Swallowing the Blue Pill

John Quiggan confesses that he is a weekday antiglobalist, and that he fears and distrusts capital markets (as a Keynesian, it is probably because they?re filled with ?Animal Spirits? and other chaotic shades such as speculators and entrepreneurs). In his confession, he writes:

I guess, by the same token, that I'm a weekend globalist. My Golden Age is not the 19th century but the Long Boom from 1945 to the early 1970s, a period of unparalleled prosperity brought to a close by the pressures of capital mobility. Like Brad, but for the opposite reason, I wake up two days a week worrying that it was all an illusion and the capital mobility was the red pill that enabled us to see the truth

But mostly, I think that the long boom failed because of avoidable mistakes, and that our best hope is a modernised and refurbished version of the Keynesian/social democratic policies that gave us that boom. In this context, the relevant issue is not so much capital mobility as the role of capital markets in general. I see capital markets as essential but dangerous, requiring tight regulation at all times. As Keynes said "When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done."

John was right when he worried that it was all an illusion, and that capital mobility is the red pill. But like Cypher in the Matrix, he?s willing to sell everything out in order to live in the comfortable lie again, and so he embraces Keynesian dogma- which was ?the world pulled over the eyes of the economics profession to blind them from the truth? (to paraphrase).

The first problem with the above is referring to a so-called ?Long Boom? from 1945 to 1972. The period of 1945 to 1972 characterized as a golden age? Setting aside the fact of several recessions punctuating that period, there were other things seriously unique about the context of the period to which he refers that cast doubt on his premise. Unlike today?s developed and interconnected world, the world as of 1945 was a devastated wasteland. It had been rocked by war, death, pestilence, and famine- touching all except for the United States. International trade for most intents and purposes did not exist, and aside from the Soviet Union (which did not engage in world trade), the US was the only source for capital and even consumer goods. So for the first half of this supposed golden age, the US rebuilt the world (as only it could), with essentially no competitors for goods and services (and thus capital flow). Capital(savings) flowed into the US from the rest of the world, through legitimate trade and the US government printing money out of thin air to give to developing countries (and Europe) to buy American goods, and thus capital and consumer goods did flow out from US factories and warehouses. When the rest of the developed world finished rebuilding itself, the US turned to the printing presses to keep the economy moving and absorb US production. Because in the Keynesian world tomorrow never comes, since after all ?in the long run, we?re all dead.?
However, the dreaded capital market wasn?t banished or eliminated even in those benighted times:

By 1959 US gold reserves had dwindled to 20 billion dollars. By 1960 Europeans had outstanding claims on US reserves in excess of 25 billion dollars. Speculators made a run on the Dollar. However, the US forced Europe to continue to back the dollar. However, the need had arisen for a system of collective multilateral economic management. The IMF and WB stepped in as the clearinghouse for short and long term loans for national development of third world countries. However, since the WB was under funded, a system emerged in which the economic loans from the IMF were contingent on these countries buying US goods under their established economic recovery plan.

So, sweeping in like hackers from Zion, the dreaded speculators ruined the fun of the party by exposing the fraud of the US government?s monetary and fiscal schemes. So much so that a new system had to be formed, even after the US used its strong arm to twist those of the European governments into supporting and defending the increasingly hollow US currency. Of course, the new system (developed by the Keynesian true believers in the US) conveniently continued to tie international funding to the purchase of US goods. With the arrival of the Vietnam war, the US economy had a splendid new sink to absorb US production, and economic prosperity was upon the country once again.

Until tomorrow finally did come in the early 1970s, and all of the chickens came home to roost. The Vietnam war ended, lowering military goods spending (and the subsidiary industries that had grown up to serve primary government contractors). The government had debased the currency so badly that the US had to dump even the highly modified gold standard it had in 1971 (and subsequently the price of gold jumped to ten times it?s pegged value when freely traded). In short, the US had used up the pool of available real funding in the US, and the rest of the world (East Asia and Europe in particular) was now in direct competition with aging, protected US industries that, until the 70s, could rely on easy terms and plentiful contracts from the US government- so world capital stayed away from the dollar, and away from US investments. Thus for the rest of the 1970s, the mask was ripped off the Keynesian fa?ade, both in the US and elsewhere.

