2008 will go down as one of the wildest years in financial history, having witnessed two huge earthquakes that have reordered the political and economic landscape, just as surely as the collapse of the twin towers did on 9/11/2001.
One shock in 2008 was the meteoric rise in energy prices, which crested just shy of $150 a barrel in the summer, followed by an equally bloodcurdling descent. Whole US industries--airlines, trucking, housing, autos--responded in the summer with a near death experience.
Following this oil shock was the cratering of various markets in September and October, which brought to a sudden new intensity the bear market in just about everything that began in the last part of 2007. Commodities, seemingly exempt, succumbed in August after oil prices peaked in July. Emerging markets crashed. Europe crashed. Latin America crashed. Asia crashed. And, of course, so did the good ole' USA.
The dark specter--a return of another Great Depression--seemed suddenly to be decidedly more than a remote possibility. It would be a capital historical irony for that to happen, for US officials have for three generations taken the avoidance of that experience as their lodestar. At least, that is what they thought they were doing. Yet there it was again, big as life and twice as ugly, baying at the door.
Scary times.
The charts that follow in this chapter on financial stress provide a sketch of the havoc now ongoing. Then we'll look to causes, consequences, and remedies.
10/17/08
Six Lessons From the Financial Crisis
1. The conclusion seems irresistible that the defenders of capitalism proved its undoing. The most zealous proponents of free markets put them at profound risk. The financial institutions that stood at the epicenter of the world economic order proved to be based on a scam, at the center of which was the privatization of profit and the socialization of risk. Capital markets whose fundamental rationale was the most efficient allocation of scarce resources for investment failed miserably in their basic function. The most egregious rates of executive compensation ever produced the biggest failures of economic leadership ever. To those of us with a sentimental attachment to free markets as against command economies, all this is a blow.
2. We are made aware of how grave a responsibility is the management of a country’s currency. Money and credit are like oxygen; taken for granted in most circumstances, but when withdrawn inducing asphyxia. In terms of economic theory, the whole experience bears out the vital importance the Austrian economists placed on the credit cycle and underlines their skepticism toward fractional reserve banking. This is not to urge a return to the gold standard, but it is to urge derision and contempt upon those who constructed the house of cards and who ignored its vulnerabilities. There are many villains in the piece, but Alan Greenspan will surely stand out in retrospect as bearing the heaviest responsibility. Blithely indifferent to the dangers of debt and derivatives, he led us down the garden path.
3. We move inexorably toward the socialization of credit risk and a much larger role for the state in the direction of the national economy. Courtesy of Bush and Greenspan, Marx has made a comeback. In The Communist Manifesto, the fifth proposal in Marx’s ten point plan for placing the means of production in the hands of the proletariat was the “centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly.” Marx didn’t get it quite right; we’re getting there via the dictatorship of the kleptocracy. But hey, it's a start.
4. The collapse of America’s credit bubble is very likely to lead, both here and abroad, to the revival of various forms of national socialism. That is not a prediction of the revival of German National Socialism, but simply that the direction of economic affairs is likely to be swayed much more by the dictates of nationalist and socialist impulses. The Euro is especially vulnerable to the centrifugal forces unleashed by the crisis, with unfavorable consequences for the European experiment. Sheer cronyism may win out over state socialism, to be sure, and financial internationalism will battle to survive against the reassertion of nationalism. Still, I wouldn't underestimate the power of nationalist and socialist tendencies in the new era.
5. The opportunity cost of the financial bailout is huge. Moreover, insofar as it is based on the idea of reflating the financial, insurance, and real estate sectors (the FIRE economy), it is very dangerous to long term economic revitalization. The old Wall Street model is broken because most of the things they made money on (securitization, fees, leverage) turned out, in due time, to be based on a fundamental misapprehension of risk. Real estate remains overvalued by various traditional measures. A far more logical use of public resources is the tackling of our energy and environmental problems, both of them requiring large investments in infrastructure and alternative energy. We face the challenge of a generation in adapting to these challenges; the economic crisis, and the response given to it thus far, constitutes a formidable obstacle in doing so.
6. The financial crisis has opened up a great gap between our aspirations and resources. This must have profound implications for American foreign policy. We have a foreign policy more ambitious than that crafted in the heady days of unipolarity in the late 1990s, when observers marveled at the sheer surfeit of American power in its military, economic, ideological, and cultural dimensions. Though American power has weakened on every count, there is no reconsideration of objectives. The last thing that presidential candidates wish to do is to reconcile themselves to limits on American purposes. It goes entirely against the American grain, which treasures happy talk and fairy tales over the recognition of constraint. But finance is inexorable: it sets limits, diminishes horizons, induces constraint. Surely a profound adjustment in America's world role is coming.
2. We are made aware of how grave a responsibility is the management of a country’s currency. Money and credit are like oxygen; taken for granted in most circumstances, but when withdrawn inducing asphyxia. In terms of economic theory, the whole experience bears out the vital importance the Austrian economists placed on the credit cycle and underlines their skepticism toward fractional reserve banking. This is not to urge a return to the gold standard, but it is to urge derision and contempt upon those who constructed the house of cards and who ignored its vulnerabilities. There are many villains in the piece, but Alan Greenspan will surely stand out in retrospect as bearing the heaviest responsibility. Blithely indifferent to the dangers of debt and derivatives, he led us down the garden path.
