by To all who argued the financial world would’ve collapsed without the bailouts: The political world is collapsing now because of the bailouts — Emanuel Derman (@EmanuelDerman) June 25, 2016 The bigger picture of the early 21st century follows: Western nations experienced a massive blowout bubble of leverage, irrational exuberance, and Hayekian pseudo-money creation. Yet this money was not going to overwhelmingly productive causes. The real output of the Western world did not follow anything close to the ebullience of the financial markets. Without the growth and jobs needed to service the debt load, many of the debtors—including most famously subprime mortgage borrowers—defaulted. And thus the securitized debt bubble burst when—in the midst of two large and expensive American wars—the animal spirits of the market turned to panic over debt defaults. What followed was not, it turns out, enough to right the ship. In theory, when markets are frightened of the future and productive human and financial capital lies idle, government borrowing can re-employ these resources until the animal spirits of the market emerge from their slump. In my view, there are two key measures of this: unemployment, and interest rates on government borrowing. High unemployment rates signify idle human capital. Low interest rates signify idle financial capital. But this balancing did not occur.
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To all who argued the financial world would’ve collapsed without the bailouts: The political world is collapsing now because of the bailouts
— Emanuel Derman (@EmanuelDerman) June 25, 2016
The bigger picture of the early 21st century follows: Western nations experienced a massive blowout bubble of leverage, irrational exuberance, and Hayekian pseudo-money creation.
Yet this money was not going to overwhelmingly productive causes. The real output of the Western world did not follow anything close to the ebullience of the financial markets. Without the growth and jobs needed to service the debt load, many of the debtors—including most famously subprime mortgage borrowers—defaulted. And thus the securitized debt bubble burst when—in the midst of two large and expensive American wars—the animal spirits of the market turned to panic over debt defaults.
What followed was not, it turns out, enough to right the ship. In theory, when markets are frightened of the future and productive human and financial capital lies idle, government borrowing can re-employ these resources until the animal spirits of the market emerge from their slump. In my view, there are two key measures of this: unemployment, and interest rates on government borrowing. High unemployment rates signify idle human capital. Low interest rates signify idle financial capital.
But this balancing did not occur. Even as the Brown and Obama governments engaged in a degree of fiscal stimulus, voters were not won over by the logic of this, and austerian conservatives came to parliamentary power in both the United States and United Kingdom. Government purse strings tightened. Instead, stimulus came down to central banks, who kept interest rates super low, and used quantitative easing as a form of simulated rate cut to cut interest rates beyond the lower bound of zero.
In my view, the political collapse we have seen since in the last year in both the United Kingdom and United States illustrates that this was not enough. Moreover—and more importantly— the continuation of the low interest rate environment illustrates that this was not enough. If quantitative easing had been worked as intended, interest rates would surely have bounced back by now, rather than remaining depressed? Certainly you can make an argument that we are now in an era of depressed interest rates as a result of our ageing society, where rising numbers of retirees mean that demand for savings is outpacing demand for productive investment opportunities. There is certainly some truth in that view. But ultimately, that is just one of many facts that governments and central banks had to weigh in getting the economy back to normal after 2008.
And maybe more quantitative easing would have allowed the market to bounce back and renormalize faster. Somehow, I doubt it. Why? Because quantitative easing is a Rube Goldbergian form of stimulus. It is a matter of pushing on a string. It is leading the horse to water. But there is no guarantee that the horse will drink. And the horse—in this case, the market—has not drunk. Demand for productive investment has not recovered, in spite the fact that that the central banks have made it super cheap. So the banks that got access to the cheap financing just sat on the money, instead of using it productively.
There is a bigger picture here, and it is something that I referred to in 2011 as Japanization. To wit:
Essentially, in both the United States and Japan, credit bubbles fuelling a bubble in the housing market collapsed, leading to a stock market crash, and asset price slides, triggering deflation throughout the respective economies—much like after the 1929 crash. Policy makers in both countries—at the Bank of Japan, and Federal Reserve — set about reflating the bubble by helicopter dropping yen and dollars. Fundamental structural problems in the banking system that contributed to the initial credit bubbles—in both Japan and the United States—have not really ever been addressed. Bad businesses were never liquidated, which is why there has not been aggressive new growth. So Japan’s zombie banks, and America’s too big to fail monoliths blunder on.
They have now blundered on into full on systemic contagion. Unhappy voters have lashed out and thrown out incumbents—the European Union and David Cameron in Britain, and the Bush-Clinton dynasties in America.
Unhappiness with the economy is at the very core of this. There has already been a quite voluminous debate about whether or not Trumpism and Brexitism were fuelled by economic anxiety or whether they are a traditionalist cultural backlash against minorities. Such debates present a false dichotomy. If Trumpism and Brexitism were not about the state of the economy, why did they not occur when the economy was strong? Why did they suddenly start rising after a financial crisis in the presence of a depressed economy—just as they did in the 1930s during the Great Depression? Hitler did not come to power when Germany was economically strong. Mussolini did not come to power when Italy was economically strong. The reality is that economic weakness and economic anxiety open the door to cultural backlash, to anti-immigrant sentiments, and ultimately to white supremacy. People who feel that the economy is bad are primed to listen to scapegoating. Immigrants, rising foreign powers, and establishment politicians like David Cameron and Hillary Clinton provide easy targets.
However, even within the false dichotomy of anxiety vs backlash, there is substantial evidence that the Trumpist communities that were falling behind. A Gallup analysis in August of this year found that: “communities with worse health outcomes, lower social mobility, less social capital, greater reliance on social security income, and less reliance on capital income, predicts higher levels of Trump support”. Indeed, as Max Ehrenfreund and Jeff Guo of The Washington Post—who took the “it’s not economic anxiety” position—noted, “there does seem to be a relationship between economic anxiety and Trump’s appeal”, even if that relationship is not as simple as unemployed and poor people diving into Trump’s camp.
The same is true for the Brexiteers. As Ben Chu of The Independent notes: ” new research by the labour market economists Brian Bell and Stephen Machin… suggests the Leave vote tended to be bigger in areas of the country where wage growth has been weakest since 1997″.
The financial crisis of 2008 provided politicians with an opportunity to re-engineer the economic system to prevent these groups from falling behind so dramatically. The system failed, completely and utterly. Policy makers were in a position to re-design it. The financial system could have at very least been re-engineered to provide financing, training, and education to people in areas which lost out on manufacturing jobs thanks to automation and globalization.
Instead politicians capitulated utterly to Wall Street, and bailed out a fragile zombie system, as Japan did in the 1990s. The machine keeps blundering on, sitting on vast quantities of productive capital instead of setting it to work. Later, they set in place reforms like Dodd-Frank to shore up some of the fragilities in the banking system. These—in combination with the ongoing quantitative easing—may have prevented a financial crisis since 2008 (and Trump repealing such things may make the system much more fragile again). But that did not address the underlying problems. The fragility in the financial system was absorbed by the political system, and thus transferred into the political system. And now we reap the whirlwind of those choices, in the shape of a new nationalist populism that blames globalization, trade policies, and migration for the failures of Western politicians.
Trump already is setting his stand out as a builder and an investor in infrastructure, just as Hitler did.
As Keynes wrote in his introduction to The General Theory:
The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire.
The laissez-faire West failed to implement his ideas and avoid an economic depression (albeit a relatively mild one compared to the 1930s) following 2008. Now proto-totalitarians like Trump will get their chance, instead.