Many people think that Joseph Schumpeter was the first person to explore the idea of ‘creative destruction’. But as Hugo and Erik Reinert explain in a fascinating paper, the idea of ‘creative destruction’ has a long history. In the same paper, they also provide some subtle insights into the meaning of creative destruction.
First, creation implies destruction. When Apple created the smartphone, it necessarily annihilated the sales of dumb-phones and cameras. However “this relationship exists only in one direction and does not function when reversed. Denial does not imply affirmation, destruction itself does not lead to creation”. Nietzsche often explored this theme in aphorisms such as:
Whoever must be a creator always annihilates.
affirmation requires denial and annihilation.
You must wish to consume yourself in your own flame: how could you wish to become new unless you had first become ashes!
Second, the opposite of creative destruction is stagnation. The ‘Great Stagnation’ is the logical consequence of an economic environment where both job creation and destruction are falling.
I find it surprising that those who argued that QE had very little effect in the economy are now ready to blame the central bank for all the damage they will do to the economy when they undo those measures. So they seem to have a model of the effectiveness of central banks that is very asymmetric – I would like to see that model.
One possible model that contains such an asymmetric response is the model of addiction. Let me provide an analogy that I have explored in detail in an earlier post – the history of psychotropic medication in the United States and its usage to combat an ever-increasing laundry list of mental “disorders”. You keep taking the pills and you hang on, you barely function albeit in a somewhat dysfunctional manner. If you increase the dosage the benefits are negligible. But if you stop taking the pills and do nothing else to break the fall then you risk a catastrophic collapse. That is the asymmetric response of addiction.
Unlike the critics that Fatas refers to, I’m not opposed to the withdrawal of monetary stimulus but the stimulus itself. In particular I am opposed to the nature of the stimulus which focuses all its efforts on propping up asset prices. However, unlike most Fed critics who tend to be conventional “austerians”, I’m a strong critic of asset-price based monetary policy and an equally strong advocate for combined monetary-fiscal stimulus in the form of direct cash transfers to households. I support helicopter drops not just because it is fairer and more “neutral” in its impact on income distribution than quantitative easing. I support helicopter drops because it is the parachute that prevents the hard landing if we stop quantitative easing. I support helicopter drops because it is the most free-market of all macro-stabilisation policies. Rather than bailing out banks and firms and propping up asset prices, helicopter drops simply mitigate the consequences of macroeconomic volatility upon the people. I support helicopter drops because it helps us build a resilient economic system as opposed to chasing the utopian aim of perfect macroeconomic stability.
Over the next few months, I will post a lot more frequently on this blog. But most of my posts will not be long essays but shorter off-the-cuff notes and responses to blog posts elsewhere.
The primary reason for this change is that I’m writing a longer, book-length piece on the ‘invisible foot’. Hence its unlikely that I will find the time and energy to write too many other long-form essays on economics. But my reading and writing sessions generate quite a few byproducts which will find their way here.
Thanks for reading.
Many people think that quantitative easing monetises the government’s deficit spending. As I have argued in a much longer post, the question itself is meaningless. Government debt is already monetised when it comes into existence. Government debt is money. Ask any bank or insurer how they view their holdings of treasury-bills and they will tell you that they view them as money. More importantly, they can use their bondholdings as money. Market counterparties accept treasury-bills as collateral and if bondholders ever need “real” money, they can repo their t-bills for real money.
This “moneyness” of government bonds is not a new phenomenon. In the United Kingdom, it has been true since at least the 18th century when the East India Company repoed its bonds with the Bank of England for money. But the money supply is not “elastic” in this manner in all economies. Take a look at the ongoing Chinese liquidity crunch. In China over the last week it is not clear that T-bills can be repoed for money. But in most western economies, this has been the case throughout the central banking era. By limiting the elasticity of the money supply, the Chinese central bank effectively gives up control of the interbank interest rate (hence the spikes in the overnight interbank lending rate). In a financialised economy such as the United States, this would be a catastrophe. In China, it is unclear what impact this would have on the real economy. India suffered such liquidity crises with habitual regularity throughout the 90s with barely any impact on the real economy.