In other words, when world economies faced the world of tomorrow, when the US and other economies faced the problems of rising unemployment and drop in ?aggregate demand?, Keynesian economic prescriptions had no answer, no cure. The US government continued to follow the Keynesian prescription, and pump cash into the economy with public works programs and through regular monetary inflation since, according to Keynes, you can either have inflation or unemployment, but not both. The joke was on the US consumer as that indeed happened in the late 1970s, when US industry was so badly out of sync with both domestic demand and the world economy, that nobody was willing to buy (many) domestic goods at any price.

Certainly people weren?t willing to buy big ticket items when inflation was making the prices of the very staples of life spiral higher and higher. Inflation ate away private savings (essentially transferring cash from private individuals to the favored industries that got the new infusions of inflationary federal spending) and prompted further consumption of basic goods. Yet this increased basic consumption couldn?t keep people employed (at least, not in the highly visible, politically sensitive yet near obsolescent manufacturing sector). So not only were people?s checkbooks being erased, jobs were disappearing again as industrial equipment simply wore out (and could not be replaced at inflation-spiked prices in the US), and this time without a drop in federal spending.

So it cannot be said with any sincerity or accuracy that the problem of the 70s was not enough Keynesianism/Social Democratic Consensus, but rather (in accordance with the consensus of economic and historical opinion) too much of the same. It certainly was not due to any supposed ?emergence of capital markets? (since the early 1960s saw speculative runs on an overvalued dollar, indicating that large scale global capital movements and markets were in place at least 12 years prior)

John goes on from this to give some historical examples of ?When Capital Markets Attack?:

Brad's views are confirmed by the experience of the 1980s, when capital markets acted as the enforcer of fiscal discipline on wayward governments, notably in Latin America, and broke down the power of entrenched interest groups. These experiences gave rise to the famous 'Washington consensus'.

Mine are confirmed by the experience of the late 1990s, when financial market panics produced a string of apparently unnecessary financial crises in Mexico, Thailand, Indonesia, Argentina and so on. In every case, the countries affected had been financial market darlings up to the day the panic struck.

I?m not sure what John means by his fears being confirmed by the experience of the 90?s. Each financial crisis of which he speaks is, in broad terms, of the same nature as the ones in the 80s- enforcement of fiscal discipline. Certainly no one can argue that Argentina was doing just fine until nasty speculators came and overturned the apple cart.

But what is meant by ?financial market darlings?? That speculators liked all of the crisis countries in the 90s? I rather think that if speculators and traders love your market, that?s not an endorsement but the equivalent to buzzards circling. Indeed, a financial market will love a government trying to play a high stakes shell game, as (for example) Mexico and Argentina certainly were trying to do, simply to provide the service. The markets simply provided the casino in which the Mexicos, Argentinas, Indonesias and others came to play their games- the countries in the question were the one?s rolling the dice, and it?s certainly not the dealer?s fault they crapped out. The solution in their cases was the same as in the 80s- fiscal (and monetary) discipline. Don?t issue more currency than you have reserves, and don?t get your country locked in severe debt.

What we have here, in both his conception of the postwar period to the early 70s and of the varied financial crises of the 90s, is a mistaking of the true cause and effect of the postwar prosperity and decline in the 70s. It was the exigencies and unique historical context of the US vs. a destroyed world (as well as forced savings in the US during the war) that caused the 'boom', not Keynesian policies, and in fact those policies ("avoidable mistakes") were the direct cause of the malaise days of the 1970s.

(With regards to John?s final misconception regarding the efficiency of modern financial/capital markets in allocating investment funds, I shall address that in a later post.)

Share this