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"...public opinion deserves to be respected as well as despised" G.W.F. Hegel, 'Philosophy of Right'

Washington reneges « Previous | |Next »
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.

| Posted by Gary Sauer-Thompson at 1:22 PM | | Comments (4)


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.

Paul Krugman's recent piece in the New York Times makes for interesting reading. He says:

It’s not certain, even now, that we’ll have a formal recession, although given the news on Friday you have to say that the odds are that we will. But what is clear is that 2008 will be a troubled year for the U.S. economy — and that as a result, the overall economic record of the Bush years will have been dreary at best: two and a half years of slumping employment, three and a half years of good but not great growth, and two more years of renewed economic distress.

Krugman says that:
When the economy is doing reasonably well, the debate is dominated by hype — by the claim that America’s prosperity is truly wondrous, and that conservative economic policies deserve all the credit. But when things turn down, there is a seamless transition from “It’s morning in America! Hurray for tax cuts!” to “The economy is slumping! Raising taxes would be a disaster!”

It's beginning to look grim for US policy makers. In Australia the big banks are raising rates as the nonbank institutions are squeezed by being unable to access cheap funds overseas to fund their mortgage lending.

I was in Cibos in Gouger Street early this morning--it's just around the corner from my office.I'm able to glance through their newspapers and post to my public opinion using their free wireless.

Laura Tingle in the AFR has realized that something has shifted with the global financial crisis. She says:

...the reality is the financial markets have undergone a profound change in the wake of the sub-prime crisis and that will inevitably mean a change in the political games that are played around them.

She refers to the banks not facing the aggressive competition from the non-banklenders anymore, and so they are able to rebuild their profit margins on top of the underlying increases in their cost of funds.

So what can Swan & Co do, given that they cannot be seen to be interfering with the markets. Ensure that the banks profit taking is not excessive.

it seems that we now have the sale of US assets and revenue streams to foreign creditors. The creditors are buying bank shares (eg.,US banks: Bear Stearns, Citigroup, Morgan Stanley and Merrill Lynch) and the result is shift of power from west to east(eg., Middle Eastern and east Asian sovereign wealth funds).

Will the financial shift be followed by a comparable geopolitical shift in favour of the new export and energy empires of the east.

I'm working off this op ed by Niall Ferguson in the FT.