Inflation does not arise from the central bank’s purchase of the stock of existing government bonds. Inflation arises if the government takes advantage of the central bank’s bond purchases to increase its present and future spending. The central bank in Zimbabwe bought its government’s new debt issuance at a fixed price irrespective of the market demand or inflation. But the inflation arose because the government used this commitment from the central bank to embark upon an uncontrolled spending spree. Whatever your views on our current deficit situation, we are not in the same boat today.
If a robot could do everything that a human could, then why would any human be employed? The pragmatist would respond that robots still cannot do everything that a human being can (e.g. sensory and motor skills). Some would even argue that robots will never match the creative skills of a human being. But it is often taken for granted that if robots were equivalent to humans in an objective sense, then there would be no demand for human “work”. Is this assumption correct?
In Philip K. Dick’s novel ‘Do Androids Dream of Electric Sheep?’, androids and synthetic animals are almost indistinguishable from human beings and real animals. Yet every human being wants a “real” animal despite the fact that a real animal costs much more than an artificial animal that can do everything that the “natural” animal can. A real ostrich costs $30,000 and an equivalent synthetic ostrich costs $800 but everyone wants the real thing. Real animals are prized not for their perfection but for their imperfection. The sloppiness and disorder of real life is so highly valued that fake animals have a “disease circuit” that simulates biological illness when their circuits malfunction.
Dick’s vision is a perfect analogy for the dynamics of value in the near-automated economy. Even in a world where the human contribution has little objective value, it has subjective value in the economy. And this subjective value comes not from its perfection but from its imperfection, its sloppiness, its humanness. Even in a world where androids can dream of electric sheep, technological unemployment can be avoided.
In many respects, we already live in such a world. Isn’t much of the demand for organic food simply a desire for food that has been grown by local human beings rather than distant machines? Isn’t the success of Kickstarter driven by our desire to consume goods and services from people we know rather than from bureaucratic, “robotic” corporate organisations?
However even if the human contribution is not an expert contribution, it must be a uniquely human contribution. Unfortunately our educational system is geared to produce automatons, mediocre imitations of androids rather than superior, or even average, human beings.
One of the core ideas in my essay ‘People Make Poor Monitors For Computers’ was the deskilling of human operators whose sole responsibility is to monitor automated systems. The ability of the automated system to deal with most scenarios on ‘auto-pilot’ results in a deskilled human operator whose skill level never rises above that of a novice and who is ill-equipped to cope with the rare but inevitable instances when the system fails. As James Reason notes1 (emphasis mine) :
Manual control is a highly skilled activity, and skills need to be practised continuously in order to maintain them. Yet an automatic control system that fails only rarely denies operators the opportunity for practising these basic control skills. One of the consequences of automation, therefore, is that operators become de-skilled in precisely those activities that justify their marginalised existence. But when manual takeover is necessary something has usually gone wrong; this means that operators need to be more rather than less skilled in order to cope with these atypical conditions. Duncan (1987, p. 266) makes the same point: “The more reliable the plant, the less opportunity there will be for the operator to practise direct intervention, and the more difficult will be the demands of the remaining tasks requiring operator intervention.”
‘Humans monitoring near-autonomous systems’ is not just one way to make a system more automated. It is in fact the most common strategy to increase automation within complex domains. For example, drone warfare largely consists of providing robots with increasing autonomy such that “the human operator is only responsible for the most strategic decisions, with robots making every tactical choice”2.
But if this model of automation deskills the human operator, then why does anyone choose it in the first place? The answer is that the deskilling and the fragility that comes with it is not an instantaneous phenomenon. The first-generation automated system piggy backs upon the existing expertise of the human operators who have become experts by operating within a less-automated domain. In fact expert human operators are often the most eager to automate away parts of their role and are most comfortable with a monitoring role. The experience of having learnt on less automated systems gives them adequate domain expertise to manage only the strategic decisions and edge cases.
The fragility arises when the second-generation human operators who have no experience of ever having practised routine tactical activities and interventions have to take over the monitoring role. This problem can be mitigated by retaining the less-automated domain as a learning tool to train new human operators. But in many domains, there is no substitute for the real thing and most of the learning happens ‘on the job’. Certainly this is true of financial markets or trading and it is almost certainly true for combat/war. Derivative traders who have spent most of their careers hacking away at simple tool-like models can usually sense when their complex pricing/trading system is malfunctioning. But what about the novice trader who has spent his entire career working with a complex, illegible system?
