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January 6, 2008
These days the economic establishment seems to offer the same answer to every question: let markets decide. Those policymakers and thinkers who suggest alternatives--some form of intervention by governments are shrugged off as leftist dinosaurs fighting yesterday’s battles. Consequently, most economists don't generally dare to buck conventional economic "wisdom" and policy makers generally talk up the economy, often insisting in the face of contrary evidence that the outlook is positive, the fundamentals are sound, and the good times will continue to roll.
A classic example is the US President---George Bush continues to strike an upbeat note despite despite a worsening housing crisis; continuing turmoil in credit markets and the evidence pointing to a hard landing (recession) for the US economy. But the Washington Republicans are being mugged by economic reality and Bush is talking in terms of government intervention:-- stimulus package may be required to nudge the market to what it should do--an adjustment/cathartic process that sorts things out. Despite the market being the natural order of things the hand of man is required in Washington to do something about the slowing American economy.
Just a little stimulus mind you---a little something for the housing construction industry, which has become caught up in the sub-prime mortgage crisis. That means the market can no longer prevent the US economy from getting into a bad shape. A little crack in the neo-liberal edifice.
In America’s Houses of Cards at Project Syndicate Joseph E. Stiglitz says that there is a macro-story and a micro-story here:
The macro-story is simple, but dramatic. Some, observing the crash of the sub-prime mortgage market, say, “Don’t worry, it is only a problem in the real estate sector.” But this overlooks the key role that the housing sector has played in the US economy recently, with direct investment in real estate and money taken out of houses through refinancing mortgages accounting for two-thirds to three-quarters of growth over the last six years.
With higher interest rates depressing housing prices, the game is over. As aggregate demand weakens so will the economy. He says:
The micro-story is more dramatic. Record-low interest rates in 2001, 2002 and 2003 did not lead Americans to invest more – there was already excess capacity. Instead, easy money stimulated the economy by inducing households to refinance their mortgages, and to spend some of their capital.
It is one thing to borrow to make an investment, which strengthens balance sheets; it is another thing to borrow to finance a vacation or a consumption binge. But this is what Alan Greenspan encouraged Americans to do. When normal mortgages did not prime the pump enough, he encouraged them to take out variable-rate mortgages – at a time when interest rates had nowhere to go but up.
Now reality has hit: newspapers report cases of borrowers whose mortgage payments exceed their entire income. Globalization implies that America’s mortgage problem has worldwide repercussions.
What happened? Why the free marketeers went very quiet on all their stuff about moral hazard and ran to their respective governments demanding a bail out for America’s bad lending practices. Will that lead to greater financial sector regulation, especially better protection against predatory lending, and more transparency in financial markets?
Nope. The market is best left to do its thing say the financial free marketeers. Government intervention is not required. It has negative consequences and strangles economic growth. It's a mantra isn't it?; one told by those who need to sustain their faith in the natural workings of the free market.
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Gary
I was in Cibos coffee shop in Adelaide CBD this morning and I glanced through the AFR that is provided along with the other newspapers.
Their frontpage article was about jobs slump, rising unemployment, and recession in the US. The jobs slump is on top of a housing slowdown, global credit crunch, high oil prices and weaker manufacturing activity. The US consumer, who accounts for 70% of US activity, is being battered. Warner Bros Entertainment is saying its even affecting DVD sales, which is why they've decided to back the Sony Blu-ray high definition system over Toshiba's HD-DVD. Consumers won't buy DVD whilst the format war is going on.