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Taming Finance in an Age of Austerity
The "innovations" unleashed by modern finance did not lead to higher long-term efficiency, faster growth, or more prosperity for all. Instead, they were designed to circumvent accounting standards and to evade and avoid taxes that are required to finance the public investments in infrastructure and technology - like the Internet - that underlie real growth, not the phantom growth promoted by the financial sector.
The financial sector pontificated not only about how to create a dynamic economy, but also about what to do in the event of a recession (which, according to their ideology, could be caused only by a failure of government, not of markets). Whenever an economy enters recession, revenues fall, and expenditures - say, for unemployment benefits - increase. So deficits grow.
Financial-sector deficit hawks said that governments should focus on eliminating deficits, preferably by cutting back on expenditures. The reduced deficits would restore confidence, which would restore investment - and thus growth. But, as plausible as this line of reasoning may sound, the historical evidence repeatedly refutes it.
When US President Herbert Hoover tried that recipe, it helped transform the 1929 stock-market crash into the Great Depression. When the International Monetary Fund tried the same formula in East Asia in 1997, downturns became recessions, and recessions became depressions.
The reasoning behind such episodes is based on a flawed analogy. A household that owes more money than it can easily repay needs to cut back on spending. But when a government does that, output and incomes decline, unemployment increases, and the ability to repay may actually decrease. What is true for a family is not true for a country.
More sophisticated advocates warn that government spending will drive up interest rates, thus "crowding out" private investment. When the economy is at full employment, this is a legitimate concern. But not now: given extraordinarily low long-term interest rates, no serious economist raises the "crowding out" issue nowadays.
In Europe, especially Germany, and in some quarters in the US, as government deficits and debt grow, so, too, do calls for increased austerity. If heeded, as appears to be the case in many countries, the results will be disastrous, especially given the fragility of the recovery. Growth will slow, with Europe and/or America possibly even slipping back into recession.
Stimulus spending, the deficit hawks' favorite bogeyman, did not cause most of the increased deficits and debt, which are the result of "automatic stabilizers" - the tax cuts and spending increases that automatically accompany economic fluctuations. So, as austerity undermines growth, debt reduction will be marginal at best.
Keynesian economics worked: if not for stimulus measures and automatic stabilizers, the recession would have been far deeper and longer, and unemployment much higher. This does not mean that we should ignore the level of debt. But what matters is long-term debt.
There is a simple Keynesian recipe: First, shift spending away from unproductive uses - such as wars in Afghanistan and Iraq, or unconditional bank bailouts that do not revive lending - toward high-return investments. Second, encourage spending and promote equity and efficiency by raising taxes on corporations that don't reinvest, for example, and lowering them on those that do, or by raising taxes on speculative capital gains (say, in real estate) and on carbon- and pollution-intensive energy, while cutting taxes for lower-income payers.
There are other measures that might help. For example, governments should help banks that lend to small- and medium-size enterprises, which are the main source of job creation - or establish new financial institutions that would do so - rather than supporting big banks that make their money from derivatives and abusive credit card practices.
Financial markets have worked hard to create a system that enforces their views: with free and open capital markets, a small country can be flooded with funds one moment, only to be charged high interest rates - or cut off completely - soon thereafter. In such circumstances, small countries seemingly have no choice: financial markets' diktat on austerity, lest they be punished by withdrawal of financing.
But financial markets are a harsh and fickle taskmaster. The day after Spain announced its austerity package, its bonds were downgraded. The problem was not a lack of confidence that the Spanish government would fulfill its promises, but too much confidence that it would, and that this would reduce growth and increase unemployment from its already intolerable level of 20%. In short, having gotten the world into its current economic mess, financial markets are now saying to countries like Greece and Spain: damned if you don't cut back on spending, but damned if you do as well.
Finance is a means to an end, not an end in itself. It is supposed to serve the interests of the rest of society, not the other way around. Taming financial markets will not be easy, but it can and must be done, through a combination of taxation and regulation - and, if necessary, government stepping in to fill some of the breaches (as it already does in the case of lending to small- and medium-size enterprises.)
