18 thoughts on “Weekend reflections

  1. I think the China milk scandal shows what happens when markets, companies and products are not regulated and tested properly by full government oversight. China is playing the market game without understanding that free markets unleash extreme opportunistic behaviour in a proportion of the population. Societies with free markets must at the same time guard most vigilantly against these amoral oppotunists.

    You can never simply trust a capitalist or an entrepreneur to be honest though some may be. And a proportion of them are inherently amoral and selfish in the extreme. They must be closely regulated. In the same way you can clearly never trust a banker. The FBI is now investigating over 400 of them (at last count) in relation to the US financial debacle.

    Competition is an inducement to dishonest actions as much as it is an inducement to improve products or prices. The warning “buyer beware” is not enough. People do not possess sophisticated chemical testing laboratories at home to test every edible product they buy. In fact, most milk factories do not run tests sophisticated enough to detect melamine, C3H6N6, as opposed to protein.

    The melamine’s nitrogen content fooled the standard protein test which is used to detect watered down milk. Melamine is implicated in chronic toxicity affecting reproductive system and leading to bladder or kidney stones.

    The market is needed to trade good and allocate resources efficiently, that I grant. However, extensive government standards, oversight, regulation and testing are needed to keep the bastards honest. Time and again we learn this when regulatory standards are relaxed.

    People want to talk about the cost of stringent regulation. Well what about the cost of lax regulation? 50,000 Chinese children damaged at least. Is that a cost worth bearing? Personally, I am extremely suspicious that this scandal was ready to break before the Olympic games but the Chinese authorities smothered the story until the games were over.

  2. Ikonoclast, isn’t the problem more fundamental than just being a matter lack of regulation?

    China provides perfect conditions for this kind of event because it combines two systems which suffer from variations of the same problem of extreme hierarchicalism. Party oligarchy creates a selective environment favouring those who are willing to entirely assent to the Party’s ideology de jour. Corporate capitalism selects for the greediest and most amoral individuals. Combine the two and you get conditions for a perfect storm of corruption.

    Regulation might ameliorate this a little. But it has to work so much against the grain of the system that it would inevitably end up as a stifling bureaucratic nightmare.

  3. Crispin, yes my point was about regulation but I take your point that there may well be other and worse forces at work. Entrenched oligarchies create great problems for sure. I did criticise the Chinese govt in my post above. It’s worth mentioning too, the plutocracy of the US is another such entrenched oligarchy.

    For those who possess a copy of John Ralston Saul’s “The Unconscious Civilization”, I think it’s time to pull it out of the bookshelf and read it again. Those who have not read it should read it now. JRS must be feeling very much vindicated. He has been a trenchant critic of post 1960’s corporatism.

    Among other things, JRS has been a critic of our obsession with economics. He places the western traditions of democracy, humanism, individualism and science as all arising well before capitalism.

    He points out the absurd naivety of the modern belief that capitalism created democracy as one which could be only be held by people who have forgotten history. He points out that capitalism is quite compatible with totalitarianism and of itself offers no force to combat absolutism.

    Corporatism by its nature it undemocratic as it promotes the power of the rich and the managerial class over the people. Those who expect a free market to create democracy in China could be in for a long wait.

  4. Hi…this isnt in regard to your weekend reflection. Im just in the mood for sharing my ideas with the world : ) (I’m Canadian, eh) see below…but you say that your a social democrat, so…i think this is relevant to that…cheers!

    Last year it was reported by TVOs, The Agenda and the Toronto Star, that 20 percent of Canadians were controlling 80% of the pre- tax wealth or conversely that 80% of Canadians had access to only 20% of the pre-tax wealth. those numbers became more pallatable when looked at post-tax ( i forget the exact proportion, i think 60-40) but what ‘post- tax’ wealth meant wasnt clearly explained ie., if the government is controlling the after tax wealth and the babyboomers are controlling the government then whose wealth is it? Still Canada has social programs that are available to everyone so all Canadians do become ‘wealthier’ after tax. But still, I found the numbers disturbing enough, shocking, even.

