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Financial Crises and Economic Depressions

Why Revive the System?


One of the more telling stories of Western economics takes me back to my days as a wee lad studying at university. Ben Bernanke (Chairman, Federal Reserve) and Andrew Abel had co-written the imaginatively titled ‘Macroeconomics’ inflicted on we in the studentariat at some level above introductory. In this book Mr. Bernanke bragged, if memory serves me, of creating a model that predicted economic growth really well as long as he left the Great Depression out of it. While I’m not sure how that reads to those not damaged by an education in ‘economics,’ it is roughly analogous to writing a review of the play at which Abraham Lincoln was assassinated without mentioning the assassination.

Related, a debate has arisen between the liberal and right factions of mainstream economics over the nature of the Great Recession of 2007 – ????. Leading members of Mitt Romney’s economics team challenged an historical review written by Ken Rogoff and Carmen Reinhart in 2008 on economic downturns that follow financial debacles. The Romney team produced stunningly shoddy research to make their case that financial debacles have little effect. True to form, following the smack down of team Romney by Rogoff and Reinhart, liberal economists left financial debacles exactly where they found them—as accidents of history and facts of nature.

As a former economist at both the IMF (International Monetary Fund) and the Federal Reserve, Mr. Rogoff has good reason to leave financial crises at the doorstep of nature lest inquiry lead to questions of what those two organizations have done to facilitate them. The liberal wing of the economic mainstream has good reason as well as the role of finance, and in particular the role of banks in the economy, has been reduced to simple transfer mechanism, the politically and economically neutral meeting place where savers and investors converge for the purported benefit of us all. If, with recent history so fresh in the minds of the unemployed, foreclosed upon and struggling to get by, that view seems a smidgen too generous to the titans of Wall Street and the capitalist economists behind the debacle, they might just have a point.

In fact, there is no disagreement here with the proposition that history is replete with economic events that share characteristics that can legitimately be called financial crises. That, dear readers, is the point. There appear common causal factors for particular types of economic episodes characterized by mass economic misery and yet it is the mass misery that is either addressed or not, and never the cause. Where Ben Bernanke’s useful-lite economic growth model comes in is that it (accidentally) illustrates that economic debacles that follow financial debacles are ‘not normal,’ something different that must be addressed in its difference rather than in its similarity to ‘normal.’

Recognizing this difference, economist John Maynard Keynes created a host of economic patch-jobs to save capitalism from more effective solutions. In the pit of the Great Depression FDR (Franklin Delano Roosevelt) implemented programs based on Mr. Keynes’ ideas and smaller programs already under way and these programs, along with stupid math tricks (a 50% decline in an index like GNP requires a 100% rise to recoup lost ground) produced minor relief now deemed by the economic insightful-lite to be a ‘robust’ economic recovery. (FDR’s job creation programs produced major benefit to millions of unemployed). But the cause, leveraged (finance) capitalism gone wild, was only temporarily tamped down by regulation while its intrinsic instability was left intact.

Why this matters is that there are two related strains of toxic nonsense now being put forward by the economic mainstream. The first being promoted by ‘liberal’ economists recalls Mr. Keynes in suggestions that the symptoms of economic debacle be addressed without addressing the causes. This view was put in motion in Barack Obama’s fiscal stimulus program. The second, and related, strain is that the Bush / Obama administrations’ revivification of the banks, the dysfunctional institutions of finance capitalism, resulted in much less economic pain than otherwise may have occurred.

In the Bernanke-world of liberal economics, economic depressions caused by financial crises are just especially crappy versions of normal—what the West is currently experiencing is just like the economic recession of 1957, only worse. If something else were afoot– something intrinsic to finance capitalism causing recurrent economic depressions, what then? Either there are benefits that offset recurrent economic depressions or the rational public policy solution is to shut the financial system down. The second order question is: if recurrent economic depressions are ‘justified,’ why is their burden not equally shared? One needn’t argue intent to point out that the benefits of the existing system are extremely concentrated while a growing proportion of the population shares its detriments.

And here lies the point of departure—Western economists concern themselves with the economic ‘system,’ in the sense that the academic right sees it as self-correcting when ‘it’ is left alone while liberal economists argue that it requires adjustments so that the system doesn’t run off the rails. Hence Mr. Romney’s economists infer that all times are ‘normal’ and go about proving so by conflating unrelated issues via hack research to fit their argument. But liberal economists simply up the ante arguing on the one hand economic downturns that follow financial crises tend to be quite severe (not normal) while on the other that it is the resulting economic downturns that must be treated instead of the system that caused them. If (1) financial crises cause severe economic downturns and (2) their burden falls disproportionately on the vast majority of the population, most particularly on the already economically marginalized, why then revive the system? Cui bono? 

The politically convenient argument that the Bush / Obama revivification of the financial sector saved the broader economy from a deeper downturn necessarily assumes no causal relation between the financial debacle and the downturn or the system has simply been revived to kill again. The common factors identified by Mr. Rogoff and Ms. Reinhart as being behind financial debacles—excess (private) debt, wildly skewed income distribution etc. are still largely in place. Furthermore, the financial system is still dependent on public assistance as evidenced by ongoing guarantees under the too-big-to-fail policy and continuing subsidies (bailouts). The point is that it is a dysfunctional financial sector that was revived, not a functioning one.

Typical political argumentation over economics has one side ‘poor-mouth’ economic conditions while the other paints a rosy scenario. However, when ‘both’ sides are behind the economic policies and trajectory of the last forty years, as they are, enhanced mis-direction is required. If there are common factors behind financial debacles that lead to severe economic declines as Rogoff and Reinhart suggest and liberal economists are coming to embrace, the ideology behind neo-liberal economics is brought to the fore. Democrat Bill Clinton was the most effective proponent of radical capitalism (neo-liberalism) in modern history. Globalization and financialization are policy outcomes, not facts of nature. And for all of the highfalutin theorizing behind the neo-liberal transformation of the world, it was bundles of crappy little mortgage loans that were the spark that lit fire to the global economy.

Calls for re-regulation, managed capitalism, beg the question: re-regulate what? As demonstrated by history, the system of finance capitalism is intrinsically unstable and economically destabilizing. Under the guise of reviving a functioning financial system a dysfunctional system has been revivified, not revived, and nearly all benefits continue to accrue to a tiny economic elite. Again, this is one of the conditions identified by Rogoff and Reinhart that are linked to financial and economic debacles. Radical capitalists profoundly changed the West over recent decades and the “experiment’ is a catastrophe. But to be clear, these radical capitalists are also liberal economists. This is why claims of substantive differences between democrats and republicans are so misguided—they are jointly radical capitalists.

The other enduring memory of Herr Bernanke’s textbook was the most contorted attempt to develop a market-based analysis of environmental degradation on house prices in modern history. By drawing the circle of what could be considered in the analysis so tightly around what is acceptable discourse in academic economics, its utter irrelevance was pre-determined. But the acceptable discourse in mainstream economics is more that just a sociological oddity, it is a function of well-hidden ideology. Please consider this when listening to debates over GNP growth rates and the ‘true’ unemployment rate. These aren’t even starting points for relevant discourse on the political economy.

Rob Urie is an artist and political economist in New York.