From the October 26, 2008 Sunday Times (London)
October 27, 2008
by Irwin Stelzer
“We are suffering just now from a bad attack of pessimism. It is common to hear people say that the epoch of enormous economic progress . . . is over; that the rapid improvement in the standard of life is now going to slow down; that a decline in prosperity is more likely than an improvement in the decade ahead. I believe that this is a wildly mistaken interpretation of what is happening to us.” So wrote John Maynard Keynes in 1928.
Actually, the pessimists had a point: a decade later many countries were still recovering from the Great Depression. But that is to niggle: Keynes’s main point, that “we are suffering, not from the rheumatics of old age, but from the growing pains of overrapid changes”, stands today, as we will see when we emerge, blinking, into the “broad sunlit uplands” that Winston Churchill foresaw during another period in which the future looked grim.
The world of finance capitalism will, of course, be different, just as it was different after Franklin Roosevelt laid hands on its architecture in the 1930s. Out went rampant insider trading, in came the Securities and Exchange Commission to enforce rules about honest dealing and transparency. Out went runs on banks, in came the Federal Deposit Insurance Corporation to calm the nerves of panicky savers by guaranteeing the safety of their deposits. Out went indiscriminate home repossessions, in came the Home Owners’ Loan Corporation to give struggling families a means of revising their mortgage commitments. Capitalism survived, in a new form.
We are likely to see further changes when we emerge from the current crisis and impending recession. All of Roosevelt’s New Deal reforms have already been strengthened. The Sarbanes-Oxley act of 2002 requires corporate executives to report truthfully on pain of criminal prosecution; deposit insurance has been increased and extended; steps are being taken to minimise repossessions.
But there will be more than extensions of New Deal reforms. Rating agencies will be forced to become somewhat more parsimonious when it comes to issuing the triple-A ratings that they have lavished on dicey securities. Mortgage originators will have to retain some of the default risk associated with the loans they write. Banks will be forced to have more shareholder capital behind the loans they make: the old days of leveraging capital 30 times will be gone, replaced by limits in the 12 times range. And throughout capital markets, transparency will be the watchword.
So far, so good. But as is the case with all swings of the pendulum, this swing will go too far. Financial innovation will be slowed, even though many of the innovations of the past decade have added to the efficiency with which capital is allocated and risk shared. Gone are the investment banks and the swaggering masters of the universe who did so much to make capital available to entrepreneurs; they are now subsumed in bureaucratic bank holding companies, the price of access to the Treasury and the Federal Reserve Board in times of stress.
Worse still, control follows money, and the governments that now own a piece of many banks will have their own ideas about lending practices. Already Gordon Brown has made it clear that he expects the taxpayer-supported banks to lend at the same rate as in 2007 – when credit was too freely available. He expects them to help first-time homebuyers; with house prices in decline, this is the equivalent of inviting another generation to catch a falling knife. Small business is to receive preferential treatment.
And there will be a price to be paid for the recent bank bailouts. Unless the banks recover, and the value of the assets on their books increases as the economies of the developed world recover, taxes will have to rise to cover any losses. And with all the new money being pumped out - governments have to run the printing presses overtime to have the wherewithal to pay for the preference shares they are buying - inflation will go up. Indeed, in America the rate demanded by investors in long-term government securities is already rising in anticipation of inflation.
But these problems are nowhere as severe as the doomsayers claim, at least in America. All the bailouts in America come to something like a tolerable 5% of GDP (in Britain the figure is a more worrying 30% of GDP), and history suggests that most of the taxpayer money being invested in financial institutions will eventually be recovered. As for inflation, lower oil and commodity prices will help to dampen it down.
The view from the “broad sunlit uplands” at that point will be of a world in which economic and political power are more widely shared, which is a good thing. World economic rivalry is not a zero-sum game: America does not become poorer because China and India become richer. Quite the opposite. And there is no reasonable time span in which any rising power will be in a position to threaten America’s military primacy. Narrow the gap, yes, but overtake America, no.
The posturing of Nicolas Sarkozy and his EU allies will produce high-level conferences, a good deal of sound and fury, and probably a few new assignments for the International Monetary Fund. But America, not even if led by Europeans’ ideal of an American politician, Barack Obama, is not about to cede control over its financial institutions and monetary policy to any international organisation, no matter how hard Gordon Brown tries to sell his highly regulated version of a new world financial order.
So, much will change, but much will not. The capitalism that will emerge from our current trials will be a New Capitalism, not socialism or some other ism. The balance of power between government and the private sector will shift a bit to government; the balance between cash and debt in businesses and households will shift to cash; other nations will be richer, relative to the United States, not a bad thing. An uplands not cloud-free, but sunny nevertheless.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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