    The idea below evolved from another idea I had which I called…How to Acheive Worldwide Economic Prosperity,. Social Justice and Environmental Sustainability all for the low low cost of $125 Cdn(per Canadian of course). It suggested that governement take some tax revenues and invest on the part of each Canadian on the day of their birth a small amount, $1000, say , an amount which could then grow throughout their lives and then provide retirement savings ( 1000 dollars invested at 10% for 70 years would provide approx. $1 000 000). Of course you’d have to account for inflation etc. but the basic gist of the idea is that government uses taxes to buy individual ownership in stocks or mutual funds etc. The idea received (not entirely unexpectedly) not a small amount of criticism, and I imagine that given the current financial crisis would recieve even more. How ever if you visit TVOs website (tvo.org) and go to The Agenda/ Your Agenda…”talk about everything else” and do a search…you might still be able to find the idea ( and its criticisms). But as I said its ( and the criticisms!) what led to the idea below…

    If you’ve been paying attention then you know that I sugested that Stephen and Dalton instead of returning, in the past year, taxes to the people (7 billion dollars between them —not to mention the $50 billion Stephen Harper returned to corporations) they could have taken that money and instead, used it to form InnoCan: the Canadian Business and Arts Innovation Cooperative. A co-op owned by all Canadians as equal partners dedicated to the production of Canadian actual and cultural wealth. It would operate kind of like a venture capital organization…would invest in the innovative business (sceince and technology) and arts ideas that Canadians (or non Canadians…) brought to it, but wouldn’t have the same conditions necessary for financing as the banks and other individualist wealthist institutions require. That is… the important thing would be the idea–( the science or technology breakthrough for eg.,). A prospective client wouldn’t have to put up their own collateral or be subject to financial consequences if their enterprise failed ( unless there were serious fraud or some other sort of serious illegality). On the other hand for the enterprises that didn’t fail and became huge successes, Innocan ( and its owners–all Canadians) would retain a large percentage of the profits ( 50-75 percent…the actual amount would have to be determined). Imagine, for example, if RIM had be financed by InnoCan from the get go. The business and arts ventures that InnoCan financed (hopefully over the long term if necessary) would operate purely as private enterprises ( thought presumably they could come to InnoCan for business advice etc.). InnoCan would have as its mandates.. innovation ( of course) environmentalism…equality of opportunity for all Canadians. …balanced approach to work life etc. ( these ‘mandates’ would have to be decided democratically or maybe in a consensus based way).

    When i say ‘have as its mandates’ what i mean is that individuals or groups ( Arts or Business) that came to InnoCan for financing would need to demonstrate to the cooperative how their enterprise would embody these mandates. ie., they would have to ‘prove’ to InnoCan that they were indeed meeting them. and InnoCan would enforce its mandates. So an enterprise that didnt have women ( or men) as 50% of its employees, or couldnt provide evidence to InnoCan that it was working toward that goal, for example, would lose its financing. Enterprises would have have to show how they pro-actively preventing harassment, for example, of religious minorites or of gays in the workplace and how thwy were actively promoting the careers of these individuals. Similarly, an enterprise would have to show how it was acheiving ‘environmentalism’. etc. furthermore, an innovation coop owned by everyone like this might help to provide a buffer to the problem of the off-shoring of labour. As we know right now off-shoring is a 4 letter word. for obvious reasons….good jobs leave wealthy countries to be replaced by lower paying ones. but if the coop owned 50 -75 percent of the company in question, it might actually be in the interest of its owners (the population of the country). in other words, part of the point of these mandates would be to solve the problems that government is currently unwilling or unable to solve.

    I should stress that as the way I see it, InnoCan would be an entirely private organization ( ie., a cooperative with a lot ( an entire country of partners). and be completely transparent and accountable to its owners. The role of government would be to set it up initially and to provide the funds ( the tax that it collects) for its operation ( 2% of the gst or the $6 billion that Harper returned to consumers this year, or perhaps %10 of the $50 billion corporate tax cut!) and the funding would have to be stable perhaps constitutionalized so as not to be left up to whichever party happens to be in power. ( especially initially..the first 25 or 50 years? in order that its efficacity can be assessed). The wealth earned by the cooperative’s successful ventures would be returned to its owners. How it is returned would be up for the cooperative to decide…it could be returned as the ‘yearly membership fee’ for example which would have the advantage, after it became a going concern, of no longer needing to tax the population in order to fund itself. ( something that should appeal to the right). Another possibility is that it could be returned as a guaraunteed annual income to its members or it could go to pay for health care and other social programs that are important to Canadians etc. Clearly, one would expect more sucessful than non-sucessful ventures.

