Business Times - 19 Dec 2008
Being centrist in helping the poor as well as the middle classes should do it
By PAUL SAMUELSON
IT IS an old story when a bubble in real estate is followed by a crash. However, what caused chaotic meltdown in Wall Street and around the globe this time was an utterly new factor - namely that this bust in home construction and mortgage borrowing impinged on the new Frankenstein inventions of mathematical financial engineers.
Virtually no pundit in Wall Street understood the strange things that were happening from week to week. Investment banks such as Goldman Sachs and Morgan Stanley, as well as huge ordinary banks such as Bank of America, suddenly discovered that their debts had soared way above their available assets.
Oddly, actions on Main Street, where people look for jobs and hope to earn enough income to both save for rainy days and eventual retirement, were slow to fall much in 2007 and 2008. But by now, as sure as the sun sets at night, Main Streets all over the world are hurting a lot. Their hurts are directly traceable to the Wall Street shenanigans. According to forecasters at the International Monetary Fund and the World Bank, the worst is still to come; and it may last longer than anything since the 1929-1939 years of the Great Depression.
As a macro economist, I try to keep an eye on financial markets and on how central banks - the US Federal Reserve and the European Central Bank, as well as the centuries-old Bank of England - react to try to lean against the adverse winds of speculative markets. That occupies my mathematical mind.
But more importantly, what occupies my heart as a scholarly economist is what's likely to happen to families in the first years of Barack Obama's presidency. How will he repair the damage from eight years of George Bush's bungling?
I must agree that government bailouts were necessary to forestall a complete economic collapse. President Franklin Roosevelt discovered that in his first 1933 post-inauguration week. But as the New Deal leader who saved the capitalistic system, Mr Roosevelt learnt that those bankers, after being saved, firmly refused to venture into making loans to risky businesses and families. How then did the New Deal succeed in wiping out most unemployment by 1939? Today's economists under 60 years of age have forgotten the answer to that question - if indeed they ever did know the true answer. Even Fed chief Ben Bernanke, a prize scholar at Harvard and MIT, was unduly influenced by the late Milton Friedman's crude monetarism when he wrote his PhD dissertation on the Great Depression in 1979.
Actually, neither the Federal Reserve nor the Bank of England did the heavy lifting that restored high employment and healthy growth in real gross national product by 1939. Why not? Early on and for much of the 1930s, central bank interest rates had dropped to nearly zero.
The Wall Street Journal carried a story this week that US prime, safe, 90-day Treasury Bills cleared the auction market at a zero (!) rate of interest. That means that Mr Obama starts out in a 'liquidity trap' much like that which has been keeping Japan in a 1991-2008 slowdown. During a liquidity trap, the smart thing to do is hoard money and not spend it on labour or consumer goods.
Go back and read the 1987-2006 speeches of Alan Greenspan or governor Mervyn King at the Bank of England. Were they away from school the day that concept was taught?
Current evidence and past economic history suggest strongly that during the Obama presidency, it will be massive doses of deficit fiscal spending that will pull Europe, America and Asia out of the post-meltdown slump. Only after that will the Federal Reserve's normal tools begin to be restored to potency.
The new president will be splashed with contradictory advice. Here is my suggestion: Seek the middle way by being a centrist. That's not because you can't make up your mind. On the left are the failed notions of Marx, Lenin, Stalin, Castro and Mao. All of these were like idiotic Keystone cops when it came to organising any large economy. On the right are the extremist libertarian views of the post-Reagan crowd. Yes, market systems alone can preserve this millennium's affluence and progress. However, unregulated markets will generate their own demise, as we have seen.
Centrists are doomed to have to make compromises. In good times, it can be folly to keep bumbling Detroit car companies in business. (Harvard's Joseph Schumpeter called this 'capitalism in an oxygen tent'.) When rates of unemployment swell to 10 per cent or above, a different decision might be justifiable.
Dropping newly printed greenbacks from helicopters can be one way to generate growth. Such new currency will get spent rather than being hoarded or saved. However, spending that new currency on roads to somewhere will be better than roads to nowhere. In Japan, construction industry lobbyists determined where public spending should be directed. In America, we can do better, provided that the old Bush gang has become only an unpleasant memory.
Moral: Be centrist in your decisions about helping the poor as well as the middle classes. Females and Hispanics and others who come late to the feast deserve justice in the centrist court. Those who presume to give advice become boring fast. Still, I will offer a final important caveat. A centrist must, of necessity, be a 'limited' centrist. A centrist can be successful only in a limited degree to lessen the inequalities that are inevitable in a market system. That's far from abolishing most inequality.
To pursue that unobtainable, quixotic goal would be a sure way to plunge the modern world into the past stages of stagnation. -- Tribune Media Services
The writer is considered a founder of modern neo-classical economics and was awarded the Nobel Prize for Economics in 1970
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