Being a Skeptic Also Means Ignoring (Most) Economists
This was the seeming incongruous thought which came to mind as I skimmed this dubious excuse for a think-piece by Kenneth Rogoff in the Globe & Mail, and this even more dubious arm-waving about a Ponzi scheme by a columnist in the National Post. Rogoff is a former IMF chief economist, but despite that, I want to stress that this piece makes a good deal more sense than, say, those emanating from the tobacco-defending cretins and (until recently) zombie advisors at the Fraser Institute. Rogoff is not a leftist by any stretch, but he doesn’t seem to be an idiot.
Which it what makes this piece all the more disturbing. What is being advanced by mainstream economists is not (despite what their fake Nobel Prize says they’re doing) a science of the markets, so much as a theology of the markets. The economy written about in pieces like these is a raging beast beyond our control. It’s easy to forget that “the free market,” as such, doesn’t even exist. It’s an academic abstraction for a certain range of ways in which people interact, carefully bounded by laws and regulations. In their headlong rush to build a “science” worthy of the name, economists have built a god of their own making and are attempting to drag us down into the same mud they’re mired in. Depressions aren’t caused by greedy fraudulent bankers and their pet politicians stripping away law enforcement and regulation, and plunging into absurd schemes from which they know taxpayers will grudgingly bail them out — they’re caused by a long-term economic process that just “happens,” every 70 or 80 years, to cause a major contraction.
Like all gods, the market appears to exist outside of human control, but at the end of the day it is our creation, and it is not a necessary one. We don’t need to allow preachers, or economists, to operate outside of the usual standards of logic and empiricism. We don’t need to run to either of these priesthoods whenever there’s a problem so they can prescribe meaningless fixes. We choose to create markets. And we choose to allow banks to operate as Ponzi schemes.
I’m going to set aside the Rogoff column; I brought it in to point out the extremely narrow range of “acceptable” opinion which exists between the “liberal” Globe and the “conservative” Post. The main takeaway from Rogoff is the trifling claim that we’d be in less of a mess if we called this a contraction rather than a recession, because we’d conceive of the world differently (the sort of Grand Semantics argument usually taken up by New Leftists rather than economists). More worrying still is the Post column, by Cato Institute fellow Steve Hanke, which in apparent seriousness argues — typical of his ilk, since the Cato is a sort of American cousin of the cretinous morons at the Fraser Institute — that the reason Europe is gripped by such an intractable economic malaise is that they are attempting to raise the capital requirements of the big banks.
It’s possible that the Post is simply assuming its audience is so sophisticated that they don’t need to understand what this means beyond the fact that “regulation = bad,” although if that’s true, you’d think they’d also be intelligent enough to sense the underlying problem here. To understand what Hanke is talking about, we need to take a step back and look at the artificial market of the banking sector. Yes, artificial — not free. Ironically, the most influential sector of the “capitalist” countries is not actually capitalist. It is a carefully regulated dance between government and corporations, and right now the corporations are the ones deciding on the steps.
The root of it is that banks are given an exception from the usual fraud laws. When you deposit your $1000 pay cheque in the bank, they are allowed to loan $960 of your money to another customer, and then send both of you bank statements claiming you both actually have money. You don’t really have $1000 anymore — you only have $40. But the bank sends you a statement saying you have $1000, and it sends another statement to its second customer saying they have $960. It does this because it assumes that it’s very unlikely you’ll all demand all your money simultaneously. When demands for withdrawals exceeds the real money in the bank, there’s a bank run, and the bank collapses, like all such frauds.
But this process continues. The bank holds back $40 from Customer 2, and then lends $920 to Customer 3. And then it holds $40 back from Customer 3, and loans $880 to Customer 4. And then it holds back $40 from Customer 4, and lends out $840 to Customer 5. It does this five more times, too. Now, at the end of the month, the bank sends out ten monthly statements, claiming it is holding a total of $8200 for its customers. It isn’t. There’s still just the original $1000 sitting in the bank.
In “civilized” countries, there are laws which state how much bank have to hold back. The assumption, apparently, is that without such laws they would operate as genuine fraudsters, taking $1000 from me and then loaning all of it to other customers. The fact that this is the principle underlying the regulations, and that a Cato Institute scholar sees no need to draw attention to it, tells you all you need to know about whether banking is really a free market activity. In a free market (so goes the catechism), banks would understand the risks and set their own capital requirements accordingly. They don’t, and they don’t have to, because at the end of the day there’s a big pile of free money waiting for them at the central bank if they goof up. One of the roles of the central bank is to operate as a welfare dispenser for large corporations who spend considerable sums of money attacking public welfare for everyone else through mouthpieces like the Cato, Fraser, and C.D. Howe institutes.
