The hole in the political landscape

One way to think about the political impact of the GFC is to look at the range of political positions it’s rendered untenable. This range is large, encompassing, in the US context, everyone from Bill Clinton to Newt Gingrich. More generally, it covers anyone who embraced the claim that a US-style economic system, as of, say, 1995-2005, was the best that could possibly be achieved, and could only be improved by making government smaller and/or more business-like.

Minus the US-specific triumphalism, this range includes the positions held by most major political leaders in the developed world at the time the crisis erupted, notably including both John Howard and Kevin Rudd, not to mention George Bush and Barack Obama. It covers anyone who saw the growth of the financial sector and the explosion of global financial transactions as beneficial and who regarded with equanimity phenomena like the growth of inequality and the decline of trade unions which both resulted from and reinforced these trends. Virtually everyone holding this view downplayed or disregarded the looming crisis until it exploded in late 2008.

A critical assumption underlying this views is that the system is stable enough to maintain equilibrium without substantial government intervention and without collapsing into crisis. As far as I can tell, no one seriously argues this in relation to the current financial crisis. There are those who argue that the kind of massive intervention we’ve seen shouldn’t be undertaken and/or will only make things worse. But, AFAIK, no one seriously suggests that, without intervention the system could right itself fairly fast and return to the situation prevailing in, say, 2006.

What are the implications of the collapse of such a large section of the political landscape, both for those who formerly occupied it, and for the rest of us?

Whatever their original position, politicians who actually have to manage national economies have scrambled to find some tenable ground to the left of the chasm that has opened under them, whether this means nationalising financial institutions (Bush was actually the first to do this, I think), taking over financial markets (Ruddbank for example), large-scale Keynesian stimulus packages (Rudd, Obama) or raising taxes on the rich as a first step to paying off the bills that are now piling up (Obama, Brown, hopefully Rudd in the near future).

Unsurprisingly, the immediate reaction (most evident in the Geithner plan) has been to aim for the minimal possible shift, in the hope that as much as possible of the status quo ante can be restored when the crisis is over. But it should be obvious by now that large and irreversible changes are already underway. Rudd has probably gone further than most in recognising this, at least in rhetorical terms.

The only tenable position for anyone who wants to maintain any part of the existing economic and social order is Keynesian social democracy, modernised to deal with the developments of the last few decades, and disciplined enough to avoid the disasters that brought down the Bretton Woods system in the late 1960s and early 1970s.

For those out of power, there are rather more options. The most common is simple wishful thinking, scoring cheap political points by opposing bailouts and stimulus packages while offering no reason to believe that the system can be sustained in their absence. This is the line taken by the Liberals in Australia and the Republicans in the US. It was evident in a lot, though not all, of the talk surrounding the teabag rallies in the US recently.By contrast, and as I predicted, the National-ACT government in NZ is offering stimulus packages Australia dvd and abandoning promised tax cuts.

The remaining option is the view that a catastrophic collapse of the existing system is both inevitable and desirable, and that, out of its ashes will emerge something new and better. For different values of “something” this is the view of Marxists, Austrians and Randite libertarians, some Greens and at least some of the populists who turned up at the teabag rallies. Obviously, the crisis implies a much higher probability for the “inevitable” part of the story than most people would have given it a year ago. On the other hand, there’s very little agreement on the desirable alternative that might emerge.

Adding-up constraints imply that the political mass that occupied the now-exploded part of the political landscape must be redistributed over the remaining territory. It will be interesting to see how this process evolves.

35 thoughts on “The hole in the political landscape

  1. #18 Ikonclast,
    There is “good debt” and there is “bad debt”. Unfortunately the way we create debt mixes the two so we cannot tell good from bad. Good debt is where you lend money you already have. Bad debt is where you lend money you do not have.

    The fractional reserve system was set up so that when there was a run on banks there would be money to pay depositors. That is, because banks lend long and borrow short it was a good idea for them to have some money in short term deposits to cover the demands when people started to withdraw deposits.

    As we have seen when we get a serious run then the government has to step in and guarantee they will keep supplying the banks with money so when it is really needed it does not work.

