Wednesday, September 5, 2012

Saving the global economy requires a new plan

In his Telegraph column, Jeremy Warner summarizes voter dissatisfaction with the policies adopted by both the Right and Left to deal with the financial crisis.

As regular readers know, both the Right and Left choose the Japanese model for handling a bank solvency led financial crisis.  This model focuses on preserving bank book capital levels at all costs.  As a result, the burden of the excess debt is placed on the real economy.  Servicing this debt deprives the real economy of the capital it needs for growth and reinvestment.

The result of choosing the Japanese model is, at best, economic stagnation.

Everyplace that the Japanese model has been adopted, it has failed:  Japan adopted it in the late 1980s and it has suffered 2+ decades of economic stagnation; the EU, UK and US adopted it in 2008 and despite massive fiscal and monetary stimulus their economies have not recovered.

There is an alternative policy that both the Right and Left could choose.  That alternative is the Swedish model for handling a bank solvency led financial crisis.

Under this model, banks absorb the losses on the excess debt in the financial system today.  Subsequently, they rebuild their book capital levels by retaining 100% of pre-banker bonus earnings.

Banks can do this because in a modern banking system they are supported with both deposit guarantees and access to central bank funding.  With the deposit guarantees, taxpayers are banks silent equity partner when they have negative book capital levels.

Everyplace that the Swedish model has been adopted, it has been successful:  the US adopted it in 1933 and it broke the back of the Great Depression; Sweden adopted it in the 1990s; and, most recently, Iceland adopted it in 2008 and its debt is back to investment grade and its economy is growing.

Isn't it time that the Right and Left in the EU, UK and US adopt the Swedish model?

Almost wherever you look among the world’s major democracies, incumbent governments, whether they are from the Right or the Left, find themselves deeply out of favour. 
Virtually all the political leaders who were in power at the time the banking crisis first hit have been toppled. Rightly, they have been blamed and punished for their unchecked profligacy and myriad policy misjudgements. 
But now the voters have grown weary of their successors, too. 
Less than a year after sweeping to power, the centre-Right Spanish government of Mariano Rajoy finds itself almost as badly discredited as its socialist predecessor. The same is true of the technocratic government of Mario Monti in Italy, while France has taken only a matter of months to start falling out of love with its newly elected socialist president, François Hollande. 
That the UK Coalition should find itself in much the same space demonstrates that it is not entirely the failings of the euro, or the particular policy leanings of Left and Right, that lie behind the disillusionment. 
Nobody, it seems, has the answers.
Actually, readers of this blog have the answer as well as the citizens of Iceland:  adopt the Swedish model.
The US may yet disprove the rule. It still looks more likely than not that Barack Obama will be re-elected, but in a country where one-term presidents are very much the exception, it’s remarkable how badly he’s doing. For his Republican opponent Mitt Romney to be equal in the polls is a truly damning indictment of four years of going nowhere.... 
It’s the same in France, where Hollande was elected not because voters liked his agenda, but because they wanted to get rid of Nicolas Sarkozy. As it is, Hollande’s scope for action is extremely limited, with no growth, mountainous public debt, rising unemployment and a bankrupt health-care and pensions system. He promised an alternative to Sarkozy’s austerity, but in practice the fiscal squeeze he is enacting is even bigger. Hollande is merely Sarkozy in sheep’s clothing. 
To understand what’s really happening here, it is necessary to revisit the underlying causes of the crisis.
Absolutely, the underlying causes of the crisis needed to be revisited.  At the top of the list for the causes of the crisis would be the rampant opacity in the financial system.

Some of this opacity was created by bankers developing complex products.  However, a sizable amount of this opacity was the result of the regulations developed by the financial regulators.
The consensus is still very much that the main mischief was years of Thatcherite deregulation, which allowed bankers to run riot. In this Brownite narrative, there was nothing much wrong with the pre-crisis economy which sorting the banking system wouldn’t fix. Get the money moving again with repeated rounds of monetary and fiscal stimulus, and demand would quickly return to the way it was. 
Confronted with the uncomfortable truth that bankrupting governments with deficit spending has failed to work as predicted, proponents argue either that there was simply not enough of such spending, or that it has been withdrawn prematurely. The reality is that the unemployment rate in the US has turned out worse with the Obama stimulus than he predicted it would be without it. There’s a shock. 
Regrettably, there is a much more painful and altogether more plausible way of looking at the crisis and its causes than this “get out of jail free” approach. Confronted by a steady loss of competitiveness, governments in many advanced economies started spending more than they could afford to support growth, and they actively encouraged households with low interest rates, credit expansion and misguided social policy objectives to do the same.
Unsurprisingly, this growth has proved unsustainable. To believe that the crisis can be corrected simply by doing more of what got countries into such a mess in the first place is to descend into fantasy. 
The mistake that both the financial markets and many economic commentators continue to make is to think that governments, providing they intervene enough, can somehow magic away the problem. In fact, the best politicians can do is simply get out of the way, thereby allowing the natural resourcefulness of their citizens to show through. In attempting to prop things up, governments are only borrowing from the future and delaying the recovery. 

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