From Notting Hill Editions
My mailbox has been overflowing in the wake of the economic summits convened to solve the European crisis.
I had expected messages of relief with minds set at ease by the impressive performance of world leaders so united in the face of the global crisis. United in identifying causes and allocating blame. United in saving the world from the dismal effects of the recession. United in unleashing all governmental resources, irrespective of cost, to stimulate the economy. United in creating a brand new world financial order. United in providing sufficient funds to the relevant international bodies to bail out insolvent national economies. United in exercising self-discipline not to favour and protect their own electorates. United to constrain bankers and emasculate tax havens. United, as per usual, to combat global warming and ease the lot of the global poor. After all, the media, in general, applauded, the markets notched up a few points and the leaders smiled at each other as they embarked on triumphant homecomings.
So why do I see so many misgivings, so much doubt, such continued bewilderment in your missives? The questions exercising all of you are how severe the economic downturn is and how long it will take us to get out of it.
And why the collapse happened in the first place. The fact is that no one in power, and wielding tangible influence, knew in time what was coming, just as no one in authority can tell us now how bleak the future will be. Your doubts as to the ability of world leaders to control the course of the economy, in ignorance of the true dimensions of the crisis, have given rise to questions of such diversity that they cannot be dealt with on an individual basis. The best I could do is to group them and formulate a small number of questions that, in their totality, reflect your most acute concerns.
How has it been possible for those in charge of our financial and economic institutions, both public and private, never to have seriously envisaged such a dire scenario? How could the world's major bankers lend with gay abandon money they did not have at ridiculous rates to borrowers congenitally unable to repay? How could pension fund managers invest people's savings in questionable and vastly overpriced assets? How could a British prime minister, having served ten years as Chancellor of the Exchequer, believe that economic cycles had had their day, declaring that he had forever done away with an economy of boom and bust? How could property prices continue to rise long after those properties had become unaffordable? Why did alarm bells observe universal silence until it was far too late to moderate events?
What goes for a pathetic excuse of an answer, widely adopted by all those responsible for not anticipating the crisis, is that it was unforeseeable and that its occurrence is unprecedented. In common language the words 'unforeseeable' and 'unprecedented' have quite precise meanings. Despite sophisticated monitoring devices, natural catastrophes, such as tsunamis or earthquakes remain to a certain extent unforeseeable. A universal cure for all cancers, on the other hand, has not yet been discovered yet, but is eagerly anticipated. That the crisis was unforeseeable implies that it was something like the striking of a natural disaster.
But, unlike the sudden shockwaves of an earthquake, there were signs in abundance of the impending recession. The claim that the crisis is unprecedented is only partially true. Recession, depression and cyclical downturns are well-rehearsed economic phenomena, but their occurrence on such a global scale is admittedly very rare. Even so, with global communications, global travel, global trading, global financial transactions and a closely interwoven global economy, would it not have been reasonable to expect a financial and economic meltdown to be global too?
So the next logical step is to seek reasons for such a blatant failure to recognise the danger. Strictly speaking, there can only be three possible ones: lack of information, ineffective organisation of information available, and a powerful disincentive to face the facts.
Our 21st century economic and financial condition certainly provides a great abundance of data, perhaps too much of it. Stock exchange indices are updated minute by minute; company results, with details of profitability and future prospects, flood in daily. Government foreign exchange reserves, country by country, are in the public domain; so are their deficits and borrowings, the notes and coins of their currency in circulation, as well as the broader measure of money supply.
Private earnings and borrowings, the consumer price index and employment figures all carefully tabulated; interest rates across the world are logged, analysed and predicted; natural resources, both above and below the ground are accurately estimated, national economies are regularly audited by highly respected international bodies like the OECD and IMF, who also forecast world trends; and so on and so forth.
So what about the organisation of this wealth of information? Professional analysts, hunched over their screens, still interpret data, predict and advise. Fund managers struggle to read the signs of a wildly perambulating market as they re-arrange their portfolios. Economic gurus are still gainfully employed to make some sense of the daily inflow of news. Bankers, having given away the bulk of their shareholders' money, are sitting tight, haunted by their worst nightmares. Great international institutions keep on publishing their routine predictions in the light of past events and present statistics. Academics, having dusted off the pages of classic economic theories, argue their relevance to the current situation. And governments worldwide are too busy formulating policies and launching initiatives to bother digesting the brutal facts.
