"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Wednesday, December 28, 2011

Worse than the 30, Ms. Lagarde, Worse ! (or “The Crisis” from an Historical Perspective)

A couple of weeks ago we got another public warning about the state of the Global Economy. This time the warning call was launched by a top economic figure,the Managing Director of the IMF ,Ms. Lagarde.

IMF chief warns over 1930s-style threats
The managing director of the International Monetary Fund has warned that the global economy faces the prospect of economic retraction, rising protectionism, isolation and . . . what happened in the 30s (Depression)

http://www.ft.com (By Hugh Carnegy in Paris, George Parker in London and Peter Spiegel in Brussels – December 16th 2011)

Now, is it reasonable to deliver a dramatic warning about our modern economy alluding to events which took place some 80 years ago ? The answer is yes, as long as the events share some common patterns . So, the question is not whether 30 and 2011 are identical (obviously, they are not not) but if they share meaningful similarities.

Most economists would agree that both events share important common patterns : Generally speaking, both crisis were preceded by a period of economic “prosperity” accompanied with an Asset/Debt bubble . Consequently the violent pricking of the bubble turned into a debt crisis ( i.e. Debt suddenly became unpayable) ,which affected aggregate demand and financial stability. The policy response ,in both cases, was a massive support to the financial institutions and injection of "real" demand through expansionary policies (monetary and fiscal as well).

Up to now, I agree with the analysis, though my reading goes a step forward ( to an area that most mainstream economists simply ignore): I claim that the bubble and the following crisis were in both cases the outcome of a distorted income distribution, skewed toward the upper income echelons ( I´ve wrote extensively about it, so whoever is interested in understanding that point is invited to read previous posts).Anyhow, to illustrate my point please look at the below graphs dealing with the US and think for yourself if there is no place for such hypothesis.... . In an Hamletian style we should say “ To Distribute or not to distribute : That is the question...” . Needless to say the solution lies in recognizing that simple message.

Top 10% share in Income US

Total Debt - US

The conclusion is that Ms. Lagarde is quite correct by applying an historical perspective when she delivers her warning. However, as “History does not repeat itself, but it surely rhymes” it would be erroneous to confine our understanding to “Similarities” between “Then” and “Now”; a proper historical narrative should draw our attention to the role of dissimilarities as well.

Coincidence or not, last week turned to be the 20th anniversary of the collapse of the USSR. Are Ms. Lagarde statement and the anniversary related ?

Well, for me the answer is YES. The main difference between 1930 and 2011 is in the political arena: The world of 1930, a minute before the spreading of The Plague (Fascism ,Nazism) was obsessed with the new economic and social alternative model represented by the Soviet Union . Regardless our views on the Soviet Regime during its Stalinist phase, the Soviet model was back in the 30 perceived as a serious alternative (or threat) to the Capitalist order. And here lies THE dissimilarity: Ever since the collapse of the Soviet Union 20 years ago, the dialectic challenge to the dominant regime on a global scale has been absent from the political arena. The result : A new wave of Globalization, an accelerated dismantlement of the Welfare State … and so on.. but this is another story for another post.

And how this difference is related to the economic arena? Lets see how the main mentor of the reform policies in the 30 , Lord Keynes and FDR , regarded their work :

"The broad thrust of his (Keynes) efforts, like that of Roosevelt was conservative, it was to endure that the system would survive"( JK Galbraith)
"The Class war will find me on the side of the educated bourgeoisie" ( JM Kyenes)
“Red Russia holds too much which is detestable" ( JM Keynes)

As can be seen, the whole concept of intervention in the economy, seen by many as a "Socialism" was considered by the its main promoters as than an attempt to save the system of private property (i.e. Capitalism). From whom? The main threat was in the East, the USSR , with its fast industrialization, GDP huge growth , and all of that before the Stalinist crimes became widely known ( BTW, THE problem with the USSR was never the lack of freedom: Just remember how the US supported for decades more than one authoritarian conservative regime around the Globe ….). FDR or Keyens were aware of the challenge imposed on the System and reacted accordingly.

As of our modern times , the Economic system lacks any real drive to reform itself as there is no imminent threat around : No Soviets, no reds.... If so, why to bother to reform? Even Keynes and Roosevelt would agree on that . The results of that tragic myopia can be observed in the half baked reforms “imposed” on the financial system (still (!) able to create exteremely wealthy bankers), .... high unemployment rates with no real policy response ....the endless summits in Europe rushing to decide something before the opening of a new trading session… and above all the return of the Austerity talk with its Deficit Hysteria….( if deficit is the problem , why not to raise taxes ???? ) . As we can see, anything is valid as long as it does maintain the current state of affairs, ironically, the very same system that proved to be fragile and unstable.

The problem is that for the mainstream economists and policy makers there is no myopia, as they are in the game for THAT reason, i.e. to protect the system, not to reform it. However it IS a myopia if we agree that the main problem to be resolved is not “Debt” ( which is by definition, other´s people Asset) but inequality and income distribution . It is a myopia for those who remember the 40 .....

Share of Top out of National Income ( OECD Figures)

My conclusion is that under the current state of affairs, absent political threats or serious social alternative, the Elites will not give up upon the privileges gained along the last 3 decades. Without the drive for reforms , the Political and Economic response will be an anti Keyensian / FDR wave i.e. more Orthodox and austere policies to reduce deicits and public budgets. Even Noble prize winners agree that such policies are a certain recipe for disaster in the midst of deleveraging and weak private demand. ("Keynes Was Right" by P. Krugman)

Such tragic path could lead to a permanent recession mode and a worse economic long run consequences than humanity experienced some 80 years ago. And let us not forget that even the relative mild policies of the 30 were not able to prevent by “new” dawn on September 1st 1939….( WWII)

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