    But cultural wealth would also be important to InnoCan. and there are two ways of looking at this. Commercial cultural weath and non-commercial (or innovative)cultural ‘wealth’. Commercial cultural wealth would be things like commercially intended films or music or novels which might not be ‘innovative’ but might still generate wealth for the cooperative in a business sense. and that could be significant…a film which costs 5 million to make, say, might generate 15 million in revenues, 10 million of which would be profit for the cooperative.furthermore such a film might still be Canadian in content and help to provide a sense of identity to the Canadians watching it and a sense of the canadian indentity ( to the extent that there is one) to those in foreign countries.The non-commercial cultural wealth would be things like experimental or theoretical visual art or music, enterprises which rarely generate ‘wealth’ in the traditional sense, atleast not immediately, but can be important to the identity or ‘cultural wealth’ of a country but again often not recognized as such atleast immediately by the general population. Yes I realize that we already have institutions in Canada for this kind of thing…mystifying and restrictive as they may be… like the Canada Council or the NFB. It really comes down to whether or not you believe that right now the institutions we have ( commercial or not) are working well and are accessible and that enough ‘art’ commercial or not is being made by Canadians. I see this as enhancing an arts funding regime (commercial or not) which currently funds a fraction of the Canadian art of any discipline, that could be being funded and produced. Just think if InnoCan had financed Anne Murray’s, or Celine Dion’s or Shania Twain’s, or Alanis Morisettes, or Avril Lavigne’s carreer from the beginning!

    Similarly there would be room for the funding of ‘businesses’ that might not be ‘innovative’ but might still generate wealth for the co-op perhaps someone needing funds to start a Tim Hortons franchize, for example, but can t get it from a traditional individualist wealthist institution. InnoCan which has a differnt mandate might be able to step in.

  5. JRS seems on the right track in the middle there. Capitalism didn’t create democracy, humanism, individualism or the scientific method. It’s clear however that if you manage to develop those elements, capitalism will come along too, ie. capitalistic behaviour is an emergent property of a humanist, democratic, individualistic, scientific society.

    But he is wrong that capitalism is compatible with totalitarianism, since capitalism requires private ownership of the means of production and largely free exchange. Capitalism is, however, compatible (in the sense that it can co-exist) with severe political repression. Socialism, of course, is on the wrong side no matter how you look at it: it cannot function without severe political repression, and is not only compatible with totalitarianism but has a very strong tendency to actually and quickly descend into that state.

    The answer? Social democracy! Wait, wait… sorry… no. Err, neoliberalism!


  6. Let me be the first to offer a bold, revisionist view. Greg Sheridan at The Australian may well be judged, ultimately, a great journalist, especially on foreign policy, especially on the war on terror.

    Also, due to the fact that he’s been right off the planet on more than a few things, I think that a recognition of Sheridan’s true greatness will take more than a few decades and I’ll go out on a limb and say that it may not actually occur until the human race is long gone and the judgement can be made by some transcendent AI cloud that chooses to analyse some old copies of The Australian.

  7. It will be interesting to see which way the Murdoch owned paper outlets jump re the big bailout!?And will they suggest a rush on Gold and Silver,or stacking up their newspaper,add some vinegar and flog it as toilet paper!? N.S.W. has schools out,and parents normally are not worked up in all the details of money and the details of such.This could be tragic,or at least a more intense scrutiny heard before, but with not the same intensity.

  8. I would like to draw attention to a series of essays by George Mobus on ‘Sapient Governance’ in which he explores the relationship and consequences of varying amounts of wisdom versus cleverness in modern humanity, and trys to set out a system of governance for the future and challenges to implementing that system.


    The recent financial events are woven into the theme which is about the cognitive capacity we Humans have or not, to deal with the challenges currently facing the world.

  9. I wonder if we could (briefly) put aside the unending pissing contest over which end of the egg to open – no,wait, make that the relative merits of social democracy and neoliberalism.

    There are more practical questions we should be thinking about:

    Why has the economic meltdown been largely confined to the US?

    Were they just unlucky?

    Are we next?

    Some commentators have suggested that the Basel II financial regulatory system is fundamentally flawed. If that’s the case, we’re all potentially in serious trouble because that model is used right across the OECD.

    Personally I think what happened in the US is a classic speculative bubble exacerbated by a massively expansionary fiscal and monetary policy and ineffective banking regulation.

    Of those three elements, there’s been clear signs of a speculative bubble in Australia and the UK (and probably elsewhere too).

    Government monetary and fiscal policy has been less irresponsible in most other countries than in the US.

    So far too it appears that banking regulation in other countries hasn’t been as disfunctional as in the US.

  10. The Economist has an excellent article on the bail-out which answers a number of questions I’ve been wondering about.

