Hypocrisy does not help

The financial crisis that began on this date in August 2007 has not ended. It continues, and will continue so long as policy-makers and economists fail to learn its lessons.

Instead, what we have is a mountain of hypocrisy. Almost everybody is being economical with the truth. This applies to central bankers, financial regulators and many bankers.

Let me explain. The financial crisis was not caused, as many economists allege, by the Chinese suddenly deciding to save more, or fiddling with their exchange rate, but by the erosion of discipline on all major parties in financial markets – governments, central banks and financial institutions. In this, it had much in common with previous crises since the 1970s, such as the third world debt crisis and the so-called Asian crisis. These were grounded in the same conditions – financial innovation, in the presence of loose monetary policies, fluctuating exchange rates and expectations of government bail outs. Financial institutions, governments and, yes, consumers also took advantage of the lack of discipline to pursue their short-run objectives.

Now, the major parties are still trying to go back to something like business as usual, while the public interest suffers. ‘Business as usual’ includes so-called ‘tighter financial regulation’ – the typical policy response after every crisis. Current regulatory initiatives are making the current recession deeper and will make the next crisis worse.

Central bankers are hopelessly conflicted, unable to admit their monetary policy-making models contributed to the disaster. “Credit or quantitative easing (QE) for ever” is not a serious policy. Indeed, monetary policy has run out of options. Schemes to encourage lending benefit banks not their customers.

Consumers and businesses rightly mistrust current policies and keep their wallets closed. That is the key reason for the bleak outlook. Their spending cannot be replaced by that of governments.

The debate between expansionists and defenders of fiscal austerity diverts attention from the monetary roots of the crisis.

Central banks are sowing the seeds of the next crash but they have no other option within the current policy-making setup.

Central bankers have to claim their policies have worked and will work, when all the world knows they have’t measured up to any common sense definition of “success”. Regulators privately doubt that their new policy tools will do anything to prevent future crisis but can’t say so publicly. In reality, the old banking system is broken and can’t be fixed. Major banks should be broken up. But bankers can’t admit it. How often have officials muttered to me in private that “it will take a worse crash to get real reform”?

The only way out of the money trap is, first, to abandon the pretence that current policies are likely to be effective and then build a real international monetary and banking system where governments and banks are subject to common rules. This will require international cooperation on a scale not before witnessed since the days of Bretton Woods. The rules for global finance must have as a key objective ending ‘too-big-to-fail’ once and for all. The US will have to recognise that the price for getting rules obeyed by Europe and China is accepting that they apply to the super-power as well.