Thursday, October 23, 2014

Did Capitalism Fail?

NEW YORK – Until six days before Lehman Brothers collapsed five years ago, the ratings agency Standard & Poor’s maintained the firm’s investment-grade rating of “A.” Moody’s waited even longer, downgrading Lehman one business day before it collapsed. How could reputable ratings agencies – and investment banks – misjudge things so badly?

Regulators, bankers, and ratings agencies bear much of the blame for the crisis. But the near-meltdown was not so much a failure of capitalism as it was a failure of contemporary economic models’ understanding of the role and functioning of financial markets – and, more broadly, instability – in capitalist economies.

These models provided the supposedly scientific underpinning for policy decisions and financial innovations that made the worst crisis since the Great Depression much more likely, if not inevitable. After Lehman’s collapse, former Federal Reserve Chairman Alan Greenspan testified before the US Congress that he had “found a flaw” in the ideology that self-interest would protect society from the financial system’s excesses. But the damage had already been done.

That belief can be traced to prevailing economic theory concerning the causes of asset-price instability – a theory that accounts for risk and asset-price fluctuations as if the future followed mechanically from the past. Contemporary economists’ mechanical models imply that self-interested market participants would not bid housing and other asset prices to clearly excessive levels in the run-up to the crisis. Consequently, such excessive fluctuations have been viewed as a symptom of market participants’ irrationality.

This flawed assumption – that self-interested decisions can be adequately portrayed with mechanical rules – underpinned the creation of synthetic financial instruments and legitimized, on supposedly scientific grounds, their marketing to pension funds and other financial institutions around the world. Remarkably, emerging economies with relatively less developed financial markets escaped many of the more egregious consequences of such innovations.

Contemporary economists’ reliance on mechanical rules to understand – and influence – economic outcomes extends to macroeconomic policy as well, and often draws on an authority, John Maynard Keynes, who would have rejected their approach. Keynes understood early on the fallacy of applying such mechanical rules. “We have involved ourselves in a colossal muddle,” he warned, “having blundered in the control of a delicate machine, the working of which we do not understand.”

In The General Theory of Employment, Interest, and Money, Keynes sought to provide the missing rationale for relying on expansionary fiscal policy to steer advanced capitalist economies out of the Great Depression. But, following World War II, his successors developed a much more ambitious agenda. Instead of pursuing measures to counter excessive fluctuations in economic activity, such as the deep contraction of the 1930’s, so-called stabilization policies focused on measures that aimed to maintain full employment. The “New Keynesian” models underpinning these policies assumed that an economy’s “true” potential – and thus the so-called output gap that expansionary policy is supposed to fill to attain full employment – can be precisely measured.

But, to put it bluntly, the belief that an economist can fully specify in advance how aggregate outcomes – and thus the potential level of economic activity – unfold over time is bogus. The projections implied by the Fed’s macro-econometric model concerning the timing and effects of the 2008 economic stimulus on unemployment, which have been notoriously wide of the mark, are a case in point.

Yet the mainstream of the economics profession insists that such mechanistic models retain validity. Nobel laureate economist Paul Krugman, for example, claims that “a back-of-the-envelope calculation” on the basis of “textbook macroeconomics” indicates that the $800 billion US fiscal stimulus in 2009 should have been three times bigger.

Clearly, we need a new textbook. The question is not whether fiscal stimulus helped, or whether a larger stimulus would have helped more, but whether policymakers should rely on any model that assumes that the future follows mechanically from the past. For example, the housing-market collapse that left millions of US homeowners underwater is not part of textbook models, but it made precise calculations of fiscal stimulus based on them impossible. The public should be highly suspicious of claims that such models provide any scientific basis for economic policy.

But to renounce what Friedrich von Hayek called economists’ “pretense of exact knowledge” is not to abandon the possibility that economic theory can inform policymaking. Indeed, recognizing ever-imperfect knowledge on the part of economists, policymakers, and market participants has important implications for our understanding of financial instability and the state’s role in mitigating it.

Asset-price swings arise not because market participants are irrational, but because they are attempting to cope with their ever-imperfect knowledge of the future stream of profits from alternative investment projects. Market instability is thus integral to how capitalist economies allocate their savings. Given this, policymakers should intervene not because they have superior knowledge about asset values (in fact, no one does), but because profit-seeking market participants do not internalize the huge social costs associated with excessive upswings and downswings in prices.

It is such excessive fluctuations, not deviations from some fanciful “true” value – whether of assets or of the unemployment rate – that Keynes believed policymakers should seek to mitigate. Unlike their successors, Keynes and Hayek understood that imperfect knowledge and non-routine change mean that policy rules, together with the variables underlying them, gain and lose relevance at times that no one can anticipate.

