Friday, July 16, 2010

Economics in freefall

Economics in freefall
By Paul Craig Roberts

Jul 16, 2010,

I admire Joselph E. Stiglitz, because he has a social conscience and a sense of justice, the absence of which turns economists into monsters. Despite his virtues and Nobel Prize, Stiglitz sometimes falls down as an economist. Readers of my new book, How The Economy Was Lost, will be aware that I take him to task for the Solow-Stiglitz production function, which seriously misleads economics about the scarcity of nature’s capital.

Another of Stiglitz’s shortcomings, one that he shares with most economists, is his habit of reifying the market economy. The market is a social organization. The results of market activity reflect the behavior of the human participants in the market. When economists reify the market, they attribute the behavior, ethics, and morality--or lack thereof--of humans to the market itself. Thus, Stiglitz describes human failures as “market failures,” and he asks in his new book, Freefall, “why didn’t the market exercise discipline on bad corporate governance and bad incentive structures?”

Social institutions are inanimate. They do not possess life and cannot impose good outcomes on human action.

Libertarians also reify markets, but instead of blaming markets for human failures, they imbue the market with human virtues and even with the super-human virtue of producing results that human intelligence cannot improve upon. Economists’ “risk models” for which Nobel Prizes have been awarded and Federal Reserve chairman Alan Greenspan attributed the social institution with economic wisdom beyond man’s.

It is likely that the practice of reifying the market economy developed as a form of shorthand. It was convenient to say that the market did this and that rather than to have to describe the human interactions that produced the results. The market was transformed from an abstraction into a life form and became the actor instead of the humans operating within the institution.

If the outcomes are good, libertarians attribute the good results to the market’s virtues; if bad, libertarians blame human interference -- government regulation. Economists of Stiglitz’s persuasion see it in the opposite way. Good results are produced by regulation; bad results are the result of allowing the market to make decisions on its own.

This way of thinking, which reifies a social institution, is ingrained in economics. It is the source of enormous confusion and has resulted in a pointless long-running ideological battle that Stiglitz calls “a battle of ideas.”

It is possible to clear away the confusion. First, understand that a free market is one in which prices are free to respond to supply and demand. Economists of all persuasions understand that to fix a price below the price at which supply and demand equate results in shortages. Economists have learned this from rent control. Fixing a price above the price at which supply and demand equate results in surpluses. Economists have learned this from agricultural subsidies. A free market does not mean a market in which human behavior is not regulated. A free market is one in which supply and demand are permitted to equate.

Second, understand that regulation regulates human behavior, not the market. It is the actors in the market who are charged with regulatory infractions, not the institution itself. Regulation is necessary because of human faults, such as greed, fraud, carelessness, not because of market faults. Regulation is necessary because of human failure, not because of market failure.

Third, understand that the problem of regulation is that it is done by flawed humans. Human flaws do not disappear by moving human action from the economy to government. Most likely the flaws worsen as government decisions are often unaccountable. Many economists assume that regulators act in the public interest. However, as George Stigler, another Nobel Prizewinner, pointed out several decades ago, regulators are invariably captured by the industries that they regulate.

There are endless examples of regulators--indeed, entire governments--captured by the private interests that they are supposed to regulate. For example, in a recent subscriber’s only edition of CounterPunch (June 16-30), Jeffrey St. Clair describes in detail the incestuous relationship between the government’s Minerals Management Service and the oil industry. An agency charged with regulating the impact of oil drilling on the environment became “a bureaucratic facilitator of big oil.” Thus, the environmental catastrophe in the Gulf of Mexico and looming catastrophes along Alaska’s fragile coastline.

Indeed, economists themselves and academics are often captured by private interest groups and turned into shills. In How The Economy Was Lost, I accuse economists of shilling for transnational corporations when they falsely describe jobs offshoring as the beneficial workings of free trade. Like the Israel Lobby, corporations have found that money will purchase professors, academic departments and think tanks, as well as journalists.

Offshoring transforms American workers’ wages into performance bonuses for executives, capital gains for shareholders, and honoraria and research grants for economists who shill for the practice.