In some domains like finance and airplane automation, this problem is already visible. But there are many other domains in which we can expect the same pattern to arise in the future. An experienced driver today is probably competent enough to monitor a self-driving car but what about a driver twenty years from today who will likely not have spent any meaningful amount of time driving a manual car? An experienced teacher today is probably good enough to extract good results from a classroom where so much of the process of instruction and evaluation are automated but what about the next generation of teachers? An experienced soldier or pilot with years of real combat experience is probably competent enough to manage a fleet of drones but what about the next generation of combat soldiers whose only experience of warfare is through a computer screen?
Near-autonomous systems are perfect for ‘machine learning’ but almost useless for ‘human learning’. The system generates increasing amounts of data to improve the performance of the automated component within the system. But the system cannot provide the practise and experience that are required to enable human expertise.
Automation is often seen as a way to avoid ‘irrational’ or sloppy human errors. By deskilling the human operator, this justification becomes a self-fulfilling prophecy. By making it harder for the human operator to achieve expertise, the proportion of apparently irrational errors increases. Failures are inevitably taken as evidence of human failure upon which the system is made even more automated thus further exacerbating the problem of deskilling.
The delayed deskilling of the human operators also means that the transition to a near-automated system is almost impossible to reverse. By definition, simply reverting back to the old less-automated, tool-like system actually makes things worse as the second-generation human operators have no experience with using these tools. Compared to carving out an increased role for the now-deskilled human operator, more automation always looks like the best option. If we eventually get to the dream of perfectly autonomous robotic systems, then the deskilling may be just a temporary blip. But what if we never get to the perfectly autonomous robotic system?
Note: Apart from ‘People Make Poor Monitors For Computers’, ‘The Control Revolution And Its Discontents’ also touches upon similar topics but within the broader context of how this move to near-perfectly algorithmic systems fits into the ‘Control Revolution’.
Pragmatic Centrism Is Crony Capitalism
Neoliberal crony capitalism is driven by a grand coalition between the pragmatic centre-left and the pragmatic centre-right. Crony capitalist policies are always justified as the pragmatic solution. The range of policy options is narrowed down to a pragmatic compromise that maximises the rent that can be extracted by special interests. Instead of the government providing essential services such as healthcare and law and order, we get oligopolistic private healthcare and privatised prisons. Instead of a vibrant and competitive private sector with free entry and exit of firms we get heavily regulated and licensed industries, too-big-to-fail banks and corporate bailouts.
There’s no better example of this dynamic than the replacement of the public option in Obamacare by a ‘private option’. As Glenn Greenwald argues, “whatever one’s views on Obamacare were and are: the bill’s mandate that everyone purchase the products of the private health insurance industry, unaccompanied by any public alternative, was a huge gift to that industry.” Public support is garnered by presenting the private option as the pragmatic choice, the compromise option, the only option. To middle class families who fear losing their healthcare protection due to unemployment, the choice is framed as either the private option or nothing.
In a recent paper (h/t Chris Dillow), Pablo Torija asks the question ‘Do Politicians Serve the One Percent?’ and concludes that they do. This is not a surprising result but what is more interesting is his research on the difference between leftwing and rightwing governments which he summarises as follows: “In 2009 center-right parties maximized the happiness of the 100th-98th richest percentile and center-left parties the 100th-95th richest percentile. The situation has evolved from the seventies when politicians represented, approximately, the median voter”.
Nothing illustrates the irrelevance of democratic politics in the neo-liberal era more than the sight of a supposedly free-market right-wing government attempting to reinvent Fannie Mae/Freddie Mac in Britain. On the other side of the pond, we have a supposedly left-wing government which funnels increasing amounts of taxpayer money to crony capitalists in the name of public-private partnerships. Politics today is just internecine warfare between the various segments of the rentier class. As Pete Townshend once said, “Meet the new boss, same as the old boss”.