That view appears to have returned to policymaking in Keynes’s homeland. As Mervyn King, the former governor of the Bank of England, put it, “Our understanding of the economy is incomplete and constantly evolving….To describe monetary policy in terms of a constant rule derived from a known model of the economy is to ignore this process of learning.” His successor, Mark Carney, has come to embody this view, eschewing fixed policy rules in favor of the constrained discretion implied by guidance ranges for key indicators.

Rather than trying to hit precise numerical targets, whether for inflation or unemployment, policymaking in this mode attempts to dampen excessive fluctuations. It thus responds to actual problems, not to theories and rules (which these problems may have rendered obsolete). If we are honest about the causes of the 2008 crisis – and serious about avoiding its recurrence – we must accept what economic analysis cannot deliver in order to benefit from what it can.

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  1. Commentedv shankar srinivasan

    The correct Q is does capitalism even exist? after the recession of 1929 america became a welfare state. all subsequent failures in the system have been bailed out in the US and the world over. is that even capitalism?

  2. Commenteddouglas ungredda

    The problem is that theoretical models need to be put in sync with today s market reality. Stock indices influence capital flows in the G-20s. Is US$ 500 trillion in outstanding derivatives contracts by definition excessive risk taking or not? Who decides on this? St Thomas Aquinas?
    Capitalism today has a same problem raised during the Great Depression when "we almost lost it all". Markets without price gyrations are akin to earth's earthquakes,and volcanic activity. Tensions build up and are released sometimes harmlessly and sometimes wreaking havoc.
    Policy has a real problem dissecting how much fluctuation is enough to stimulate growth keeping price fluctuations in check and within a moderate upward trend. This is good for risk taking, as investment, income and employment generally follow. Or so we thought until a few years ago. The problem is that economic models now are at a loss to explain why investment and employment don' t follow as before, especially when market levels today reached similar and in some cases even higher levels since the pre crisis year. In the end vested interests, financial institutions and players strive to stay one step ahead of regulations limiting "excessive risk taking".

  3. CommentedShane Beck

    Remember that it is really a political economy. The primacy of politics over the economy is important. The true question is Why did democracy fail? or Has democracy been subverted to something else?

  4. CommentedJose araujo

    Capitalism is failing because of the increase of the gap between capitalists and the ownership of the means of production.

    Capitalism is failing because of the increased role of AGENTS , who act on self interest and aren't incorporated on policies or economic theories.

    Capitalism is failing because the inner logic of capitalist interest and accumulation doen't account for agents, who are the real owners of capital but don't incurr in any risks.

  5. CommentedJose araujo

    What a mess, I don't know where to start, how do you turn a market failure into a model failure.

    How can you accuse keynesian models to fail, when these models were not keynesian to start. How do you criticize the economic intelligenzia for using keynesian models, when the models used were Austrians and Neoclassics to start with.

    Problems were not the models, problem is that Economic Science regressed more then a century, and the economics models used by policy makers were in essence derived from Hayek, Fayol and Mercantilism...

    Goes to show to what levels our sience fell... And then comes a Professor of economics and blames Keynesian models, wich were the ones with real predictive power.

  6. Commentedjack lasersohn

    In general , the goal of any economic system should be to maximize 'wealth' while minimizing use of resources, over the long term. Has capitalism succeeded in this respect? Probably, but that requires a complicated assessment of it performance relative to other competing systems such as feudalism, or centrally planned socialism or communism. I think it is very obvious that central planning does not create wealth very efficiently, but it may be less susceptible to catastrophic temporary output collapses. Capitalism almost certainly produces more wealth very efficiently, but is obviously susceptible to catastrophic temporary collapse, usually brought about by imperfect knowledge or simple moments of societal psychosis. The fact that it is not perfect does not mean it has 'failed' in the same way that occasional airplane crashes do not mean the 'air travel system' has failed.
    Capitalism is self correcting over the long run and even with its occasional and temporary outcome slumps, almost certainly maximizes wealth more efficiently than any other system we have tried.
    The real question is whether we can smooth out these slumps and bumps by 'regulating' the parts of the system which don't work very well. For externalities, (pollution, policing, etc.) the answer is clearly yes.
    For more complicated problems, like maintaining full employment without 'wasting' finite resources, the answer is maybe eventually, but probably not yet.
    Economists have yet to learn the lessons which physicists learned centuries ago. Writing good mathematical models of even relatively trivial systems is really hard. Actually calculating results from those models can be completely impossible. The economic system is not a trivial system.
    In the meantime, perhaps the better response to the slumps is not to try to reverse them , since we don't know how anyway, but rather to treat its symptoms. Massive and generous unemployment insurance, food stamps etc. all designed to be temporary if possible, while minimizing incentives to remain unemployed. This a far more rational response than Krugman's suggestion that we spend $3 trillion digging and filling in ditches.

