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Still trapped

RP’s Diary

I started writing The Money Trap two years ago because I had become irritated by the narrow terms in which the economic debate was being conducted. In all advanced countries, the same arguments, between those who wanted more expansionary policies and those who insisted on more austerity, rolled on without resolution – and without producing a successful outcome whichever was tried.

I was indignant about the way the same old myths were trotted out again and again.

Expansionists – who dominate the Anglo-Saxon media and blogosphere – warned constantly of the need to avoid Japan’s so-called ‘lost decade’ and the terrible dangers of ‘deflation’, and raged against Germany’s insistence on strict monetary and fiscal discipline. Yet the public saw that they had no convincing answer to the problem of excess public and private debts and high leverage of financial institutions. These made rapid expansion far too risky.

Yet neither did the merchants of Endless Austerity have anything to offer beyond sermons on the need for thrift, hard work and avoidance of bailouts. It was evident that the public was, rightly, losing patience with such unimaginative policies. Whenever they had the opportunity, they had already started throwing out of office any government that was in power when the crisis broke. As for the bankers, widely seen as the evil geniuses behind the credit crunch, why weren’t any of them being thrown into jail?

Back in 2010, apart from the occasional lone voice such as that of Paul Volcker, former chairman of the Federal Reserve, who was already pushing hard for real reform in the US, there was little sign of a coherent official policy to reform banking and finance.

Thus in May 2010, I formulated a hypothesis: without a profound change in official economic and financial policies, the world would remain in the money trap.

At the time, economic forecasts were optimistic. The IMF commented in January 2010 that ‘the global economy…is recovering faster than previously anticipated’, and financial markets had ‘rebounded’. The mood in the US in particular was buoyant.

I did not expect this to continue.

Now, two years later, the mood has darkened once again. Europe is back in recession. The US recovery is weak. Even Asia is stumbling. Several more governments have been booted out of office. In finance, international banks are retrenching.

Yet there are no signs of any real change in the terms in which the debate is conducted. Of course, the election of Francois Hollande with his pledge to ‘go for growth’ and the Greek voters rejection of ‘austerity’ shows rising discontent – yet we all know that hopes of real progress are likely to be disappointed, as nobody has any fresh ideas.

Banks everywhere remain on life support machines. Very few can stand on their own credit without the support – implicit or explicit – of the local State. Regulators are imposing tighter capital ratios. As a result, in Europe banks will have to dispose of big chunks of their assets, depressing demand. Increased profitability reflects merely their access to ultra cheap funding, courtesy of the central banks. The official sector has, in effect, taken over a large part of the risks of financial intermediation.

In effect, none of the problems that led to the greatest financial crisis and recession in living memory have been solved, either in Europe or the US.

My hypothesis has stood the test of two years. The trap (analysed in Part 1 of The Outline) is tightening. If we do not find a way out, it will suffocate us. For that, we need new ideas.