Three more lessons! That's the lot
7. Neglect of international causes
This is the most fatal flaw, as it is the one least understood by economists, governments or bankers.
My interpretation of the crisis emphasises its international dimensions – not only in the rapid spread of the crisis but also in its root causes (see Lesson 3).
Yet this perspective is still denied, derided or ignored.
Fashionable explanations focus rather on symptoms – excess private debt/leverage, the housing bubble, “deregulation”, financial product innovation, bad credit rating – or policy “failures”.
I think that these merely describe what they purport to explain. Analysts love phrases like”regulatory failure”, the “search for yield”, and “the housing market bubble and collapse”.
The simplest explanation is that it was caused by excess monetary expansion. But if that did occur, was it only in the US? And why? Was it a naturally and inevitable accompaniment of an inflation-targeting monetary policy?
What made central banks, notably the Fed, to insist on expanding money and credit? Why keep interest rates too low for too long? Why keep trying to raise inflation, even when international factors, notably economic globalisation and the entry of cheap goods from China, would have naturally caused a fall in consumer prices?
This was exacerbated by what the BIS economists have called the “excess elasticity of the global financial system – a key element of which is the regime of flexible exchange rates.
That is where the international cuases become paramount.
Even if the Fed had followed a more cautious monetary policy, the US housing boom would have been financed easily from Europe and around the world, given excess liquidity and the elasticity in the global supply.
This was made worse by the unpredictable nature of governments’ responses to the crisis.
As I said in 2012 in The Money Trap (page 197):
“The global financial system has evolved in such a way as to distort incentives of the players, corrupt the relationship between states and markets, and impose unacceptable collateral damage on the real economy”.
The interaction between governments and markets predisposed the system to crises.
It took place within a context that we had built. We had designed a system in which
a. major players were too big and inter-connected to fail
b. monetary policies operated without a reliable long-term anchor
c.the freedom needed by markets to provide services was also capacious enough to permit destabilising speculation
d. The public could have little confidence in the capacity of regulators to take tough decisions due to the political influence of large financial institutions.
8.….. of ethics……
The system, I said in 2012, was grossly unethical: “because of this, it was storing up political trouble”. I warned that while people had shown great patience, the public “could not be expected to put up year after year with inequitable outcomes, where rewards bore no elation to effort, skill or common sense”.
The big question, I suggested, was how a strong ethical framework could be developed for finance in the 21st century comparable to that which Adam Smith and the great classical economists had taken for granted in the 18th and 19th centuries.
In 2017, that task remains to be done.
9…and of a credible anchor
To sum up, our system continues to lack the key elements that gave the classical system of international finance such strength and durability: a credible anchor for money, fixed exchange rates and a set of ethical rules of good behaviour.
These taken together constrained the actions of all participants in the system to their enduring benefit – and that of society as a whole.
Sadly, the world seems to me as far away as it was ten years ago from understanding this.
Here endeth the lesson.
Thank you for listening.
I also want to add an apology.Many readers say my book was too difficult and they gave up. I am so sorry. I should have thought more about my readers and less about my emotions and opinions. That is why I am carrying on with this blog, five years later. I want to get through to people.As an editor I should have known better!
Equally, I am enormously grateful to readers who have stuck with me through thick and thin. Thank you!