Frank Taylor

It is perhaps just as well that we can so easily lose count of the deluge of articles in the financial columns and across the broadcast media on the financial crisis. At least ... as some degree of realisation, if not of comprehension, reluctantly dawns ... this crisis is no longer being called merely a 'credit crunch'.

But read one of these articles, read them all. They exude a shallow, formulaic mixture of self-righteousness, panic, speculation and a febrile style of description which must be rated more dramatic by their writers than by their readers. Much of the resulting verbiage must surely compete as prospective wallpaper with the share certificates of Lehman Bros, Bear Sterns or Indybank. Rarely does anything passing as intelligent analysis get into, let alone beneath, the cutaneous layer. Of course the Issue That Shall Not Speak Its Name ... the process by which money is created ... remains firmly beyond the pale as a subject of debate.

Although I do not normally rely on lengthy verbatims from the works of others ... and by that I intend no necessary criticism of those who do ... the following from Wolfgang Munchau in the Financial Times of 7th July, particularly caught my eye.

"If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation.

But there might be better explanations. As the Bank of International Settlements said in its latest annual report, subprime might have been a trigger for this crisis, but not the cause. We do not have a full understanding of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists - not in their role as teachers and researchers, but as policy advisers and policymakers."

So far the fare is as we might expect. An economic journalist, whom we might expect to be well versed in such matters, achieves a moment of epiphany when he realises that a rapid monetary expansion might have consequences above itself. Sadly this epiphany does not extend into his oxymoronic view of 'money and credit', let alone beyond. Neitzsche once opined that 'men will always believe what is seen to be strongly believed in'. Here we have it in spades.

"The worst is for economists to try out their own theories for themselves. This happened to several highly respected academics who have since become central bankers or finance ministers. If, or rather when, they turn out to be wrong, they risk a double reputational blow - as policymakers and as academics. So do not count on them to change their mind when the facts change.

Several of them have been leading proponents of an economic theory known as New Keynesianism. It is, in fact, probably the most influential macroeconomic theory of our time. At the heart of the New Keynesian doctrine stands the so-called dynamic stochastic general equilibrium model, nowadays the main analytical tool of central banks all over the world. In this model, money and credit play no direct role. Nor does a financial market. The model's technical features ensure that financial markets have no economic consequence in the long run."

In the stochastic world stuff just happens more or less out of thin air. It is a concept intended to chime with the message of globalisation; that we ordinary mortals are not, nor ought we to be, collectively in charge of our own destinies. Free markets and the Masters of the Universe will see to all that on our behalf. All we need do is to keep them in the manner to which they have become accustomed.

'Stochastic' is a manufactured word indicating complexity with unpredictability. The theory, such as it is, developed in response to the work of one Robert Lucas. His contribution, once stripped of its eye-watering jargon, was to say that because stuff has happened once, it ain't necessarily going to happen again and in the same way, especially if something new - such as a policy - is added to the equation.

As a small mitigation we might take comfort from the fact that economists now realise that economies are complicated. Aside from that it is wondrous how such a simple infant of an idea, when it is born to serve a powerful interest, swaddled in gobbledegook and laid in a manger of academic self-interest, can reap such a rich bounty of research grants, fellowships and directorships.

At this juncture we might do well to remember that seven decades ago universities across Northern Europe were filled with learned professors earnestly studying eugenics. Thus a prevalent ideology, itself created in support of the dominant power interest, constructs its supporting academic hagiography not from the ether of truth and objective science, but from the base clay of ambition, obsequious obedience, conformity, cowardice and greed. Let us continue:-

"This model has significant policy implications. One of them is that central banks can safely ignore monetary aggregates and credit. They should also ignore asset prices and deal only with the economic consequences of an asset price bust. They should also ignore headline inflation. An important aspect of these models is the concept of staggered prices - which says that most goods prices do not adjust continuously but at discrete intervals. This idea lies at the heart of some central bankers' focus on core inflation - an inflation index that excludes volatile items such as food and oil. There is now a lively debate - to put it mildly - about whether an economic model in denial of a financial market can still be useful in the 21st century.

So when economists tell us that we need to keep real interest rates negative, just as we did for long periods in the past 15 years, or that we now need to bail out homeowners and banks and raise our national debt in the process, or ignore any considerations of moral hazard while the crisis is raging, we might want to question the recipes that got us into this mess are also most suited to get us out again."

Thus we are led to what the Masters of the Universe wish to hear: that credit-based quasi-money can go on expanding more or less indefinitely; that inflation, and by implication the Great Unwashed who have to bear the brunt of it, does not matter; that the doings of financial markets have no enduring consequence, other than to us, that same Great Unwashed. All that matters is that when the card castle crashes we are required to pay even more in tribute. Thus the Masters of the Universe might achieve their nirvana of error without fault, crime without retribution, hubris without nemesis and sin without penance.

These are no mere questions of emoluments and bonuses, risk, speculation or competence. It is about the creation of an oligarchy and of the expectation by that oligarchy to be paid generous tribute whilst being shielded from any consequence. It comes down to the biggest begging bowl in history now being held before the US Congress.

"If we believe, as the BIS does, that a rapid expansion of money and credit has either caused, or significantly contributed to, the build-up of asset price bubbles and higher inflation, the opposite policy conclusions might be more appropriate.

Under this setting, the priority might not be to impede the fall in asset prices. Real house prices in the US, the UK and several other economies might end up falling by some 40-50 per cent, peak-to-trough, in the downward phase of the cycle. Let this happen and do not implement policies to prevent this fall - such policies might alleviate some pain in the short run for some people but will make the adjustment last a lot longer.

Second, monetary policy should be geared towards price stability first and foremost. When inflation expectations rise, real interest rates should be positive. This would necessitate a large interest rate increase in the US and further interest rate increases in the eurozone as well.

Third, allow some defaulting banks to go bust.

Fourth, implement long-term policies designed to reduce volatility. Amongst these are a change in the monetary policy framework to take explicit account of asset price developments, the removal of pro-cyclical incentives in the banking sector, stricter regulation of mortgages, such as the encouragement of fixed-rate loans and the imposition of maximum loan-to-value ratios, more exchange-rate flexibility in countries with fixed or semi-fixed exchange rates and, of course, the development of alternative energies to reduce our reliance on oil.

We might run a greater risk of a recession in the short run. But a recession is not the worst possible outcome. The worst is for the crisis to go on and on ... to become an eternity."

At least we might see the faintest glimpse of sobriety, even if with the biggest hangover in history.

However as with many drunks, the hair of the dog will be imbibed first. When taxpayer pockets have thus been emptied we might then ask how many times is this dead cat's corpse going to bounce before Herr Munchau and his ilk are compelled to seriously consider the Issue That Will Not Speak Its Name?

Frank Taylor