The Core Strategy of Pragmatic Crony Capitalism: Increase The Scope and Reduce the Scale of Government
Most critics of neoliberalism on the left point to the dramatic reduction in the scale of government activities since the 80s – the privatisation of state-run enterprises, the increased dependence upon private contractors for delivering public services etc. Most right-wing critics lament the increasing regulatory burden faced by businesses and individuals and the preferential treatment and bailouts doled out to the politically well-connected. Neither the left nor the right is wrong. But both of them only see one side of what is the core strategy of neoliberal crony capitalism – increase the scope and reduce the scale of government intervention. Where the government was the sole operator, such as prisons and healthcare, “pragmatic” privatisation leaves us with a mix of heavily regulated oligopolies and risk-free private contracting relationships. On the other hand, where the private sector was allowed to operate without much oversight the “pragmatic” reform involves the subordination of free enterprise to a “sensible” regulatory regime and public-private partnerships to direct capital to social causes. In other words, expand the scope of government to permeate as many economic activities as possible and contract the scale of government within its core activities.
Some of the worst manifestations of crony capitalism can be traced to this perverse pragmatism. The increased scope and reduced scale are the main reasons for the cosy revolving door between incumbent crony capitalists and the government. The left predictably blames it all on the market, the right blames government corruption, while the revolving door of “pragmatic” politicians and crony capitalists rob us blind.
Radical Centrism: Increase The Scale and Reduce The Scope of Government
The essence of a radical centrist approach is government provision of essential goods and services and a minimal-intervention, free enterprise environment for everything else. In most countries, this requires both a dramatic increase in the scale of government activities within its core domain as well as a dramatic reduction in the scope of government activities outside it. In criticising the shambolic privatisation of National Rail in the United Kingdom, Christian Wolmar argued that: “once you have government involvement, you might as well have government ownership”. This is an understatement. The essence of radical centrism is: ‘once you have government involvement, you must have government ownership’. Moving from publicly run systems “towards” free-enterprise systems or vice versa is never a good idea. The road between the public sector and the private sector is the zone of crony capitalist public-private partnerships. We need a narrowly defined ‘pure public option’ rather than the pragmatic crony capitalist ‘private option’.
The idea of radical centrism is not just driven by vague ideas of social justice or increased competition. It is driven by ideas and concepts that lie at the heart of complex system resilience. All complex adaptive systems that successfully balance the need to maintain robustness while at the same time generating novelty and innovation utilise a similar approach.
Barbell Approach: Conservative Core, Aggressive Periphery
Radical centrism follows what Nassim Taleb has called the ‘barbell approach’. Taleb also provides us with an excellent example of such a policy in his book ‘Antifragile’, “hedge funds need to be unregulated and banks nationalized.” The idea here is that you bring the essential utility-like component of banking into the public domain and leave the rest alone. It is critical that the common man must not be compelled to use oligopolistic rent-fuelled services for his essential needs. In the modern world, the ability to hold money and transact is an essential service. It is also critical that there is only a public option, not a public imperative. The private sector must be allowed to compete against the public option.
A bimodal strategy of combining a conservative core with an aggressive periphery is common across complex adaptive systems in many different domains. It is true of the gene regulatory networks in our body which contains a conservative “kernel”. The same phenomenon has even been identified in technological systems such as the architecture of the Internet where a conservative kernel “represent(s) a stable basis on which diversity and complexity of higher-level processes can evolve”.
Stress, fragility and disorder in the periphery generates novelty and variation that enables the system to innovate and adapt to new environments. The stable core not only promotes robustness but paradoxically also promotes long-run innovation by by avoiding systemic collapse. Innovation is not opposed to robustness. In fact, the long-term ability of a system to innovate is dependent upon system robustness. But robustness does not imply stability, it simply means a stable core. The progressive agenda is consistent with creative destruction so long as we focus on a safety net, not a hammock.
Restore the ‘Invisible Foot’ of Competition
The neo-liberal era is often seen as the era of deregulation and market supremacy. But as many commentators have noticed, “”deregulation typically means reregulation under new rules that favor business interests.” As William Davies notes, “the guiding assumption of neoliberalism is not that markets work perfectly, but that private actors make better decisions than public ones”. And this is exactly what happened. Public sector employees were moved onto incentive-based contracts that relied on their “greed” and the invisible hand to elicit better outcomes. Public services were increasingly outsourced to private contractors who were theoretically incentivised to keep costs down and improve service delivery. Nationalised industries like telecom were replaced with heavily licensed private oligopolies. But there was a fatal flaw in these “reforms” which Allen Schick identifies as follows (emphasis mine):
one should not lose sight of the fact that these are not real markets and that they do not operate with real contracts. Rather, the contracts are between public entities—
the owner and the owned. The government has weak redress when its own organizations fail to perform, and it may be subject to as much capture in negotiating and enforcing its contracts as it was under pre-reform management. My own sense is that while some gain may come from mimicking markets, anything less than the real thing
denies government the full benefits of vigorous competition and economic redress.
