Tuesday, March 23, 2010

Greenspan's Theorem

Alan Greenspan has recently written a 48 page paper for the Brookings Institution explaining why the Asset Bubble and subsequent collapse happened, reports The Economist. Greenspan's argument rests on one central point - that with the end of Cold War and reforms in China [and in India], hundreds of millions of workers were absorbed in the global economy; 'as the GDP growth in emerging economies soared, their consumption could not keep up with income, and savings rose. The rise in desired global savings relative to desired investment caused a global decline in long term rates, which became delinked from the short term rates that the central banks control.' [A draft of the paper, The Crisis, can be found here]

As The Economist article points out, this is broadly similar to the theory of Global Savings Glut, as espoused by Ben Bernanke. There seems to be a consensus among American Central bankers that the global decline of long term rates resulted in a speculative bubble in assets in the developed economies, and the resulting euphoria undermined the general caution and evaded the regulatory radar for increased risk.

Greenspan admits that this has caused arguably the worst economic contraction in human history. Though the contraction in economic activity was greater in the depression of the 1930s, there is no parallel to the failure of the private credit markets this time around. So, in effect, the 'bail outs' by the state is the only thing keeping us going for the moment, but unless the usual financial mechanism recovers soon enough, we are in for a cataclysmic change in the way we live or behave.

The Economist and other commentators see these statements as attempts to deflect blame by Central Bankers, and tries to establish that there is more to the asset bubble than the decline of the long term rates. This, by itself, is certainly true; the decline of long term rates can not fully explain why unreasonable risks will be taken by the bankers by handing the money out to people who can not afford it for houses which were not worth their price. But, the Greenspan Theorem is worth pondering upon, particularly to consider whether we are talking about a systemic failure of what we know as the capitalist system.

To start with, it is a bit ironic that Alan Greenspan, the high priest of monetarism and a devoted disciple of Ayn Rand, is talking about global economic trends that made the monetary policy in America, which is world's banker by the last count, ineffective. The assumption was that as long as you keep the supply of money in control and the short term interest rates in alignment with demand/supply of capital, the economy, driven by the entrepreneurial energy of private individuals, would take care of itself. This is not what seems to have happened, by his own admission. To restate his case, the economic management using the conventional tools failed because the surplus value generated by the expansion of productive activities could not be fully consumed or invested, therefore pushing down the cost of borrowing long term capital, and created a crisis. Surprisingly, this looks like a Marxian theorem.

Yes, remember, Karl Marx, who dabbled in economics, rather amateurishly, primarily because he was so concerned about the plight of the poor families, including his own. He rallied against the injustices of the system which rewards the owner of the capital disproportionately, and lets the real producers, the workers, survive on crumbs. In his brilliant poetic vision, he dreamt about a world where the resources of the world are distributed more equitably, and everyone can live a productive, meaningful life. If one thinks about Marx himself, who lived in poverty, defaulting on rent, scavenging on food, hopelessly dependent on handouts from his friend, Engels, but preferring to work on his books rather than do menial work, suddenly his theories take an intensely personal spin. And, while wishing away this poverty, hopelessness, destitution, Marx had this insight - if the surpluses are allocated to the owners of capital in a disproportionate way, one day they would run out of options to consume or employ that surplus productively, leading to a worldwide glut of capital, leading to a crisis which will destroy the 'capitalist consensus', an understanding to not to rock the boat which keeps the system running.

Marx was of course a flawed person. He underestimated the resilience of the capitalist system, proclaiming excitedly the end of the world every time there was a stock market crash. He was confrontational and at times, pedantic, and relentless in pursuing all those who disagreed with him. He remained true to his credential as a philosopher, created a band of loyal followers but failed to create a broad consensus around his ideas. After his death, the movement that took his ideas, inherited many of his personal flaws of short term excitement and intolerance of different points of views, and eventually crumbled under the weight of its own failings.

However, despite all the failings, and the permanent and valid association of Marx's name with the communist movement, it is important to recognize Marx as an important critic of capitalist economics, and one of its most humane and insightful commentators. I do believe that the solution to the current crisis needs to be found in the distribution of wealth and resources rather than in fiscal tools as favoured by the governments. Once we accept the Greenspan theorem, we see the paradox we face: an abundance of capital leading to destructive bubbles side by side with life-sucking poverty in other parts of the world. The current solution, which can be summarized as a way of funnelling excess developing country savings into investment into public expenditure in developed economies, assumes a long term continuation of world as it is. This may not happen. The developing world may simply refuse to hand in its savings, and a conflict may arise to destabilize the capitalist consensus. That will seriously threaten the whole monetary system as we know it. Imagine the collapse of dollar if you can, we are talking about that.

It may sound Utopian, but its a sin losing faith on human inventiveness: So, one can reasonably talk about a solution outside the conventional wisdom. Something like finding out a more equitable distribution of proceeds, without necessarily involving an army of bureaucrats and government edicts. This may start with just one person - who starts recognizing his life's worth outside the conventional benchmarks of luxury, and sees his/her success in terms of being unremarkable. Or, humble is the other word. Yes, this will involve changing what we believe, but we may have to do that sooner or later.

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