  7. CommentedStamatis Kavvadias

    Amazing nonsense!!! Firm belief that economics as a science cannot grasp the possible outcomes of the monetary and financial system. Still firm belief that "the near-meltdown was not so much a failure of capitalism". And the amazing conclusion: economists should guide conservative policy-making and not try to extract any progress from their science!

  8. Commentedraul ramos

    13 september 2013 manila, ph

    economy in an intelligent view,

    five years after lehman, is another crisis possible?

    my answer is simply a big yes. and this is definite,
    absolute, 100percent, why? sorry to say u.s. government
    did not get the right, the correct solutions. thanks'


    please kindly take care and God bless . . . . . . . raul

  9. CommentedPaul A. Myers

    There were two stages to the overall crisis: first, an old-fashioned bank crisis brought on by too many bad bank assets and too little bank capital, and second, a need to stimulate aggregate demand to offset contraction caused by reduced credit (and provide a demand for new credit).

    The underwater home mortgages should have been confronted decisively early on and then this impact cleaned up on the bank balance sheets. More banks should have been taken over by the government and set on the road to eventual recapitalization.

    A multi-year trillion dollar infrastructure investment program should have been launched to provide increased demand while improving future productivity, in itself a confidence building policy.

    Not fixing housing--going in big and going in quick--was a huge strategic misjudgment of the Obama administration.

  10. CommentedAhmed Hasanein Alhasania

    Capitalism did not fail in 21st century, It just needs more correction on 2 levels at least:
    1st: The level of regulation.
    2nd: The ethical level, to be more and more human; and on this level we should recognize that there were good steps were taken in 19th and 20th centuries, and the world waits more.!topic/allegyptparty/D4cOYBfHPKc

  11. CommentedAhmed Hasanein Alhasania

    Capitalism did not fail in 21st century, It just needs more correction on 2 levels at least:
    1st: The level of regulation.
    2nd: The ethical level, to be more and more human; and on this level we should recognize that there were good steps were taken in 19th and 20th centuries, and the world waits more.

  12. CommentedKir Komrik

    Oops, "here" should have been here:


  13. CommentedKir Komrik

    Great article, thanks,

    Yes, capitalism and neo-liberal western democracy in general have been an abject failure. Statistical data shows this quite clearly when we look at the failure rates of democracies in modern times. But explaining how and why capitalism has failed is a more involved discussion, but it is basically due to a grossly outdated mechanism for the circulation of currency and the lack of economic "equity". Something called General Federalism addresses all this in detail. There is a good (but long) summary of it here:

    - kk

      CommentedKir Komrik


      The first reply is all straw-man, so no need to respond. You seem to have assumed that if I reject capitalism I must embrace not only socialism but your definition of it. This is a common fallacy and is understandable in our day and age when most people don't realize there are people out there who are not ideological at all. Yes, it's possible.

      Thus, regarding your second point, it is predicated on the straw man, so no reason to reply further in that regard. To be clear, what I _do_ support is free markets in which all those affected by the commercial use of property and profit are directly represented in the same way that we hold that tenet dear in matters of law. I also hold the view that all new currency representing new wealth should be distributed equitably according to that wealth; that is, that it should obey the rule of law, which it does not under capitalism.

      - kk

      Commentedradek tanski

      Seems like capitalism is the whipping boy of every socialist leaning economist, largely because its such a large, undefined, nebulous, undefended target.

      Commentedradek tanski

      Doesn't Capitalism have to "try" before it can fail? Can you think of any country where government doesn't interfere at whim, "coz they can"? Arbitrarily deciding which values to impose? Which foreign countries to undermine? Which buddies to enrich? Which constituency to pander to?

      Really. whats your definition of capitalism?