Unsurprisingly, financial markets do not want to be tamed. They like the way things have been working, and why shouldn't they? In countries with corrupt and imperfect democracies, they have the wherewithal to resist change. Fortunately, citizens in Europe and America have lost patience. The process of tempering and taming has begun. But there is far more yet to do.
22 Comments so far
Show All"Fortunately, citizens in Europe and America have lost patience. The process of tempering and taming has begun. "
In Europe, yes but not in the USA. Most Americans are still being misled into believing that Europe's woes are much worse than the US's despite prior history to prove otherwise. Only a prolonged Great Depression, 20 years at least, will wake this nation out of believing all the financial propaganda on M$M.
The banksters' calls for deficit reduction will not result in deficit reduction.
The banksters' goal in calling for deficit reduction is to divert the money that is being spent on things that you and I benefit from into more bankster bailouts.
Unfortunately too many working class Americans (both Democrats and Republicans) are still falling for both the "don't stifle innovation by regulating the banksters" myth, and the "got to cut the deficit" myth.
I'm not so sure working class Americans are falling for anything from the banksters or deficit hawks. I think they're falling off a cliff and praying for " the miracle net " of Jesus to catch them. The big cloud guy evidently doesn't believe in Keynesian economics. I fell rapturous just typing his name.
By subscribing to that "religion", they are falling for the banksters and the wrong deficit hawks without realizing it.
Stiglitz for President!
"In countries with corrupt and imperfect democracies, they have the wherewithal to resist change. Fortunately, citizens in Europe and America have lost patience."
Is he saying the democracies in Europe and America are not corrupted by the finance sector? That's quite an assumption ...
The number of votes Democrats and Republicans get in the November elections will show just how many Americans "have lost patience".
If you vote for any Democrats or Republicans you have not lost patience.
Tame them? I don't think so. Eliminate them. Make all matters of finance public.
This would be fine, if the financial titans were simply ignorant, however they are manipulating regulation and legislation for short term windfall and the added control that comes with redistribution of wealth to them. They are not in this for long term stability, which is why regulation ( = the people putting limits on this self-destructive addiction) is critical - but won't happen - simply because these titans have gone beyond our reach - only leadership from the top can help us, and that has been totally lacking with current ineffective legislation designed to calm the masses rather than actually reign in abuses.
Unfortunately the "leadership from the top" is owned by the titans.
Stieglitz was the person who Obama would have chosen to lead his economic recovery if he intended to act as President as he had talked as candidate.
An early indication that Obama was (fill in the blank) were his choices of Geithner to head Treasury and Summers to head his Economic Council.
Yes, Obama made some poor choices for his economic team and a few poor choices elsewhere (ok, maybe more than just a few). But, my guess is that if Obama had made better choices, say Stiglitz or Krugman, some republicans might have caused trouble. They might have even accused Obama of being a 'socialist' or something nearly as bad.
Obama made great choices if you consider the only metric he measures succeess by is how many corporate dollars he attracts to the Democratic Party.
The Republicans have been calling Obama and most other white house Democrats socialists no matter how right wing their appointees are.
You need to be extremely right wing to prevent Republicans from calling you a socialist.
it is, perphaps, about time we understand two things about our social organization.
first, the most important force to promote growth and therefore wealth in a society is the power of money.
but the power of money is in the hands of a few people.
these people control the central banks all over the world. this is why, i call them: the lord of capital.
in addition to controlling the central banks, they control commercial banking, industry,mining, agriculture and trade world-wide.
secondly, the major political asset under the control of the lord of capital is the traditional political parties.
and through the control of the political parties. our lord controls every State.
in other words, the executive, the legislative and the judiciary "powers" are also powers answerable to the lord of capital
as the federal reserve bank is. as well as the european central bank and the bank of china.
do we envisage taming the financial sector.
let us deprive the lord of capital of his privilege to run all central banks...and a new world would just emerge from the ashes of this crisis.