One difference between the “real thing” and the neoliberal version of the real thing is what the economist Joseph Berliner has called the ‘invisible foot’ of capitalism. Incumbent firms rarely undertake disruptive innovation unless compelled to do so by the force of dynamic competition from new entrants. The critical factor in this competitive dynamic is not the temptation of higher profits but the fear of failure and obsolescence. To sustain long-run innovation in the economy , the invisible foot needs to be “applied vigorously to the backsides of enterprises that would otherwise have been quite content to go on producing the same products in the same ways, and at a reasonable profit, if they could only be protected from the intrusion of competition.”
The other critical difference is just how vulnerable the half-way house solutions of neo-liberalism were to being gamed and abused by opportunistic private actors. The neo-liberal era saw a rise in incentive-based contracts across the private and public sector but without the invisible foot of the threat of failure. The predictable result was not only a stagnant economy but an increase in rent extraction as private actors gamed the positive incentives on offer. As an NHS surgeon quipped with respect to the current NHS reform project: “I think there’s a model there, but it’s whether it can be delivered and won’t be corrupted. I can see a very idealistic model, but by God, it’s vulnerable to people ripping it off”.
Most people view the failure of the Soviet model as being due to the inefficiency of the planned economy. But the problem that consumed the attention of Soviet leaders since the 1950s was the inability of the Soviet economy to innovate. Brezhnev once quipped that Soviet enterprises shied away from innovation “as the devil shies away from incense”. In his work on the on-the-ground reality of the Soviet economy, Joseph Berliner analysed the efforts of Soviet planners to counter this problem of insufficient innovation. The Soviets tried a number of positive incentive schemes (e.g. innovation “bonuses”) that we commonly associate with capitalist economies. But what it could not replicate was the threat of firm failure. Managers safe in the knowledge that competitive innovation would not cause their firm or their jobs to vanish were content to focus on low-risk process innovation and cost-reduction rather than higher-risk, disruptive innovation. In fact, the presence of bonuses that rewarded efficiency further reduced exploratory innovation as exploratory innovation required managers to undertake actions that often reduced short-term efficiency.
Unwittingly, the neoliberal era has replicated the Soviet system. Incumbent firms have no fear of failure and can game the positive incentives on offer to extract rents while at the same time shying away from any real disruptive innovation. We are living in a world where rentier capitalists game the half-baked schemes of privatisation and fleece the taxpayer and the perverse dynamics of safety for the classes and instability for the masses leaves us in the Great Stagnation.
Bailouts For People, Not Firms
Radical centrism involves a strengthening of the safety net for individuals combined with a dramatic increase in the competitive pressures exerted on incumbent firms. Today, we bail out banks because a banking collapse threatens the integrity of the financial system. We bail out incumbent firms because firm failure leaves the unemployed without even catastrophic health insurance. The principle of radical centrism aims to build a firewall that protects the common man from the worst impact of economic disturbances while simultaneously increasing the threat of failure at firm level. The presence of the ‘public option’ and a robust safety net is precisely what empowers us to allow incumbent firms to fail.
The safety net that protects individuals ensures robustness while the presence of a credible ‘invisible foot’ at the level of the firm boosts innovation. Moreover, as Taleb notes programs that bail out people are much less susceptible to being gamed and abused than programs that bail out limited liability firms. As I noted in an earlier post, “even uncertain tail-risk protection provided to corporates will eventually be gamed. The critical difference between individuals and corporates in this regard is the ability of stockholders and creditors to spread their bets across corporate entities and ensure that failure of any one bet has only a limited impact on the individual investors’ finances. In an individual’s case, the risk of failure is by definition concentrated and the uncertain nature of the transfer will ensure that moral hazard implications are minimal.”