  14. CommentedZsolt Hermann

    I don't think we will ever get to the root problem, let alone to any solution as long as we try to change the system, institutions, tools without changing the user.
    It is the inherently self-calculating, ego driven human nature that is ailing the systems, the hardware has nothing to do with it.
    This is why despite all the frantic activity trying to change the economic or financial structures we keep sliding deeper into crisis.
    The initial capitalistic ideal, "what is mine is mine, what is yours is yours" seems fair and truthful.
    But our inherent human nature is not satisfied by this. We are not happy with 'what is mine", our insatiable hunger, ruthlessly competitive nature always wants more, it wants what others have, thus the initially "ideal" capitalistic slogan evolved into "what is mine is mine, what is yours is mine".
    We exploit each other, we succeed at the expense of others, and today when we have run out of "free markets", gradually running out of free or cheap labor, in this global, integral world we evolved into this "modern capitalism" has become like cancer, destroying the system and itself.
    Until we re-program the user, the human being, through global education, teaching people how we can adapt and survive in a totally interconnected and interdependent world, it is completely irrelevant how we change the rules, structures, etc.
    When the human beings is changed, suitable to exist in the global, integral world, then this new human being will work out the suitable structure, institutions.

      CommentedKir Komrik

      "I don't think we will ever get to the root problem..."

      Well, let's all go home, then.

      "It is the inherently self-calculating, ego driven human nature that is ailing the systems, the hardware has nothing to do with it."

      Then I guess you'll be perfectly happy to sign a referendum to have your government abolished and a feudal Lord put in its place who will own you as his personal slave and literally work you to death by the age of 35? After all, the mechanism doesn't matter.

      Idioms such as "what's mine is mine and what's yours is mine" (oops, I meant, yours) have no relevance here as the question is, is this how the system actually works? And it clearly does _not_ work like that. So the point is moot.

      - kk

      CommentedEdward Ponderer

      I think that Mr. Hermann is correct--both in the root cause of the matter being human ego, and that such ego can be worked with.

      It must be understood that what Peter Drucker already foresaw as a global layer of nonlinear equations was added to the lower tiers of economic realities, is coming at us with a vengeance--mathematical chaos. In our linkages with politics, the social and cultural, the family "unit," and even nature--biochemical, trans-species, general ecology, and climate--this complex has led to vast cross-components coming out of the woodwork, in addition to the direct second-order, tertiary, and higher-order attrition.

      When any communal system of independent members in nature reaches the crises of run-away chaos, success is achieved only by an altruistic re-ordering of the system and this new mutual responsible entity grabbing the Murphy's Law bull by the horns and taming it. Our own coronary system and general body homeostasis is such a success story of worst nightmare chaos becoming our best friend in mathematical control. The key is not vertical or lateral management, but fractal entity control -- from the international governmental and corporate entity, down to the local community and business, and the individual entrepreneur, worker, and family member. In short, we will require a true "Family of Humanity."

      But it won't work through a chain of managers as "Who guards the guardians" will rapidly decay a chain of command per what works best for the individual in the mind and heart of the individual--rats fleeing a sinking ship and all. The information of the necessary mutualism is stored in the system, not in an individual manager nor the chain of command. Approaching chaos, everybody, is a lynch-pin, and the overwhelming entropy make any classic management a hopeless juggling of evermore water balloons until catastrophic failure.

      As to the matter that you can't change human nature--of course you can't, but you can use it. However, only now is it possible to do so in the correct way.

      Using it, is in fact, precisely what Capitalism and Communism hoped to do.

      Communism sought to use a quasi-religious motivation of a "love your fellow as yourself," as a motivation to the ego. However it seemed to forget that it did away with this very "opium of the masses." If the masses weren't going to heaven or hell, "what the hell." Medieval knight on the Crusades didn't suddenly turn from cut-throat to holy soldier. They simply wanted to grab the gusto of the afterlife like they grabbed women and purses in this one. [And they did plenty of murder, raping, and purse grabbing on the way to the Holy Land.] Imagine that the Pope told them that there's no afterlife, just do it because its "the right thing." So what became of Communism, nouveau 1% egoism dominating 99% egos through terror, these in turn doing what they could through politburo sludge and black market corruption.

      Capitalism was a little smarter about "good ole' boy" egoism. It saw a stabilization of the system where the maximum profit to be had was, with just a little government management at most, was to be had by maximally providing a lesser benefit to the rest of society in terms of needed products at a good price and job opportunities at good to enable those purchases. The chaos possible in the system was missed, as well as the insatiable drive of the ego that would look to outsmart the system to do better. Lehman Bros., et al., is just the tip of the iceberg in terms of business, government, mass-media relations and the milking of international legal and enforcement differences in that same global-level of economy that, as foreseen by Drucker, provides us such rich chaos-empowering complexity.

      The bottom line is that the ego is no sucker for pie in the sky in a world grown up beyond a fire-and-brimstone Godly system of good behavior, nor does it's 1% representatives lack the resources to always bypass a general human system.

