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It’s the system, stupid!

Is anybody listening?


One very senior former policy-maker has written to express his broad agreement with the analysis in The Money Trap. He cites three sentences on page 33, which sum up my review of the performance of the world economy since the collapse of Bretton Woods in the early 1970s:

“The severity of the financial crisis and the depth of the recession put the record of the previous 40 years in a different light, tilting the balance towards the negative side and underlining the need for fundamental reform. Obviously, the financial market rulebook needed to be rewritten. But the players couldn’t do that without a lead from the rule-makers – governments.”

This senior statesman says he agrees with this but asks rhetorically: “Is anybody listening?”

We shall see. What is clear now is that policy makers harbour profound doubts about their models and policy tools – an existential anguish about the very possibility of a cure – but feel they are stuck. Central banks have spent four years and trillions of dollars/euros/yen/pounds to kickstart the economic machine, yet the outlook is gloomy and getting worse every day.

Gathering recession in developed countries could easily lead to a downward spiral for the world as a whole. This is partly because it will further damage financial institutions’ balance sheets and partly because of the risks of new currency wars.

Meanwhile, these policies have unwanted side-effects. This is evident in Japan, where quantitative easing, forbearance and low rates kept zombie banks and companies alive for too long, and discriminated in favour of some sectors, notably banks and the government. The same is now true of the eurozone and the UK.

Bad allocation of capital lowers long-term potential growth everywhere. Meanwhile, asset and currency bubbles are setting the stage for the next crisis.

The best comment was made by Graeme Wheeler, governor of the Reserve Bank of New Zealand: “It is a sign of desperate times for central banks, who in some instances are shouldering the burden of domestic policy paralysis over fiscal policy.”

Wheeler pointed out that despite an unprecedented expansion of balance sheets there was “little evidence of any appreciable impact on economic growth.” 1

The messages from the big central banks in Tokyo had exactly an air of quiet desperation. They cited “adverse headwinds” to explain the disappointing results of policy. They all defended use of unconventional monetary policies, but with fast-vanishing confidence.

In private, central bankers readily concede they are far from understanding what has been happening. They are still flying blind.

Yet, and this is the point, central bankers who have looked back on past policies as honestly as they can say they are not able to spot, even with hindsight, any decisive point where policy evidently took a wrong turning.

Economists tend to say that this just shows how stupid central bankers are – with the implication that if a different set of economists set policy all would be well. What conceit!

In fact such exercises go far to prove something else; that it is the system – the set of rules and institutions and accompanying incentives – rather than any individuals that are at fault. The Money Trap shows that the monetary system is badly adapted to the realities of a globalised world economy.

Indeed, it is guaranteed only to deliver repeated recessions and financial crises.

That is why a radical reform of the global financial system is so badly needed.

Yet the IMF, which a few years ago tried to developed some ideas for reform, was told by the Americans (with the tacit consent of the Europeans) to back off. That is its tragedy – and ours. Christine Lagarde should try to stand up to such pressures.

Will she tell Messrs Obama, Xi Jinping, Hollande, Cameron and Frau Merkel to listen?

NB Please see the story posted in RP’s Diary 18 November  “Five-point reform plan” for one reader’s summary of the proposals in The Money Trap