    One of the “side effects” of the system is that banks now become the way that extra currency is introduced into the system. Another side effect is that banks do not even know which money is “new money” and which money already exists.

    It is this mechanism of money creation that is the main cause of the problem because money markets cannot work as they are supposed to work. Market are meant to work so that price is the controller not so price is the driver. That is when demand increases supply can increase and while we are waiting for supply to increase price will go up. Price cannot operate that way in a market where we can increase supply instantly by as much as we like and where we use the mechanism of availability of existing assets (money) against which to back our loans to control the supply of money. That mechanism is a positive feedback and leads inevitably to asset bubbles and then to contractions. It cannot work no matter how many regulations we put on the system.

    Change the way extra money is created so that it does not require a loan to be created at the same time and it will fix most of the problems with the money markets.

    We can do it without eliminating fractional reserve – which we can still keep – provided the government (Reserve Bank) creates enough extra money backed by assets so that the banks do not end up creating extra money.

    I thought initially that we had to get rid of fractional reserve but I now believe it won’t be necessary if we have other ways of increasing the money supply. The Reserve Bank can then stop trying to guess what the price of money should be and it decides how much extra money to be created through the other mechanisms. It will take a little while for the extra money to get into the system and so price will become the controller it is meant to be.

    The problem with the current stimulus packages is that we are still creating extra money by issuing loans. This reduces the ability of the banks to make loans with existing money and so the contraction continues.

    The circuit breaker is to create extra money without loans. I have suggested one way that will not increase inflation and where the money will be spent wisely. Once we have started to create extra money this way we will see that money markets will start to operate the way they are supposed to.

    The current system is convoluted and uncontrollable. The suggested system is much simpler and it will control itself.

  2. Wishful thinking in your last paragraph, there JQ. I am certain that it will be more along the “terminator” lines where the exploded bits of the monster liquify and pull themselves into a reformed angrier monster, LRA style. And I believe this mainly because this more of a religion for these people, not reason.

    And it is important to read

    http://en.wikipedia.org/wiki/Lord's_Resistance_Army

    to see just how twisted humans can be when when a religious style philosophy can be entangled into a drive for power and dominance. Grasping at every plausible straw.

  3. I predict that the political fall-out from the GFC will probably help more women get into positions of power.

    The GFC was in large measure caused by a poor appreciation of risk. THe investment schedules were too strongly reward-attractive rather than risk-aversive.

    WOmen, by nature, are more risk-aversive. They have more to lose than men as they are the bearers of a limited supply of eggs. They know the risks of putting them all into one undiversified basket.

    So I predict that institutions will hire more cautious and conservative women to do their financial management. Iceland, as always, leads the way in this social trend.

  4. Jack
    #28 Iceland ha ha – when there is a big mess, who did they call to clean up – a woman, a social democrat and greens! A man on the other hand might only talk a lot about how bad the old cleaners were!.

  5. I meant to response earlier to John’s question of whether there are any alternatives to the social democratic response to the global financial crisis.

    It’s true that I haven’t spent much time proposing solutions, simply because I am not sure if there are any. That is, I think the weaknesses in western economies have become too entrenched now that there is not much prospect of avoiding a sustained economic downturn.

    That said, I think the only policies that are likely to mitigate things somewhat are some modest supply-side measures designed to ensure that what is left of the productive economy doesn’t collapse, including:
    – tax reform to reduce loopholes and exemptions, including winding back the Howard government’s tax free super payouts. This would help repair the fiscal side of things without hurting the economy too much. It could also be used to finance some tax relief for small business and average workers who are keeping the economy going
    – some increases in infrastructure spending
    – cut wasteful spending like the FHOG
    – reduce small business regulation
    – give failing financial institutions a choice between either going under or accepting conditions like tighter restrictions on lending in return for any assistance
    – wage restraint in order to minimise job losses
    – float interest rates, so that central bank interest rate targetting does not lead to excessive borrowing or asset bubbles

    Other than that, the idea of simply handing out money willy-nilly and hoping people will spend is a silly policy that will achieve nothing.