      But the situation has changed dramatically this century. The very interdependence of the chaotic complex forces the intelligence of the enlightened ego to realize that anybody with a hole under their seat in the global lifeboat will drown us all. Love your fellow as yourself is no longer pie-in-the-sky, nor a secular "enlightened self-interest" lip service. This enlightened self-interest has now become a literal truism. Once educated -- not by propaganda, but by a clear cold analysis of objective facts--the brain of ego is on the team, but not it takes the heart. And this is won, in terms of the 1% where it always counts most if you really want something to work, but a mass-media assisted shift from commercialism values of hedonistic happiness, to eudaimonic happiness--the true, satisfying happiness of interconnection with other human beings and the sense of purpose and self-worth in the acclaim of society for what you have done to help it.

      Through integral education and the growth of societal values of mutual responsibility, and the powerful reality of behavioral economics in the present age, we will grab that Murphy's law bull by the horn. And our egoism will not be in a cage, nor tied to the reigns of the economy, but this time will join us as a comrade in arms. -- And this time, we all will win--together!

      CommentedRobert Wolff

      Many believed the system worked much better at a Community level where greed could be dealt with at a peer level. Hillary said, "It takes a Village." The growth of centralized power over large organizations requires formal processes and procedures to replace the function of local peer pressure - i.e. management oversight.

      Oversight is the only antidote to the "absentee landlord" syndrome Americans are now experiencing with central economic power centers on Wall Street and other national corporate centers.

      Any Professor of Management that specializes in organizational behavior knows that the growth of a "small company" into a "large company" requires the same formalization of management structure otherwise top management would lose control. This same phenomenon holds true in general as a whole national economy becomes organized around power centers controlled and owned by an elite 1%. Without oversight, they exhibit the "absentee landlord" syndrome.

      Human nature - yes; but impossible to rectify - no. It just requires better organizational structure.

  15. CommentedRobert Winter

    You state: "The question is not whether fiscal stimulus helped, or whether a larger stimulus would have helped more, but whether policymakers should rely on any model that assumes that the future follows mechanically from the past." With all respect, you set up a straw man. I recall no economist -- certainly not Krugman -- who argued at the time that economic models follow mechanically from the past. All are aware of the potential for political interference in the economy, for failures of regulation, for lack of understanding by market participants, for greed, incompetence and criminality to work their way, etc. That there is indeterminacy and unknowns in the economy is presented as a revelation but is of course well known. Would you suggest that economists not use models? And, if they use models that these not be based on the past?

    With respect to the size of the stimulus, the amount set appears to have been based as much as what was politically feasible as what any models presented. And what is wrong with suggesting that the amount of stimulus being proposed at the time was pretty clearly massively less than necessary based on the loss of wealth in the housing crash and the freezing of the financial system. Recognizing the uncertainties, undertaking that type of analysis based on models to participate in what was then a pressing political debate, seems to me an entirely reasonable thing to do.

    The failure of Greespan's ideology that self-interest will lead to people behaving properly -- as opposed to seeking to line their pockets -- with a minimum of regulatory or
    corporate governance supervision seems to me largely irrelevant to the use of modeling in economics.

  16. CommentedRobert Wolff

    I do a vast amount of reading to try to determine the root causes of this disintegration in an attempt to conclude a course of action to halt that national decay. Most recently I have hung onto one of GW Bush’s statements – apparently he understood it intellectually, although the influence of the NeoCons during his Presidency destroyed any chance of his leading Us towards a better nation based on his intellectual leadership. Consequently, his Presidency resulted in wars rather than national recovery. I am referring to a little known interview in which he talked about how political philosophies that he called “Isms” fill the void of responsibility left by those regimes in power, creating their own power bases from which they achieve popularity and are consequently able to overthrow those regimes in power that relinquish the responsibilities the previously had to their own peoples. He did not say why they do this, but that is obvious to any historian who studies the fall of empires including the Roman Empire and the Hapsburg Dynasty in Europe – the regimes in power, due to some basic fault of human nature, are unable to sacrifice any of their immediate interests for the longevity of their reigns and fall to using their power against their domestic opposition stay in power - the first sign of the end of any empire. We see this in the actions of the wealthy in American society today, and in the Arab Spring rise against selfish regimes in power that are fighting against their own peoples to preserve the benefits of power for the loyal members of their own regimes. Democracy in America does not appear to stop this phenomenon from occurring here also, nor do European democracies keep it happening in the societies of European. The simple explanation is that, “Power corrupts, and absolute power corrupts absolutely.” A more realistic explanation may be that crooks (sociopaths without any intent to be socially responsibility) worm their way into favored positions of power within any regime, apparently serving the interests of the powerful but failing to serve the interests of the general population – similar to the story of infestation by Jews into German society and current anti-Semitism in America as a response to Wall Street corruption.