3. We move inexorably toward the socialization of credit risk and a much larger role for the state in the direction of the national economy. Courtesy of Bush and Greenspan, Marx has made a comeback. In The Communist Manifesto, the fifth proposal in Marx’s ten point plan for placing the means of production in the hands of the proletariat was the “centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly.” Marx didn’t get it quite right; we’re getting there via the dictatorship of the kleptocracy. But hey, it's a start.
4. The collapse of America’s credit bubble is very likely to lead, both here and abroad, to the revival of various forms of national socialism. That is not a prediction of the revival of German National Socialism, but simply that the direction of economic affairs is likely to be swayed much more by the dictates of nationalist and socialist impulses. The Euro is especially vulnerable to the centrifugal forces unleashed by the crisis, with unfavorable consequences for the European experiment. Sheer cronyism may win out over state socialism, to be sure, and financial internationalism will battle to survive against the reassertion of nationalism. Still, I wouldn't underestimate the power of nationalist and socialist tendencies in the new era.
5. The opportunity cost of the financial bailout is huge. Moreover, insofar as it is based on the idea of reflating the financial, insurance, and real estate sectors (the FIRE economy), it is very dangerous to long term economic revitalization. The old Wall Street model is broken because most of the things they made money on (securitization, fees, leverage) turned out, in due time, to be based on a fundamental misapprehension of risk. Real estate remains overvalued by various traditional measures. A far more logical use of public resources is the tackling of our energy and environmental problems, both of them requiring large investments in infrastructure and alternative energy. We face the challenge of a generation in adapting to these challenges; the economic crisis, and the response given to it thus far, constitutes a formidable obstacle in doing so.
6. The financial crisis has opened up a great gap between our aspirations and resources. This must have profound implications for American foreign policy. We have a foreign policy more ambitious than that crafted in the heady days of unipolarity in the late 1990s, when observers marveled at the sheer surfeit of American power in its military, economic, ideological, and cultural dimensions. Though American power has weakened on every count, there is no reconsideration of objectives. The last thing that presidential candidates wish to do is to reconcile themselves to limits on American purposes. It goes entirely against the American grain, which treasures happy talk and fairy tales over the recognition of constraint. But finance is inexorable: it sets limits, diminishes horizons, induces constraint. Surely a profound adjustment in America's world role is coming.
10/16/08
Implications for "Defense"
The national security establishment has barely begun to register the severity of the financial crisis and what it may mean for American foreign and defense policy. The crisis has utterly disordered national finances. It will produce further cascading demands on the public treasury. Given these factors, the constraints on policy are going to be much more exacting than the national security establishment now believes. Defense will not prove to be “recession proof.”
Defining a coherent philosophy in foreign affairs and defense strategy that is respectful of limits is vital. Especially deserving of reconsideration are the grand plans to reorder the Middle East and Central Asia via military power, to make all the world democratic, to expand NATO to embrace Georgia and Ukraine, to threaten or undertake preventive war against suspected proliferators, and to bring the entire world under intimate surveillance. We could save a lot of money if we stopped trying to do what we’re not very good at doing anyway.
The defense establishment is like a huge ship that is difficult to turn and next to impossible to stop in its tracks. But serious savings could be had by reducing force structure and limiting modernization. The most important step is to repudiate the Bush Doctrine and to rivet US military power to defensive purposes. The ground forces, slated to expand, should be reduced.
Obama is seemingly not ready to do any of this. Biden is more hawkish than dovish and will reinforce the tendency toward business as usual. But stark financial constraints and the accompanying search for limits on external ambition will define Obama’s presidency; he needs to realize that sooner rather than later.
First posted: 11/02/08
Defining a coherent philosophy in foreign affairs and defense strategy that is respectful of limits is vital. Especially deserving of reconsideration are the grand plans to reorder the Middle East and Central Asia via military power, to make all the world democratic, to expand NATO to embrace Georgia and Ukraine, to threaten or undertake preventive war against suspected proliferators, and to bring the entire world under intimate surveillance. We could save a lot of money if we stopped trying to do what we’re not very good at doing anyway.
The defense establishment is like a huge ship that is difficult to turn and next to impossible to stop in its tracks. But serious savings could be had by reducing force structure and limiting modernization. The most important step is to repudiate the Bush Doctrine and to rivet US military power to defensive purposes. The ground forces, slated to expand, should be reduced.
Obama is seemingly not ready to do any of this. Biden is more hawkish than dovish and will reinforce the tendency toward business as usual. But stark financial constraints and the accompanying search for limits on external ambition will define Obama’s presidency; he needs to realize that sooner rather than later.
First posted: 11/02/08
California at Height of Bubble
The inflation and subsequent puncturing of the housing bubble has played a great role in the unfolding crisis. Housing is vital because it is the collateral behind a great deal of US debt. Essentially, a great pile of debt and derivatives was erected on a dubious foundation. A leader of the pack was California. With a little money down, which was still required at the beginning of the boom, and you could just print money.California, like Florida and Arizona, was an extreme case. But the mania was general. From 2000 to 2006, the total retail value of housing in the United States doubled, going from roughly $11 trillion to $22 trillion in just 6 years.
As of October 2008, the situation had deteriorated dramatically.
At the end of 2008, Mr. Mortgage delivered yet more New Year's glum in this table, which he calls "the scariest housing-related chart ever."
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