There is nothing like a really big economic crisis to separate the
Cassandras from the Panglosses, the horsemen of the apocalypse from the
Kool-Aid-swigging optimists. No, the last year has shown that all is
not for the best in the best of all possible worlds. On the contrary,
we might be doomed.
At such times, we do well to remember that most of today’s public
intellectuals are mere dwarves, standing on the shoulders of giants.
So, if they had e-mail in the hereafter, which of the great thinkers of
the past would be entitled to send us a message with the subject line:
“I told you so”? And which would prefer to remain offline?
It has, for example, been a bad
year for Adam Smith (1723-1790) and his “invisible hand,” which was supposed to
steer the global economy onward and upward to new heights of opulence through
the action of individual choice in unfettered markets. By contrast, it has been
a good year for Karl Marx (1818-1883), who always maintained that the internal
contradictions of capitalism, and particularly its tendency to increase the
inequality of the distribution of wealth, would lead to crisis and finally
collapse. A special mention is also due to early 20th-century Marxist theorist
Rudolf Hilferding (1877-1941), whose Das Finanzkapital foresaw the rise of
giant “too big to fail” financial institutions.
Joining Smith in embarrassed
silence, you might think, is Friedrich von Hayek (1899-1992), who warned back
in 1944 that the welfare state would lead the West down the “road to serfdom.”
With a government-mandated expansion of health insurance likely to be enacted
in the United States, Hayek's libertarian fears appear to have receded, at
least in the Democratic Party. It has been a bumper year, on the other hand,
for Hayek's old enemy, John Maynard Keynes (1883-1946), whose 1936 work The General Theory of Employment,Interest and Money has become the new bible for finance ministers seeking to
reduce unemployment by means of fiscal stimuli. His biographer, Robert
Skidelsky, has hailed the “return of the master.” Keynes's self-appointed
representative on Earth, New York Times
columnist Paul Krugman, insists that the application of Keynesian theory, in
the form of giant government deficits, has saved the world from a second Great
Depression.
The marketplace of ideas has not
been nearly so kind this year to the late Milton Friedman (1912-2006), the
diminutive doyen of free-market economics. “Inflation,” wrote Friedman in a
famous definition, “is always and everywhere a monetary phenomenon, in the
sense that it cannot occur without a more rapid increase in the quantity of
money than in output.” Well, since September of 2008, Ben Bernanke has been
printing dollars like mad at the U.S. Federal Reserve, more than doubling the
monetary base. And inflation? As I write, the headline consumer price inflation
rate is negative 2 percent. Better throw away that old copy of Friedman's Monetary History of the United States,
1867-1960 (co-authored with Anna J. Schwartz, who is happily still with
us).
Invest, instead, in a spanking new
edition of The Great Transformation
by Karl Polanyi (1886-1964). We surely need Polanyi's more anthropological
approach to economics to explain the excesses of the boom and the hysteria of
the bust. For what in classical economics could possibly account for the
credulity of investors in Bernard Madoff's long-running Ponzi scheme? Or the
folly of Richard Fuld, who gambled his personal fortune and reputation on the
very slim chance that Lehman Brothers, unlike Bear Stearns and Merrill Lynch,
could survive the crisis without being sold to a competitor?
The biggest intellectual losers of
all, however, must be the pioneers of the theory of efficient markets—economists
still with us, such as Harry M. Markowitz, the University of Chicago-trained
economist who developed the theory of portfolio diversification as the best
protection against economic volatility, and William Sharpe, inventor of the
capital asset pricing model. In two marvelously lucid books, the late Peter
Bernstein extolled their “capital ideas.” Now, with so many quantitative hedge
funds on the scrap heap, their ideas don't seem quite so capital.
And the biggest winners, among
economists at least? Step forward the "Austrians" —economists like Ludwig von
Mises (1881-1973), who always saw credit-propelled asset bubbles as the biggest
threat to the stability of capitalism. Not many American economists carried
forward their work into the later 20th century, but one heterodox figure has
emerged as a posthumous beneficiary of this crisis: Hyman Minsky (1919-1996).
At a time when other University of Chicago-trained economists were forging the
neoclassical synthesis—Adam Smith plus applied math—Minsky developed his
own math-free “financial instability hypothesis.”