    Some quotes:

    “Both the crisis and the authorities’ response have been called the most sweeping since the Depression. Yet the differences from that era are more notable than the similarities to it. From the stockmarket crash of 1929 to the federally declared bank holiday that marked its bottom, three and a half years elapsed, and unemployment reached 25%. This crisis has been under way for a little over a year and unemployment is just over 6%, lower even than in the wake of the last, mild recession. More than 4% of mortgages are now seriously delinquent (see chart 1), but the figure topped 40% in 1934.”

    “Experience, at home and abroad, is a poor guide. In past episodes authorities have typically not committed public money to their financial systems until bank failures and insolvency have become widespread. The first wave of savings-and-loan failures came in the early 1980s; the Resolution Trust Corporation was not created to dispose of their assets until 1989. Japan’s banks began to fail in 1991, but a mechanism for taking over large, insolvent banks was not set up until 1998. Mr Paulson and Mr Bernanke are attempting to prevent the crisis from reaching that stage. “The firms we’re dealing with now are not necessarily failing, but they are contracting, they are deleveraging,â€? Mr Bernanke told Congress. They are unable to raise capital and are refusing to lend, and that, he said, is squeezing the economy.”

    “The intensification of the crisis came not from the banks but the “shadow banking systemâ€?: the finance companies, investment banks, off-balance-sheet vehicles, government-sponsored enterprises and hedge funds that fuelled the credit boom, aided by less regulation and more leverage than commercial banks. As home prices fell and loan losses mounted, more of the shadow system became insolvent.

    Insolvency cannot be cured with more loans, no matter how easy the terms. It requires more capital, which in deep crises only the government can provide. Mr Bernanke’s groundbreaking paper on the Depression, published in 1983, noted that recovery began in 1933 with large infusions of federal cash into institutions, through the Reconstruction Finance Corporation, and households, through the Home Owners’ Loan Corporation. They were, he wrote, “the only major New Deal programme which successfully promoted economic recovery.â€?”

    “Mr Paulson’s first proposal left Democrats cold: it would give the Treasury virtually unchecked authority for two years to spend up to $700 billion on mortgage assets or anything else necessary to stabilise the system. It looked like a power-grab. Democrats countered with several conditions: troubled mortgages would be modified where possible to keep homeowners in their homes; an oversight board would watch over the programme; taxpayers would share any gains for participating companies via shares or warrants; and executives’ compensation would be capped. By September 24th, Mr Paulson seemed to be bending to all these conditions.”

    (These demands by the Democrats by the way match almost exactly the list of concessions the Republicans claimed days later they required before signing off on the deal.)

    “Assuming it comes into existence, there are still numerous risks surrounding the TARP. The first is that it does too much. At $700 billion, the amount allocated to it easily exceeds the Federal Deposit Insurance Corporation’s (FDIC) estimate of roughly $500 billion of residential mortgages seriously delinquent in June, out of a total of $10.6 trillion, though that figure will rise. The Treasury has sought broad authority to buy not just mortgage securities but anything related to them, such as credit derivatives, and if necessary equity in companies weakened by their bad loans.”

    “When the loans to AIG and Bear Stearns assets are added in, the gross public backing so far approaches 6% of GDP, well above the 3.7% of the savings-and-loan bail-out in the late 1980s and early 1990s (see chart 3). That would still be much less than the average cost of resolving banking crises around the world in the past three decades, which a study by Luc Laeven and Fabian Valencia, of the IMF, puts at 16%. One reason why bail-outs, especially in emerging markets, have been so costly is inadequate safeguards against abuse, says Gerard Caprio, an economist at Williams College. “There was a lot of outright looting going on.â€?

    The Congressional Budget Office had pegged next year’s federal budget deficit at more than $400 billion, or 3% of GDP. Private estimates top $600 billion. Tack on $700 billion and various other crisis-related outlays and the total could reach 10% of GDP, notes JPMorgan Chase, a level last seen in the second world war.”

    There are at least two key differences in the current situation compared to WWII.

    1. Back in World War II the US government was borrowing primarily on domestic markets not internationally.

    2. US GDP now is much bigger as a percentage of the world economy than it was in the 1940’s. $1 trillion represents a sizeable proportion of total world annual savings.

    “The consequences will probably not be so far-reaching. The true cost to taxpayers is unlikely to be anywhere near $700 billion, because many of the acquired mortgages will be repaid. The expansion of the Fed’s balance sheet reflects a fear-induced demand for cash, which drove the federal funds rate above the 2% target.

    It is more likely that the programme will not go far enough. Conscious of the public’s deep antipathy to anything that smacks of favours for Wall Street, politicians from both parties have insisted that the protection of the taxpayer be paramount. Yet the point of bail-outs is to socialise losses that are clogging the financial system. If taxpayers are completely insulated from losses, the bail-out will probably be ineffective. “The ultimate taxpayer protection will be the market stability provided,� Mr Paulson argues.