    As regimes in power relinquish their responsibility to the totality of the societies they rule, other “Isms” replace the voids of their responsibility, as GW said, and establish a new power base. Contrast this with the plot of “Atlas Shrugged” which posed another dynamic for ideological revolutions in which the opposition purposefully “subverts” the regime in power, destroying through sophism its popularity, and takes over in a political revolution. The sad fact in Ayn Rand’s presentation of the struggle between Capitalism and Socialism its pure Hollywood misinterpretation of reality – i.e. based on the errant assumption the Socialism occurs because Capitalism is subverted by Socialists – which is patently untrue. In fact, Socialism rises because Capitalism fails in its responsibility to the greater population and that void of responsibility is REPLACED by government responsibility to the citizens whose interests have been forsaken by the capitalist regime. THIS IS A VERY IMPORTANT POINT. It means there are two interpretations of cause and effect – the one held by the outgoing regime that (1) it is being SUBVERTED by an evil opposition (which gives it justification for using its power to use force against that opposition) and the second held by the opposition (2) that the new regime is GOOD and rising to power as a result of the failure of the current regime to be responsible to the people it rules. Note that these two positions declare a different cause for the revolution: the rise of EVIL against GOOD (the position of the entrenched regime) and the rise of GOOD against EVIL (the position of the rising power).

    The “Filling of the Voids” of responsibility forsaken by capitalists and Capitalism IS the dynamic of the current rise of Socialism in America today. GW’s intellectual position supports this. Contrast this with the plot of “Atlas Shrugged” in which perfectly functioning and socially responsible capitalist institutions, serving the interests of the nation and its people, are subverted by a socialist conspiracy to replace their capitalist regime with Socialism which then causes the disintegration American society and the American economy.

    It is clear to me that the process is as GW describes, not as Ayn Rand or the “Randians” describe. What this means is that if anti-socialists in America want to stop the trend towards Socialism, they must focus on making Capitalism more responsive to and responsible for the interest of the American People – not fighting tooth and nail against government programs that are replacing the failed social responsibility of capitalist institutions with responsible government institutions.

    Obamacare is another perfect example of what GW Bush called “Filling Voids with Isms”. As Capitalism as practiced by corporations rejects responsibility for worker medical benefits, government sponsored health care replaces it. Simple eh? – QED GW’s position.

    As an afterword, I would like to mention that rise of the Sophism of “It’s just money” has been coincident with the rise of Socialism in America and is apparently an excuse to the failure of capitalist institutions to own up to their social responsibilities to the people they rule. “It’s just money” is the credo of the new socially irresponsible capitalist institutions, and means specifically that “We have no social responsibilities”.

    QED on this historical view of GW Bush.

  17. CommentedTomas Kurian

    Lehman Brothers or some another big bust, they are all the final outcome of not enough buying power in the system, which is temporarily replaced by personal loans and after they collapse, depression follows.

    Since last 30 years, enormous growth in productivity increases through IT together with outsoucing jobs to China led to serious diminishing of buying power of Americans, who were forced to take on more loans to try to supplement the missing income.

    But this is not a sustainable fix and so it collapsed.

    Without addressing this problem with higher taxation and higher entitlements, the system will continue deteriorating.

    Read more at:

  18. CommentedJohn Nick

    Market stability is not equivalent to profit maximization. The golden, fundamental, natural law is personal revenue maximization. And there's an addendum, there's a limit to personal revenue that changes behavior. If the revenue amount is big enough, stability, a secondary objective, becomes unimportant. Contemporary global economy led to such levels of revenue that stability became irrelevant. So, to make stability a valid real policy choice, personal revenues must be diminished enough. Another way is to make sure that the consequences of the instability include full material responsibility for the policy makers. Plain said, they will loose all their cumulated revenue in case of failure.

  19. Commentedprashanth kamath

    Authors: Nobel laureate economist Paul Krugman, for example, claims that “a back-of-the-envelope calculation” on the basis of “textbook macroeconomics” indicates that the $800 billion US fiscal stimulus in 2009 should have been three times bigger.

    Clearly, we need a new textbook.

    -Great quote. But, why a paragraph separator?

  20. CommentedProcyon Mukherjee

    The comments have more to do with the Title of the essay, than with the essay; I would restrict myself with the basic content, which deals with responses to excessive asset prices.