The irony of the current policy debate is that policy interventions that prop up banks, asset prices and incumbent firms are viewed as the pragmatic option and policy interventions focused on households are viewed as radical and therefore beyond the pale of discussion. Preventing rent-seeking is a problem that both the left and the right should be concerned with. But both the radical left and the radical right need to realise the misguided nature of many of their disagreements. A robust safety net is as important to maintaining an innovative free enterprise economy as the dismantling of entry barriers and free enterprise are to reducing inequality.
Note: For a more rigorous treatment of the tradeoff between innovation and robustness in complex adaptive systems, see my essay ‘All Systems Need A Little Disorder’.
As I illustrated in a previous post, “a significant proportion of the balance sheet of wealthy Americans is made up of real assets – real estate, stock and business holdings”. Therefore “what wealthy Americans, businesses and banks share is a common interest in supporting asset prices (real and nominal), a lack of interest in seeking full employment unless it is a prerequisite for supporting asset prices, and an aversion to any policies that can trigger wage inflation”. The fact that our dominant macroeconomic policy doctrine depends upon the ‘wealth effect’ simply reflects the fact that our economy is driven by wealthy special interests.
The real question again is why there isn’t more mass opposition to such a blatantly regressive policy regime. In previous posts(1, 2), I have argued that crony capitalism achieves broad-based support by piggybacking upon broad-based programs aimed at the middle class. But they also achieve this support due to the absence of a safety net that breeds middle-class insecurity. This carrot-and-stick approach ensures middle-class support for the same stabilising policies that transfer wealth to the one percent. As the table below (taken from Edward Wolff’s paper) shows, the most significant asset holding of the middle class in the United States is their principal residence. The data is no different in the United Kingdom (table below from the ONS). Supporting house prices therefore is the sop that special interests need to provide to the middle class in order to ensure their support for the ‘wealth effect’-driven economy.
Although there are many instances of direct subsidies to middle-class households via cheaper mortgages (George Osborne’s latest policy being yet another example), these are dwarfed by the impact of the primary guiding principle of macroeconomic policy throughout the neo-liberal era – house prices must keep going up. Rising house prices don’t just act as a carrot to the home-owning middle classes. The fear of being left behind and being out priced by a rising market also acts as a stick to those who don’t own homes. Again, middle-class support for the crony capitalist plutocracy is driven by the stick as much as it is by the carrot. Those who “fear” that the latest housing scheme “risks driving up prices” should realise that the increase in house prices is not an unintended consequence but the primary aim of our crony capitalist policy regime.
In his book ‘The Rise And Decline Of Nations’, Mancur Olson argued that over time stable democracies will experience a progressive increase in the power and influence of special interests and crony capitalists. Olson also identified the self-preserving nature of this phenomenon. Once rent-seeking has achieved sufficient scale, “distributional coalitions have the incentive and..the power to prevent changes that would deprive them of their enlarged share of the social output”. Olson’s diagnosis was accurate on both counts. Most developed economies are currently stuck within various stages of Olsonian demosclerosis.
But Olson also believed that there were limits to just how much of a nation’s GDP crony capitalists could extract before public anger or social instability would rein them in. Olson was almost certainly too optimistic in making this argument. In an earlier post I explained how crony capitalists can avoid these limits by piggybacking upon progressive programs that are meant to help the masses. As I concluded, “The masses become the shield for the very programs that enable a select few to extract significant rents out of the system. The same programs that are supposed to be part of the liberal social agenda like Fannie/Freddie become the weapons through which the cronyist corporate structure perpetuates itself, while the broad-based support for these programs makes them incredibly resilient and hard to reform once they have taken root”.
A common feature of most crony capitalist economies is the pervasive presence of subsidies targeted at the middle class. Progressives often view middle-class subsidies as the unavoidable price required to secure widespread support for the welfare state. But in reality middle-class subsidies act as the carrot that aligns the interests of the middle class with parasitic crony capitalism. However, along with the carrot comes a very hefty stick – the absence of a safety net. The absence of a safety net that protects individuals against catastrophic outcomes breeds middle-class insecurity. The fear of falling through the cracks causes the middle class to support the very rent-infested programs and corporate bailouts that sustain the plutocracy. In the absence of a safety net, the middle class seeks safety in the safety of the incumbent firm that employs them. I have often described the neo-liberal era as the era of “stability for the classes and instability for the masses”. But the two are not independent. It is precisely the fragility of the masses that provides stability to the classes.
