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301ba20046f86fa80bd34304_pa3137c.jpg Paul Lachine

The Treason of the Economists

There is increasing agreement that four factors interacted to cause the current economic slump: financial innovation, global macroeconomic imbalances, cheap money, and the wrong theory of financial markets. But if we are going allocate blame, economists deserve more of it than anyone else, for they established the ideas that bankers, politicians, and regulators applied.

LONDON – All epoch-defining events are the result of conjunctures – the correlation of normally unconnected events that jolt humanity out of a rut. Such conjunctures create what the author Nassim Nicholas Taleb calls “Black Swans” – unpredictable events with a vast impact. A small number of Black Swans, Taleb believes, “explain almost everything in our world.”

The prosperity of the first age of globalization before 1914, for example, resulted from a successful constellation of developments: falling transport and communication costs, the technological breakthroughs of the second industrial revolution, the pacific state of international relations, and Great Britain’s successful management of the gold standard. By contrast, in the interwar years poisonous international politics combined with global economic imbalances to create the Great Depression and set the scene for World War II.

Now consider recent financial innovations. On the back of the new computer and telecommunications technology, a giant market for derivative instruments was built. Collateralized debt obligations (CDOs, mainly tied to mortgages) made a new population of aspiring homeowners supposedly creditworthy by enabling the originating banks to sell “sub-prime” debt to other investors.

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