Yet it would surely be wrong to
make the Top Dead Thinker of 2009 an economic theorist. The entire discipline
of economics has flopped too embarrassingly for that to be appropriate.
Instead, we should consider the claims of a historian, because history has
served as a far better guide to the current crisis than any economic model. My
nominee is the financial historian Charles Kindleberger (1910-2003), who drew
on Minsky's work to popularize the idea of financial crisis as a five-stage
process, from displacement and euphoric overtrading to full-fledged mania,
followed by growing concern and ending up with panic. (If those five steps to
financial hell sound familiar, they should. We just went down them, twice in
the space of 10 years.)
Of course, history offers more than
just the lesson that financial accidents will happen. One of the most important
historical truths is that the first draft of history —the version that gets
written on the spot by journalists and other contemporaries —is nearly always
wrong. So though superficially this crisis seems like a defeat for Smith,
Hayek, and Friedman, and a victory for Marx, Keynes, and Polanyi, that might
well turn out to be wrong. Far from having been caused by unregulated free
markets, this crisis may have been caused by distortions of the market from
ill-advised government actions: explicit and implicit guarantees to supersize
banks, inappropriate empowerment of rating agencies, disastrously loose
monetary policy, bad regulation of big insurers, systematic encouragement of
reckless mortgage lending—not to mention distortions of currency markets by
central bank
Consider this: The argument for
avoiding mass bank failures was made by Friedman, not Keynes. It was Friedman
who argued that the principal reason for the depth of the Depression was the
Fed's failure to avoid an epidemic of bank failures. It has been Friedman, more
than Keynes, who has been Bernanke’s inspiration over the past two years, as
the Fed chairman has honored a pledge he made shortly before Friedman's death
not to preside over another “great contraction.” Nor would Friedman have been
in the least worried about inflation at a time like this. The Fed's balance
sheet may have expanded rapidly, but broader measures of money are growing
slowly and credit is contracting. Deflation, not inflation, remains the
monetarist fear.
From a free market perspective, the
vital thing is that legitimate emergency measures do not become established
practices. For it cannot possibly be a healthy state of affairs for the core
institutions of the Western financial system to be effectively guaranteed, if not
actually owned, by the government. The thinker who most clearly discerned the
problems associated with that kind of state intervention was Joseph Schumpeter
(1883-1950), whose “creative destruction” has been one of this year's most
commonly cited phrases.
“[T]his evolutionary…impulse that
sets and keeps the capitalist engine in motion,” wrote Schumpeter in Capitalism, Socialism and Democracy, “comes
from…the new forms of industrial organization that capitalist enterprise
creates…This process of creative destruction is the essential fact about
capitalism.” This crisis has certainly unleashed enough economic destruction in
the world (though its creativity at this stage is still hard to discern). But
in the world of the big banks, there has been far too little destruction, and
about the only creative thing happening on Wall Street these days is the
accounting.
“This economic system,” Schumpeter
wrote in his earlier The Theory of
Economic Development, “cannot do without the ultima ratio [final argument] of the complete destruction of those
existences which are irretrievably associated with the hopelessly unadapted.”
Indeed, he saw that the economy remained saddled with too many of “those firms
that are unfit to live.” That could serve as a painfully accurate description
of the Western financial system today.
Yet all those allusions to
evolution and fitness to live serve as a reminder of the dead thinker we should
all have spent at least part of 2009 venerating: Charles Darwin (1809-1882).
This year was not only his bicentennial but the 150th birthday of his
paradigm-shifting On the Origin of
Species. Just reflect on these sentences from Darwin's seminal work:
All organic beings are exposed to
severe competition.”
“As more individuals are produced
than can possibly survive, there must in every case be a struggle for
existence.”
“Each organic being…has to
struggle for life and to suffer great destruction.... The vigorous, the healthy,
and the happy survive and multiply.”
Thanks in no small measure to the
efforts of his modern heirs, notably Richard Dawkins, we are all Darwinians now—except in the strange parallel worlds of fundamentalist Christianity and
state-guaranteed finance.
Neither Cassandra nor Pangloss,
Darwin surely deserves to top any list of modern thinkers, dead or alive.