The problem that the US economy faces is far more serious than the financial crisis resulting from financial deregulation. The reason that traditional monetary and fiscal policies cannot produce an economic recovery is that so much of the US economy has been moved offshore. As the jobs have departed, there is no work to which low interest rates and massive government spending can recall workers. This is the real freefall....
The debt overhang as we previously mentioned is staggering. In order to give you prospective, in 1998 debt to GDP was 257%. Today it is at 357%, which means the private sector is still overleveraged in a big way. This means inventories will be slow to liquidate, manufacturing will slow and unused space will expand in factories, retail and offices. Foreclosures continue a pace. No one really knows what the total of residential vacancies are, but the figure has to be near 1-1/2 years supply, whereas four months is normal. By the end of the year, that figure could be more than two years. The tax credits are over and now comes the avalanche. In addition, builders will build 535,000 homes this year. Next year should be a big year for builder bankruptcies. That is unless there is another tax credit or the Fed literally floods the economy with money and credit. After four years we just may start to cover our housing shorts. As we mentioned some time ago government intends to consolidate the housing industry into three companies, which will then be nationalized.
All of the above means higher unemployment. Building and manufacturing should reflect higher unemployment for years to come. America needs a net monthly gain of 150,000 jobs just to keep up with the birthrate. In the last 11 years eight million jobs were lost to free trade, globalization, offshoring and outsourcing, plus another 5.3 million jobs have been lost in our three year depression and some ten million are forced to work part-time or 34.1 hours per week. Unemployment is 22-3/8% and will hit 25%, the same as it was during the “Great Depression,” by the end of the year.
As America waits to see if the Fed is going to inject $5 trillion into the US economy, Spanish banks stumbled and borrowed $161 billion from the ECB in June, an 18% increase from May. Spain is in deep trouble as European bankers and politicians continue to lie concerning Europe’s financial problems. There is no liquidity. Germany realizes this and wants to write off 2/3’s of the PIIGS debt, and finally exit the euro. It is also significant that no one has lent funds to any Spanish financial entity for more than two months, except the ECB. We should also mention that $560 billion has already been written off since the beginning of the global credit crisis in 2007, now almost three years old.
Spain has the 3rd largest deficit among countries in the euro zone. One third of the euro zone members are insolvent and that is why stress tests have not been released and probably won’t be. Even the solvent nations and their banks are in serious trouble. Sovereign bonds and CDOs are not worth the paper they are written on. Worse yet, they, like US banks and other corporations, are carrying two sets of books. If one set of books were kept all the toxic waste would have to be written off and that would deplete their capital and most likely put them out of business. Is it no wonder banks do not want to lend to each other? Banks and nations are lying, the ECB and its president Jean-Claude Trichet are lying about it. European banks were almost all involved in the same speculative activities that the US banks were involved in. The ECB is doing the same thing in Europe that the Fed has done in the US, and both are equally insolvent. It is incredible that the public doesn’t understand that the system is broken. The bankers still control the system from behind the scenes and still are making billions. European lenders have $3.3 trillion at risk in PIIGS loans. German banks alone are preparing to write off some $325 billion this year – a bill to be paid by German taxpayers. It is now only a matter of time until the PIIGS leave the euro zone and the euro is no more. The write offs could last 30 to 50 years, and that as well could be how long the depression will last. Ninety-five percent (95%) of the bad debt on average in Europe and the US has yet to be written off. Worse yet, nothing has been done to solve these problems, which has resulted in record unemployment in Europe and the US. The ECB has lent out $1.3 trillion it created out of thin air. This means the world will experience the Japanese experience of the past 18 years for another 30 to 50 years. In addition, most of this is done in secret, so the citizens won’t know what is going on. Banks are doing their own stress tests and lying about the results. Even at that the results are dreadful. Derivatives now reflect 60% losses on Greek bonds. By the time this is over all the bad paper will be 62.5% written off, not just in Europe but in the US and UK as well, as we predicted months ago. This is where we are headed and it is not good. Your only protection is gold and silver assets.
Thank heavens, Barry's in command or we would really be in a serious situation... The Soetero-Pelosi-Reid-Dodd "financial reform" package should do wonders to get us back on track. After all, TPTB promise to "fix" the derivatives problem starting in 2052....!

Paul Craig Roberts was Assistant Secretary U.S. Treasury, Associate Editor Wall Street Journal, Columnist for Business Week, Senior Research Fellow Hoover Institution Stanford University, and William E. Simon Chair of Political Economy in the Center for Strategic and International Studies, Washington, D.C.

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