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Causes of the financial crisis (no, its not the usual list)
Fabius Maximus, RGE Monitor
Summary: Much of the analysis of this great crisis — now clearly the worst since the 1930’s — focuses on minute, even trivial, aspects of the problem. This is natural, as its sweep and magnitude dwarf anything seen during our lifetimes (for most of us, at least). It has affected almost every business, kind of investment, nation — and before the end will probably affect almost every person (except those in the least developed nations).
… These financial shocks are byproducts of deeper trends, in my opinion. The world has begun a process of regime change, as the foundations of the post-WWII geopolitical order decay. Here are some of the major trends forging a new world. Each of these has played a role in bringing us to this point; some will play an even bigger role forcing events during the next few years.
(a) The transition from a bipolar (or unipolar) world to a multi-polar world.
(b) Entering the transition period to peak oil, as global oil production peaked (not necessarily the peak) in 2005. Since then biofuels have provided most of the growth in liquid fuel consumption. Rapid GDP growth (almost 5%) required high prices to match ex ante demand with flattish liquid fuel production.
(c) The replacement of the US dollar as the reserve currency (by what we do not yet know), after 30 years of foreign borrowing — 30 years of increasing current account deficits.
(d) The exhaustion from overuse of monetary and fiscal policy. Persistently too-low interest rates yielding serial investment bubbles. The long decline to near zero of the marginal elasticity of GDP with respect to debt.
(e) Structural weakness: Funding long-term businesses with “hot” (aka liquid) capital, from the disintermediation of household savings. Money shifted from vehicles where institutions bear the risk (insurance, annuities, CD’s, etc) to direct participation (owning stocks and bonds either directly or through mutual funds). See this post for an explanation.
(f) The Thomas Kuhn-type paradigm crisis in Keynesian economics, by which the world economies have been steered for fifty years. The aggregate debt level of an economy is not a significant variable; attempts to integrate into orthodox theory by radical Keynesians (e.g., Hyman Minsky) were unsuccessful. Sometime after 2000 we reached and broke though the edge of the “operating envelope” of Keynesian theory. We ran like Wile E. Coyote off the cliff and beyond — a few exhilarating years — and now we fall.
Black Swans
How comforting to think that these were Black Swan events! … Unfortunately, none of these were “black swan” events. All were widely predicted by experts for decades (see here for 2 dozen examples from major institutions and experts). These warnings were made early, allowing us sufficient time to act and prevent this crisis.
(30 October 2008)
Economics needs a scientific revolution
Jean-Philippe Bouchaud, Nature
With stock markets at decadal lows, money markets frozen and recession looming, economics is in the dock. In an Essay this week, Jean-Philippe Bouchaud argues that the economic sciences that failed to predict these events need to up their game. The critical approach to axioms and models that is characteristic of the natural sciences has been suspended, with notions such as the primacy of the marketplace untested, raised to the status of dogma. A revolution in economics is overdue, based on new economic models that give a more realistic representation of the financial markets.
… To me, the crucial difference between modelling in physics and in economics lies rather in how the fields treat the relative role of concepts, equations and empirical data.
Classical economics is built on very strong assumptions that quickly become axioms: the rationality of economic agents (the premise that every economic agent, be that a person or a company, acts to maximize his profits), the ‘invisible hand’ (that agents, in the pursuit of their own profit, are led to do what is best for society as a whole) and market efficiency (that market prices faithfully reflect all known information about assets), for example. An economist once told me, to my bewilderment: “These concepts are so strong that they supersede any empirical observation.” As economist Robert Nelson argued in his book, Economics as Religion (Pennsylvania State Univ. Press, 2002), the marketplace has been deified.
Physicists, on the other hand, have learned to be suspicious of axioms.
… The supposed omniscience and perfect efficacy of a free market stems from economic work done in the 1950s and 1960s, which with hindsight looks more like propaganda against communism than plausible science. In reality, markets are not efficient, humans tend to be over-focused in the short-term and blind in the long-term, and errors get amplified, ultimately leading to collective irrationality, panic and crashes. Free markets are wild markets.
(30 October 2008)
Recommended by Michael Lardelli. Original article was behind a paywall, but is now available. -BA
Buy-Local, Buy-Global Debate Is Mostly Civil, But Some Sparks Fly
Jeffrey R. Wakefield, University of Vermont
A full house of 700 people crammed into the Grand Maple Ballroom of the Davis Center on Wednesday afternoon to watch Bill McKibben, award-winning writer, environmentalist, and Middlebury College scholar-in-residence, take on Russell Roberts, a prominent economist at George Mason University and Stanford University’s Hoover Institute.
The occasion was an event titled “Buy Local or Buy Global: A Debate,” the inaugural match-up in a new debate series called the Janus Forum featuring thinkers with opposing views on important social and economic issues.
The event delivered Crossfire-like heat, on occasion, but a good amount of light, as both speakers enumerated in detail the environmental and economics analyses for which they’re known, McKibben in support of the buy-local movement, Russell in opposition.
Listen to a recording of the debate on UVM’s iTunes U page. (Clicking on the link will launch iTunes on your computer, or prompt you to download the program.)
… McKibben opened the session with a high-speed recitation of 14 points, each one bristling with research citations, supporting the notion that buying food and energy locally would result in both a more environmentally durable economy and more cohesive communities. He challenged Russell to answer his points — ranging from the fact that fertilizer-intensive agribusiness is eroding soil, an historic hallmark of civilizations that collapse, to the idea that Wal-Marts and other box stores deplete community well being and actually shorten lifespan — any one of which would win him the debate, he argued, if not factually disproven.
Russell allowed his analysis to range beyond food and energy, which were set in advance as the twin focal points of the debate, McKibben reminded audience members several times, to more comprehensively indict the buy-local movement. Humans always want “more and better,” Russell said. While it’s important to temper that basic human urge, he said, human striving has resulted in a bounty of innovation unimaginable100 years ago that has made life better. Eschewing global trade in favor of buy-local style self sufficiency, he said, is the road to poverty.
(30 October 2008)