These attempts at organising and interpreting a voluminous flow of data may be of value in some instances when restricted to very specific matters. A thorough analysis of company balance sheets will give a good indication of their fragility. The size of a budget deficit should determine a government's room for manoeuvre when considering expansion, taxation and borrowings.
The statistics of dry goods shipments, their volume, free capacity and rates, tell the story of the probable trend of global economic activity in the succeeding months. The world's potential copper production in relation to a projected demand will definitely have a bearing on its estimated future price. Some of the predictions derived from an assiduous study of specific economic or financial factors turn out to have been on the nail, others end up many miles from the eventual outcome. The trouble is that it is not possible, with any degree of certainty, to know in time which is which. But even choosing to follow one set of predictions, perhaps based on better research and more cautious assumptions will not tell us how deep the world recession is and when it will end. Unfortunately, the same applies to national economies given their ever-closer interdependence.
So if the organisation of the information is inadequate, the next logical question is this one: is the exact meaning of what is being measured by the available statistics clearly understood? More simply, do we know what the figures show us? Some of you mention, for example, a key measuring instrument, known as the Gross Domestic Product (GDP).
Every national economy has its own figures, made public with monotonous regularity every quarter. It enjoys the status of biblical sanctity, its meaning never questioned, never probed. It is supposed to be a measure of how well or badly an economy is doing. Positive figures mean growth, the higher the figures the greater the growth. Year-on-year growth means more activity, more output, more jobs, and more tax revenues.
But what does GDP really measure? If it measures anything at all, it tracks the aggregate volume of economic activity. This activity includes virtually everything under the sun: manufacturers producing physical goods, plumbers plumbing, policemen policing, teachers teaching, nurses nursing, armies fighting. But, you are asking, does GDP tell us anything beyond the volume of the economy? Does it measure the quality, the profitability, the sustainability of these activities and their contribution to the value of the economy?
You are, of course, right in pointing out that a manufacturer may be producing goods at a loss; traders may be merely replacing items prematurely expired. The police, the army, schools and hospitals, all critical to the well being of our society, constitute costs not gains; bank paper profits, as we are now witnessing, may damage the economy rather than contribute to it. Indeed, the volume of any business has little to do with its viability and prospects. Relying on GDP as a key indicator of the health of a national economy is akin to estimating the earning power of a family by counting the number of times its members go in and out of their front door. This might be putting it a little too strongly, but an answer to the basic question is crucial. To estimate the true state of the economy, we need other analytic tools.
But would improved analytic tools on their own be sufficient to help us get to grips with the true nature of the crisis? Or is there a common fault line in economic models implicit in the explanations currently on offer to account for the savage downturn? Economic theories made their first tentative appearance with the Age of Enlightenment when mankind became convinced that the universe, and everything within it, lent itself to rational explanation.
But unlike full-blooded sciences, such as physics, chemistry and astronomy, all subject to objective observation and experiment, economics have never attained such scientific credentials. Whilst statistical data of economic transactions grew in sophistication and detail, divergent theories have grappled with the burning issues of the day: balancing demand and supply, freeing trade and abolishing tariffs, controlling the money supply, regulating financial markets, guiding government intervention, managing inflation and deflation, avoiding excessive growth and severe contraction. But fragmented debates and considerations of bits and pieces do not create a coherent whole.
Confusion reigns supreme because economic theories, from Adam Smith to Keynes, Hayek and the Monetarist School, do imperfectly mirror 21st century realities. Those at the forefront of advocating various measures to alleviate the current situation tend to use selected distortions of respectable theories to justify their proposals.
What we need is a new conceptual architecture to prepare the context for the strands that make up the crisis. Historically, the crucial missing element from economic models is man himself, the principal agent of all material transactions. The difficulty economists have always had in quantifying human nature as a factor in any equation. Insofar as man featured at all, it was as someone having rational, or on rarer occasions, irrational expectations. But what is happening now has little to do with a distinction between aberrant and calculating behaviour. It has to do with a wide-ranging spectrum of fears and ambitions that underlie the human psyche. This psyche has to find its way into any meaningful economic model.