    This is especially critical in deciding how the government will set the price for the assets it purchases. An impaired mortgage security might yield 65 cents on the dollar if held to maturity. But because the market is so illiquid and suspicion about mortgage values so high, it might fetch just 35 cents in the market today. Recapitalising banks would mean paying as close to 65 cents as possible. Those that valued them at less on their books could mark them up, boosting their capital. On the other hand, minimising taxpayer losses would dictate that the government seek to pay only 35 cents. But this would provide little benefit to the selling banks, and those that carried them at higher values on their books could see their capital further impaired.”

    “This will not come without a price. The unprecedented intrusion of the federal government into the capital markets seems certain to be accompanied by a heavier regulatory hand, something on which both Barack Obama and John McCain now agree.

    Even without new rules, more of the system will be regulated because so much of it has been absorbed by banks, which are closely overseen. Sheila Bair, chairman of the FDIC, thinks this is a good thing. Banks were relative pillars of stability because of their insured deposits and the regulation that accompanied it. Although some banks have failed, she notes that other banks, not taxpayers, will pay the clean-up costs. Now that institutions like money-market funds are caught by the federal safety net even though that was never intended, they can expect to pay for it.

    Yet predictions of a sea change towards more invasive government are premature. The Depression witnessed a pervasive expansion of the federal government into numerous walks of life, from trucking and railways to farming, out of a broadly shared belief that capitalism had failed utterly. If Mr Paulson and Mr Bernanke have prevented a Depression-like collapse in economic output with their actions these past two weeks, then they may also have prevented a Depression-like backlash against the free market.”


  11. On the impact of US government borrowings of $1 trillion or more on world investment rates:


    “After fluctuating around 22½ per cent of world GDP in the 1980s and 1990s, the world saving and investment ratios declined after 2000, and currently stand at around 21½ per cent of GDP, slightly below their historical averages for the period under review (Graph 2).5 Much of the recent decline in world saving reflects developments in the US, as the level of saving outside the US has held steady at around 24½ per cent of GDP, while much of the recent decline in world investment can be attributed to developments in the non-US economies.”

    Let’s say world savings rates are 20% of output.

    World output is approximately US$55 billion at current nominal exchange rates or $65 billion in purchasing power parity terms.

    So total world savings per year are around $11-13 trillion. The US government over the next year will need to borrow close to 10% of total world savings.

    US consumer borrowing will probably fall as the economy slows but US corporate borrowing will probably increase as firms deal with their liquidity problems.

    The United states current account deficit was close to $700 billion back in 2004. I wouldn’t be surprised if its now close to $1 trillion.

    So all up the US is likely to be looking to borrow the equivalent of 20% of world output.

    At the moment I’m really, really happy that my business involves importing books from the US because I think the $A cost of my stock will be going down quite a lot.

  12. Ian, thanks for the excellent links. Sorry my country is run by 1% who benefit from serial crises of neoliberalistic capitalism. Note they don’t all live here — the media mogul Rupert Murdock has considerable influence in U.S. politics, mostly used for ill.

    While economists love to savage her unpersuasive economic arguments, Naomi Klein does a reasonable job of highlighting a real problem in “The Shock Doctrine.” Crises are now viewed by an opportunistic investor class as engines of profit, and thus incentives to preclude crises are diluted or eliminated. We’ve outsourced military functions to Blackwater, and Blackwater only continues to exist if military problems persist. How does the world benefit from corporations that live on endless war to profit?

  13. So how will the ban on short-selling work on semi-private exchanges like Archipelago where regulation and oversight are much laxer?

    I don’t even want to think about the “dark pools”, which are mechanisms to allow people to buy and sell stock without revealing their identity or the volume of stock they’re buying or selling.

    Also, if a speculator wants to bet on a stock falling can’t he simply buy a stock from an institutional investor or merchant bank at $10 with a put option to sell it back to them at $8 in a week’s time?

  14. A question John. You have often written about the equity premium problem.

    Are not the current events in capital markets good reasons for insisting on a premium return on equities? I think Mandlebrot makes this sort of point. Very occasion long-tailed events mean investors are smart to insist on what look ‘above average’ returns.

  15. #17 Indeed they are, Harry. Of course, this is a problem specific to equities and related financial assets, not a description of what is happening to the underlying return on capital. So, there is no reason for governments to regard the rate of return on equity as being welfare relevant for example in discounting returns to public investment.

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