose 14 percent that day.

It didn’t last.