If you took an undergraduate economics course, you were probably introduced to reserve ratio requirements there. At least a decade ago, the textbooks were still using the obsolete example of a requirement that 10% be held back as a guarantee that the bank was solvent. Actually the real number is 4% (the one I used above), though it will be increasing to 7% over the next several years. In Canada, the banks are ahead of the curve and apparently will rise to the 7% level by next year. This is the “good” level for regulators — and according to Hanke it’s much too high, which is why the economy is failing.
Now, there’s two implications here, and they’re both disturbing. First, Hanke says it’s wrong to raise the requirements, because it means that banks will be unable to keep the economy moving. This is absurd. The original reserve requirements were 25% — from which they have been steadily lowered under pressure from the banks. Instead of looking at reserve requirements, you really only see the absurdity of this technocratic sophistry by approaching it from the consumer‘s perspective: Hanke is saying that the economy will be just fine if the banks are allowed to take 96% of my money and give it to other customers, but there will be financial armageddon if they can only take 93% of my money. This isn’t just trifling. We’re approaching “how many angels can dance on the head of a pin” territory here.
Second, Hanke seems to think that the difference between a 4% requirement and a 7% requirement is a meaningful one. From the banks’ perspective, it is almost double. But from the public’s perspective, the fact still is that we have created special regulations allowing a certain class of corporations to claim they are holding money for you when they actually aren’t, and that — looking at the system as a whole rather than at individual banks — by definition this has to be unsustainable. A fraud scheme in which participants are assured they have money when they don’t can only survive through fresh influxes of new money to maintain the facade. In short, banking doesn’t just benefit from government bailouts, it needs them to survive over the long term.
Ultimately, there are only two solutions to this problem. Either banking has to be a genuine market activity, conducted by private corporations with no access to a special till at the government central bank, or it has to be a nationalized activity, carried out wholly by the central banks. Either way there would be fresh new problems, but at least we wouldn’t have to worry about legalized fraud.
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Jon
Banks and the financial sector don’t really produce any real wealth or value on their own. They should be seen more as a facilitator, like the grease or the oil in the engine of the economy.
Problem is that they and others think too highly of themselves, f.ex “because it means that banks will be unable to keep the economy moving.” as if the banks should be planning and executing the economy’s movements. Virtually all the world’s money flows through the banking sector so of course it must be the most important, and so we get ever more devices that serve the interests of high finance: from dark pools to over the counter derivatives to financial weapons of mass destruction.
One of the great features of capitalism is there’s a sort of natural selection inherent to it. If a company screws up big time, they go bankrupt, their assets are sold off, and we’re left with other companies that presumably aren’t screw ups (else they’ll go bankrupt soon too). The 2008 crisis showed that too many powerful people believe that banking *is* the very engine of the economy. The financial sector was far too important to leave to the vagaries of the invisible hand, of the free market, and of capitalism. The steady hand of the State was employed to save these screw ups with $700 billion of corporate welfare, instead of letting them go bankrupt and serve as a lesson on what not to do.
Strangely, if a nation gives $700 billion of welfare to failing banks, they’re called capitalist. If they give that $700 billion to the people whom this tool we call ‘the economy’ is supposed to serve, they’re called communist instead.
Sixth Estate
Jon — Thanks for commenting. Your idea that banks need to be humbled is exactly where I was going with my suggestion that they either need to be treated on a par with other economic activities, or simply taken over and run as an arm of the state alongside other basic social utilities, like power and water.
The thing about natural selection, which you mention as a benefit of a genuine capitalist market, is that all that means is that the types of businesses that thrive under a certain set of conditions are more likely to thrive when those conditions are present. It doesn’t mean the outcome is “good,” either ethically in the short term, or even from a survival perspective in the long term. It’s not a progressive force. Natural selection gave us human beings, but it also gave us dodo birds. Dodo birds were exceptionally highly tuned through natural selection, too.
In this case, we’re attempting to recreate an environment for natural selection to operate in through “free” markets, but my point is that, especially in banking, these markets by definition have to be artificial. This means that the businesses most likely to succeed are the ones that can game the rules that are imposed on the marketplace. At the very least, a “market” exists only where the state imposes such things as a currency, a property system, and a legal system to enforce the first two of these.
In the case of the banking system, while the recent experience was unusual, history is a pretty reliable indicator that states will intervene to support the banking system: a central bank to manipulate the currency, a deposit insurance scheme to prevent bank runs, and of course bailouts, most of which go through the central bank without any sort of overview by the legislature. In this case, the American bank bailout was several times as large as the $700 billion figure that is commonly cited: that’s just the component that went through Congress, whereas several trillion was pushed out the door at the Federal Reserve.
Economics as theology?
[...] an interesting post over at The Sixth Estate, which questions whether economics should really be considered a science: …What is being advanced by mainstream economists is not (despite what their fake Nobel Prize [...]