Liberals like Stiglitz are well-intentioned, but they just don't get it. Who says that finance is a means to an end, or is supposed to serve the needs of society? Certainly not those who own and run major financial institutions. For them finance is a means to one end only: profit. And government, as constituted in capitalist society, can't make these institutions serve larger social purposes because they are more powerful than it is.
The optimism hinges on the noton of "government stepping in" as expressed by Mr. Stiglitz near his conclusion. Expecting loss of patience by Americans and Europeans is relying on a mirage. The masses are controlled by the media arms of the financial industry. Don't expect solutions from national press, magazines, broadcast TV, cable, radio and elected officials, as the fix is in already. The Internet is the only place to try to reach people, accepting the fact that the poor and unemployed don't even have that access. If Mr. Stiglitz expects President Obama to do the "stepping in," perhaps he can outline just what the President ought to do. It would be too much to expect Obama to invite Stiglitz to a private chat, as FDR conferred with Bernard Baruch. Having said that, perhaps I am more idealistic than Mr. Stiglitz, who is to be applauded, even as he is ignored by the Obama administration.
Washington is overrun with Bernard Baruchs. They tell the President what he will do.
End USURY: INTEREST! Nationalize all banks! Outlaw corporations! Abolish the military! That ought to get things off to a good start. Otherwise you can kiss it all good-by.
Stiglitz writes here:
"But financial markets are a harsh and fickle taskmaster. The day after Spain announced its austerity package, its bonds were downgraded. The problem was not a lack of confidence that the Spanish government would fulfill its promises, but too much confidence that it would, and that this would reduce growth and increase unemployment from its already intolerable level of 20%. In short, having gotten the world into its current economic mess, financial markets are now saying to countries like Greece and Spain: damned if you don't cut back on spending, but damned if you do as well."
He's pretty much hinting at who is in charge of international markets here. The smaller nations lack leverage compared with international finance. Meanwhile, who is really in charge of international finance? No clear answer from this article...just a hint.
How's your personal credit rating? "damned if you don't cut back on spending, but damned if you do as well."
I keep asking people around me if we are headed for inflation or deflation. Nobody seems to have an answer. One thing does seem certain: there will be no "recovery."
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Dare we conclude that an international banking cartel, fighting the "too big to fail" reformers, need their size in order to rule over small and even medium size countries in this 21st century version of financial totalitarianism? Question, how many banks in Israel were hurt by the sub-prime crisis, or did they "magically" evade the crisis?
fd3200 asks:
"Dare we conclude that an international banking cartel, fighting the "too big to fail" reformers, need their size in order to rule over small and even medium size countries in this 21st century version of financial totalitarianism? Question, how many banks in Israel were hurt by the sub-prime crisis, or did they "magically" evade the crisis?"
Fascinating questions.
Israel exists in the absence of internationally recognized borders.
Israel has no Constitution.
Israel demands that its "settlements" in Palestine be guaranteed "natural growth," which translates to progeny. Out-populate the Palestinians. This same issue exists within Israel...
Divide the question: "how many banks in Israel were hurt by the sub-prime crisis, or did they "magically" evade the crisis?"
Does Israel actually have a "bank"? I don't know. What I do know is that given the SUPPLICATION of the West to the condition called Israel, the latter doesn't really need a bank.
The "banks" in Israel need not be Israeli banks.
Here, I go off the PTSD edge: Maybe if Lehman Brothers had understood, then maybe none of this would have happened!
How's that for Wizard of Oz?
Understood WHAT?
What could be understood in the flurry of nasal coke and the best pot money could buy? Just ask the latest What's-his-name, Spitzer.
Yeah, I share some positions of the so-called TEA Party.
How many of these Titans of Finance took time out to even glance at the moon?
PTSD! I'm nuts! Do you get this yet? Al Gore is PTSD!
Now, so is his wife. (I always thought she was half nuts...)
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