Many of you are deeply puzzled by the credit crunch, especially after having lived through at least a decade of everyone busy lending and borrowing. The credit crunch, such a prominent feature of the crisis, is characterised by fear. A fear that is holding financial markets in its grip, slowing down the movement of money and making loans of all sorts so hard to come by. This is a real conundrum. To try to get to the bottom of it, we have to learn to appreciate the wondrous and unique quality of money. This needs some explaining and a letter for itself.
But, irrespective of the mysteries of money, you go on and ask how could the financial markets on their own create havoc with a real economy supposedly so strong, so healthy, so resilient? The much-cultivated claim of material economic soundness uprooted by financial frenzy, promoted in governing circles, is gaining general support.
Frankly, I am very sceptical as to its merit. It is too convenient a lightning conductor to locate the epicentre of the crisis in the financial world. It is fairly obvious that financial markets and the real economy cannot be related to each other in terms of direct cause and effect. If one is to determine the other, it is the real economy that would be more instrumental in shaping financial markets rather than vice versa. But it is more realistic to think of the economy and the market as mutually reinforcing. If the economy is strong, the market is buoyant and, when market sentiment is optimistic, money moves more easily, boosting the economy. I suspect therefore that there has been something radically wrong with the economy. Something that has been the major cause of the crisis, something vital that we have failed to see.
Some of you are getting a little tired of hearing the constant refrain of the global crisis. It tends to convey the impression that somehow the crisis is not of our making, that it belongs to the world at large and that it is the world's business to get rid of it. On the face of it, there is nothing wrong with reminding us that the severe recession affected all the economies on our planet. And it is a fact that virtually all economies have been growing apace for the best part of two decades. But the term 'global' conjures up a misleading image of a seamless universe within which a variety of substances circulate freely.
Rises in temperature, the finality of resources, trade, terrorism, epidemics, flow of information, the spread of culture, all have an obvious global dimension. But their effects are not uniformly distributed and the response to them must vary from country to country. The current crisis does have a global aspect, but not every economy is equally indebted, suffers the same severity of imbalances or is in so dire a peril. You are right, instead of using the mantra of global, we should try to understand with greater accuracy the nature of economic interdependence, as we address the complexity of the crisis.
By far the most frequently posed questions concern the government. You all want to know what role it has in the crisis. The general tone of official and unofficial pronouncements makes it clear that the government has been in no way instrumental in the inception of the recession, that its present well-intentioned intervention has the power to end the crisis. I suggest we do not dwell on the inherent contradiction implicit in these statements; it is too obvious. Whatever the impact of the government, its influence on the economy must make itself felt as much in good times as in bad ones. And its power is considerable. Let me just say here that it is the employer of a big chunk of the working force, it is by far the largest single spender and borrower, and that it has the unique authority to create money and determine its cost.
The extent of government control over the economy raises all sorts of questions about the measures now being taken to reverse the downward trend. Irrespective of the differences swept under the carpet, there was a performance of unanimity at the various summits as to what should be done. Looking around, there are not many dissenting voices. People are mostly content to ask how effective these measures are, and how quickly they will put an end to the crisis.
I know you are instinctively troubled by the whole approach. You are uneasy about accumulating more and more debt on top of the massive amount most of us have. You find it hard to believe that our ills could be remedied by the very medication that caused the illness in the first place. As for myself, I have no doubts. I am certain that the medicine being administered is toxic. It is more dangerous than even the toxic debts on banks' balance sheets. Radical and sudden government intervention in the organic functioning of any economy has invariably had a negative outcome. What is being done now, as a consequence of a profound misdiagnosis, will damage our economy, our finances and our society for at least one generation to come.
Of course, the question on every one's lip is when will the recession end and the economy return to normal? You will have noticed just how vague, evasive and unhelpful the proliferating answers to this reasonable query are. Even when officials, experts and advisers venture to hazard definite dates, these bets are hedged by so many conditionals as to make them worthless. In any case, these hypothetical dates tend to change with every fresh fragment of information leaking out of governments, companies and financial markets. Yet, once the state of economies is properly assessed, it is not impossible to reach a prognosis, to venture a well-reasoned guess.
Using the language of common sense, free of technical jargon, the question answers itself. The meaning of money and the market becomes intelligible. The economy, made up of expectations and assets, is no longer a forbidding complexity. The heavy hand of governments is exposed for what it is. And we may find that the crisis does not so much end as transforms our way of life. Maybe society would have to moderate its material demands and, in years to come, we will all learn that what we now consider a normal economy is anything but.
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