    Do the asset prices reflect the true intrinsic potential? This question cannot have an unique answer, as then any trade would stop and it would be the end of economics. The question to the investor is whether the 'excessive' asset prices are matched with the ability to take the 'knock' when a 20% change happens or even more. This is about risk management, a rather mundane subject, that had been relegated to a tertiary subject by those who can make all the 'back of the envelope' calculations by mental math, or should I say, 'straight from the gut'?

  21. CommentedRoger McKinney

    Nice perspective on the crisis. Keynes and Hayek have more in common that either have with mainstream econ.

    The only thing I would add is the problems that the Fed causes by keeping interest rates too low for too long and multiple rounds of QE. Your statement that investors "are attempting to cope with their ever-imperfect knowledge of the future stream of profits from alternative investment projects" is right on. Manipulation of interest rates makes their job even more difficult and is the main cause of the business cycle.

    Also, the US hasn't tried capitalism since 1929. The US is every bit as socialist as any nation in Europe. BTW, those socialist nations also had a crisis.

  22. Commentedhari naidu

    If truth be told, after 2008 financial meltdown, it was not capitalism that per se failed.

    Macroeconomic fundamentals - both in theory and fact - failed the system.

    It's over-time to remodel the world economy under some form of global sustainable foundation - with a view to benefit more than just the 1% rich capitalists.

  23. CommentedFrank O'Callaghan

    This worship of capitalism is part of the problem. We have a system where those who contribute the most time, work, energy, intelligence and value to society are rewarded least. The rewards go to the "owners" and the destroyers. It is unsustainable.

  24. CommentedGeoff Robinson

    A system doesn't fail when a bunch of people do stupid things and bad things happen. A system fails when it necessarily means people do stupid things, like Marxism.

    As others mentioned, Greenspan and the government interfered with market signals. But even taking that out of the picture, I'm not buying the premise.

  25. CommentedTravis Zly

    I think that Capitalism evolves.
    Since 2008, I see the following accounting relationships evolving.

    Since Lehman Brothers:
    Financial Market Losses = Dollar Printing (QE) = Inflation + Tax Theft

    Since Detroit:
    Local Government Losses + Bank losses = Theft of Pension Funds
    (This policy is now being investigated as a “Template” by the Netherlands)

    Since Greece:
    Sovereign Debt Default = Theft of Banking Capital/Deposits + Tax Theft
    (Euphemism “Public Sector Involvement”)

    Since Cyprus:
    Bank Losses + Sovereign Debt Default = Theft of Deposits + Haircut of Assets for Cronies + Tax theft
    (Euphemism “Bail-in". This policy has been endorsed as a “Template” by the IMF and European Commission. Discussions are ongoing about which victim of State Theft will incur the least political cost: Senior Bondholders, Junior Bondholders, Shareholders, Senior Creditors, Junior Creditors, Depositors, Taxpayers)

  26. CommentedRobert Wolff

    Capitalism fails when investors cannot make a profit at the same time that who must work to earn a living are employed.

    You cannot do both in America today. The only possible conclusion is that Capitalism has failed.

      CommentedRobert Wolff

      John, never said it was not crony Capitalism that has caused Capitalism to fail. That is the failure mechanism.

      The economy and money system are becoming unamalgumated as those who control the money system vie to make its functioning in their service more and more impervious to the vagaries of the real economy. The irrelevance of the economic system to the current management of the money system is the result of those with substantial holdings of money and assets attempting to isolate and protect their money holdings and the value of their assets from any negative impact of a failing real economy.

      Needless to say, this attempt to protect money holdings and asset values from any negative impact of a bad economy is ultimately futile - and doomed to failure because, as has been proven over and over again, it becomes the actual cause of economic depressions (the failure of Capitalism). I.e., the cause of the failure of Capitalism is crony Capitalism.

      CommentedJohn Primm

      Robert, I beg to differ. Capitalism has not failed, it is rather that the US has embraced crony capitalism. It is not a new phenom and under the Obama administration it has reached new "heights" of abuse. Solyndria is only one of the green investments that comes easily to mind. However, that close embrace of govt and business has been around for a long time. Most big business' have no interest in competing and so look for federal or state help. And when you have lawmakers walk out of their offices and into private or quasi-private companies and continue their foolish behavior-I am thinking of the whole Fannie/Freddie mess-then you have a prescription for trouble.

  27. CommentedScott Wolfel

    What about the role of misguided policies and ideologies, such as the Greenspan put and financial deregulation as well as the prevalence of large structural deficits under the "supply side" ideology of Republicans since Reagan, creating the conditions for future instability and the relative impotence of Keynesian and Monetarist interventions?