Government provision of a safety net is not just a matter of social justice. It is in fact a critical component of a free enterprise economy. Just as those on the left of the political spectrum need to appreciate the insanity of supporting a system that ties the security of the masses to the security of its incumbent crony capitalists, those on the right of the political spectrum need to, as Reihan Salam argues, “embrace the idea of a social safety net as an important element of a free enterprise economy, not just as an unfortunate accommodation to political reality”. An employer-independent safety net promotes free enterprise by enabling us to dismantle the privatised welfare state that is the lifeblood of crony capitalism. Only if we construct a safety net for individuals can we dismantle the hammock that incumbent crony capitalists in our economy currently enjoy.
The debate as to whether the Greenspan Fed’s easy money policies are to blame for the 2008 financial crisis tends to focus on the Fed’s actions after the bursting of the dot-com bubble in 2001. Some (like Stanley Druckenmiller) argue that the Fed should have allowed a recession and a “cleanup” while others such as Paul Krugman argue that it is ludicrous to tighten monetary policy in the face of high unemployment and low inflation.
The simplistic criticism of Greenspan-era monetary policy is that we should have simply allowed recessions such as the 2001 recession to play themselves out. In other words “let it burn”. But the more nuanced criticism of the ‘Greenspan Put’ school of monetary policy is not that it supports the economy, but that it does so via a monomaniacal obsession with supporting asset prices and hoping that the resulting wealth effect trickles down to the masses. I have made this point many times in the past as have many others (e.g. Cullen Roche).
There are many ways to support the economy and only our current system focuses entirely on bailing out banks and shoring up asset prices in exclusion to all other policy options. Why can’t we allow the banks and the market to fail and send helicopter money to individuals instead? Why can’t we start money-financed deficits and increase interest rates at the same time? By narrowing our options to a choice between ‘save everybody!’ or ‘let it burn!’, we choose an economic system that favours the 1% at all times. The Fed Kremlinologist extracts rents from the Greenspan Put during the times of stability and the sharks come out during the collapse1.
Krugman is correct in arguing that a recession is no time to stop the firefighting so that an asset market bubble may be prevented. But the original sin of the Greenspan era was not in triggering bubbles during a recession. It was in using monetary policy to support asset markets and the financial sector even when the real economy was in no need of monetary stimulus. The most egregious example of such an intervention were the rate cuts during the LTCM collapse which were implemented with the sole purpose of “saving” financial markets at a time when the real economy showed no signs of stress. Between September and November 1998, the Fed cut rates by 75 basis points solely for the purpose of supporting asset prices and avoiding even a small failure within the financial sector. Even a cursory glance at market events would have told you that the wider economy was in no need of monetary stimulus. Predictably, the rate cuts also provided the fuel for the final exponential ascent of the dot-com bubble2. This “success” also put Greenspan, Robert Rubin and Larry Summers on the cover of TIME magazine, which goes to show just how biased political incentives are in favour of stabilisation and against resilience.
The problem with the ‘Greenspan Put’ doctrine is not that it fails to prevent bubbles when a recession is on. The problem is that it creates conditions such that eventually there are only two states possible for the economic system – a bubble or a collapse. Market participants could assume that any fall in asset prices would be countered with monetary stimulus and took on more macroeconomic asset-price risk. They then substituted for the market risk they had been relieved of by the Fed with increased leverage. Rates of return across asset classes settle down to permanently low “bubble-like” levels except during times of collapse which are increasingly catastrophic due to the increased system-wide leverage. The stark choice faced by Greenspan in 2001, either an asset bubble or a recession, was a result of his many misguided interventions from 1987 till 2001. Of all these interventions, the LTCM affair was his biggest mistake.
- As Constantino Bresciani-Turroni notes in his book on the Weimar hyperinflation ‘The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany’, “even in the past times of economic regressions, of social dissolution, and of profound political disturbances have often been characterised by a concentration of property. In those periods the strong recovered their primitive habits as beasts of prey.” ↩
- For example, the last rate cut by the Fed came three days after TheGlobe.com set a record for the largest first-day gain of any IPO on Nov 13, 1998. ↩