  6. Monkey’s Uncle @30,

    There are several issues intertwined in your views. I’ll set aside one, namely the name of the political framework – social democracy – on the grounds that while our host has expertise in economics and politics, I have no independent opinion on politicl classification systems. That is, I take Prof. Quiggin’s political classification as a given. As a casual observer I can say that the ideas and policies that go under the term ‘social democracy’ seems to overlap with several political party platforms, sometimes more so than at other times.

    As for the economic content, I can’t agree with you on the following grounds.

    The basic idea of a ‘market’ is ‘exchange’. Supply side economics is not market economics because it focuses only on one side of potentil exchange situations – in aggregate, ‘the supply side’. Similarly, a version of so-called Keynesian economics – aggregate demand management – focuses only on one side of the market. It may well be that for short periods of time in specific countries under specific circumstances, a policy which looks like ‘supply side’ or ‘demand side’ may be relevant.

    The current problem cannot be dealt with by ‘supply side’ policies. The current problem is a financial systems failure. IMO, this failure is largely due to the naive believe that financial markets (almost a misnomer) work like fruit and vegetable markets, characterised by many small suppliers and many small buyers. Furthermore, the ‘supply side’ arguments of tax reductions for corporations and high income earners have contributed significantly.

    The idea of ‘floating the interest rate’ on government money and the idea of reducing the minimum wage to reduce unemployment may well be as solution to a problem, but not the problem we have.

    The problem faced by governments is non-trivial: How to reduce the significant disequilibrium prices between physical and financial assets to make them less incompatible with wages. IMO, the so-called ‘cash handouts’ are one element in this process. Furthermore, there is a lot of double counting in some financial market data (ie aggregation of financial assets) and there is missing data on the characteristics of financial assets. That is, a re-conceptualisation of financial markets is called for.

  7. Excuse me, John Quiggin!

    John Maynard Keynes was a life-long member of the British Liberal Party, and later a Liberal Lord. Your firm linkage of his political and economic philosophy to social democracy is a re-write of history and entirely your construct.

    Keynes loathed the tyranny of trade unions and the evil intent of communists but did express sympathy for socialists though he was deeply sceptical of the efficacy of their favored techniques.

    I strongly recommend you read (or re-read) Minsky – of Minsky Moment fame – and all will become clear:
    John Maynard Keynes by Hyman P. Minsky, 1975 Columbia University Press

    Many in the commentariat characterize the smoothing of economic activity by governments through surplus and deficit accounting as ‘Keynesian’.

    While this was part of Keynes’ General Theory, the full Keynes prescription – notably including, first satisfying the absolute needs of all by raising minimal consumption standards and then turning to the pursuit of the important noneconomic goals of life – has never been tried.

    Keynes regarded himself as economically far to the left of the then-socialist British Labor Party. They, like the conservatives, believed in high investment; Keynes was for high consumption and none of this cossetting of business with tax breaks and government incentives.

  8. David C, I was aware of these aspects of Keynes’ thought, but I think you are making a bit of a leap from “Keynes did not invent ‘Keynesian social democracy'” to “Quiggin invented Keynesian social democracy”. There are some other possibilities.

    Since Keynes died in 1946, it’s hard to say how he would have viewed the Keynesian social democratic model that prevailed for the next few decades and was the first to deliver anything close to the goal of “raising minimal consumption standards” that you mention. And since Keynesian social democracy was developed and named before I was born, I don’t think I can claim the credit for it.

    The point about non-economic goals is an interesting one. I have long had a half-written essay on this, which I will post some time.

  9. ProfQ,

    What DavidC is trying to explain is that there is a tenuous link between Keynes the man and how he is perceived. He is right that Keynes was a lifelong Liberal and was never a supporter of the Labour Party (the promoters of social democracy/democratic socialism).

    I remember a quote of Keynes from 1942 after a dinner with fellow economists when he stated that “I was the only non-Keynesian there”. Considering that Keynes died before the welfare state was properly established, you are right to suggest that he could have demolished the economic principles upon which it was established if he disagreed with it.

  10. Of course, Keynes was paraphrasing Marx. My general point is that detailed discussion of “What X really thought” is primarily of historical interest.

    I’ll ignore your final mischievous imputation, except to spell out my view that Keynes would in fact have supported the welfare state designed, in large measure, by his fellow Liberal William Beveridge. And of course, he would have been right to do so.

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