    As Hayek and others have pointed out, the roots of the crisis can be found in the excesses, and misallocation of capital, from the past. Economic actors, from bankers through homeowners, weren't necessarily acting "irrationally" given the incentives that were presented to them by the misguided policies of the fiscal and monetary authorities.

    What are the implications for this for the denouement of the current set of monetary policies, which are essentially going "all in" on the policies that contributed to a series of increasingly disruptive financial crises going back to the 1987 crash?

    Does anyone else find it ironic that Summers may book end the crisis, spearheading financial deregulation (the other Greenspan put?) and presiding over the end game of aggressive monetary intervention in financial markets?

    Perhaps, the wrong question isn't whether capitalism failed. Perhaps, we should ask has it been tried? While morally distasteful to some, there are winners and losers in capitalism, and a price for excessive risk taking and leverage, which leads to the proper allocation of capital. Rather than allowing free markets to sort this out, the monetary authorities repeatedly intervened in this process for 2 1/2 decades, subsidizing excessive risk taking and leverage, with the financial deregulation that created the "too big to fail" banks promoting it.

    Dr. Frankenstein's monster is all grown up and he's hungry. You say you want to "taper," taper this? The Treasury issued $21 billion of 10 year Treasuries at about 140 bps higher than they could have a few months ago, which will add an additional $2.94 billion in interest payments to the deficit over the next 10 years. Multiply that by the $17 trillion in gross debt or $12 trillion in net debt, or $65 trillion (NPV) in "off balance sheet" unfunded entitlement liabilities, and we're talking "real" money, assuming that concept still has any meaning. The Fed lost a few hundred billion on its "portfolio" and the holders of our $60 trillion in total debt lost trillions in the last few months, not to mention the impact of the spike in interest rates on the housing "recovery" and other economic activity. Verizon puked out $49 billion in debt the other day at a large premium, which will reprice the entire credit market, because they were terrified that the betting window will slam shut.

    What does a "rational" actor do in the face of this? If Soros was able to break the bank of England with what is now a laughably small amount of money, is the Fed or BOJ immune? Presumably we will learn the limits of interventionist monetary and fiscal policies (aka: the Greenspan put) in coming years.

    If interest rates are the domestic price of money and currency rates are the international price of money, and both are being completely manipulated by the monetary authorities, what does this mean for capitalism? What does "capitalism" mean if you can't determine the "value" of its fundamental building block and every asset that's priced off of it?

    In "The Economic Consequences of the Peace" (1919), Keynes wrote:

    "Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers,", who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

    Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

    Me thinks the Keynesians are (mis)reading the wrong Keynes. He could have written that today!

    While inflation isn't imminent (watch Japan), and I remain in the debt/deflation camp, the rest of Keynes brilliant analysis holds. If, "...all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery," whither capitalism?

      CommentedRobert Wolff

      Touché Lenin.

      After listening to Hank Paulson interviewed by Pete Rose, supported by his admirer who says he can do no wrong, it is clear the world and the American People really need to drill down on this banking system that caused the current crisis. The first hypothesis by Paulson (unopposed) was that Americans know nothing about economics.

      There is no relationship at all between the banking system and the real economy (the production and distribution of goods and services) under crony Capitalism. Those who control the economic system and those who control the money system talk past each other and do not even mention the same subjects or concerns.

      So when bankers claim that Americans know nothing about economics that is a blatantly ignorant statement by bankers and indicates the depth of their ignorance -because the truth is that it is bankers who know absolutely nothing about the real economy. It is of no actual concern to them. They have shot themselves up into a system of belief that has absolutely no relationship at with the real economy.

      The problem of Americans is not that they know nothing about economics, but that they know nothing about the motives of those who control the money and banking system who themselves have no real concern about the production and distribution of goods and services except to avoid losses due to failure of that real economy.

      It simply amazes me about Henry Paulson how much he knows about the money system; and how little he knows about its relationship to the system of production and distribution of goods and services. We finally have achieved a new religion and a new ideology based on that religion - the separation of the economy from the money system. I think we can assume, at this point in time, that the management of the money system has absolutely nothing to do with the management of the real economy.

      CommentedJohn Primm

      Scott I am not an expert in financial matters, although I know enough to know I am no Keynesian, but I agree entirely with your quote from Lenin--'debase the currency' (sic) and add another one of his. "The capitalists will sell you the rope to hang themselves". Sadly he was right on both counts--FDR and the Brits gave him and Stalin just about everything they wanted in the 20's and 30's and look where that got them.

  28. Commentedradek tanski

    Not failure of capitalism. More like inevitable consequence of government intervention externalities.