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January 23, 2014
David Warsh, Proprietor


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A Hundred Years Later: How Are We Doing?

A century after the outbreak of World War I, in 1914, and the memory of the wholly unexpected series of horrors to which it led, many commentators are feeling a little gloomy. Ordinarily I am persuaded by whatever sensible, knowledgeable, well-connected Martin Wolf has to say.

So I was surprised last week to find the chief economics columnist for the Financial Times arguing that our future is once again threatened by ignorant elites, just as it was in the years after 1914.  This time, he wrote, the best and the brightest have been mismanaging the peace rather than bungling a war and its aftermath.

Wolf’s bill of particulars:

First, the economic, financial, intellectual and political elites mostly misunderstood the consequences of headlong financial liberalization. Lulled by fantasies of self-stabilizing financial markets, they not only permitted but encouraged a huge and, for the financial sector, profitable bet on the expansion of debt. The policy making elite failed to appreciate the incentives at work and, above all, the risks of a systemic breakdown.

When it came, the fruits of that breakdown were disastrous on several dimensions: economies collapsed; unemployment jumped; and public debt exploded.

The policy making elite was discredited by its failure to prevent disaster. The financial elite was discredited by needing to be rescued. The political elite was discredited by willingness to finance the rescue. The intellectual elite – the economists – was discredited by its failure to anticipate a crisis or agree on what to do after it had struck.

The rescue was necessary. But the belief that the powerful sacrificed taxpayers to the interests of the guilty is correct.

It seems to me that the history of the last forty years is susceptible to a very different interpretation:

that the Cold War, which began with the partition of Europe after 1945 and the Communist Revolution in China in 1949, entered its last phase with the five-day meeting of the ruling committees of the Chinese Communist Party in December 1978, little more than two years after the death of Mao Zedong;

that the financial liberalization in the West, in the US in particular, began just in time, in the Seventies, to facilitate the entry of China into the global market system, starting in 1979;

that markets in the Eighties in general coped very well with a vast expansion of world trade; and that the immediate aftermath of the Cold War saw remarkably little loss of life, except in the Balkans;

that experts in the Nineties navigated a series of crises in Mexico, in Asia, in Brazil and Argentina, preserving the international financial system and maintaining global growth;

and that, when the twenty-five-year boom ended, in 2008, with the threat of a systemic breakdown of terrifying proportions, thanks to a global banking system that had evolved in ways that were little understood, central bankers correctly diagnosed the panic and the US Congress passed its test, appropriating funds necessary to preserve the banking system.

At least in the US, the necessary rescue probably cost the taxpayer little or nothing. The loans have been repaid. The severe losses – homes, jobs, earnings, careers, the fisc – stemmed from the deep recession, which otherwise could have been much worse. (The continuing crisis in the Eurozone is another matter. So is the Middle East.) True, by hampering the Fed’s ability to act, the Dodd-Frank Act probably makes it harder, not easier, to deal with the next crisis. But there is still time to deal with that.

I’d like to think that Wolf was simply writing for his audience, which consists almost entirely of those elites whom he castigates. There’s nothing wrong with leaning against the preferences of your readers.  He cited weakening bonds of citizenship amid growing inequality and the constitutional disorder of the Eurozone as further evidence that elites are losing touch..

It seems to me more reasonable to fear that the rise of China and India to superpower status may cause increasing friction with their neighbors and with the West. The experience of World War I suggests that there may be something about coming into the club that wants a war.  That was the case with Prussia’s becoming Germany, and Russia’s designs on the Ottoman Empire in the run-up to August, 1914. This time the problem of climate change may be enough to keep the lid on.

Some pretty serious trials lie ahead.

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2 Comments

  1. Eric wrote:

    The story you tell is more or less true depending on your point of view. From the point of view of the Chinese or euro-American elites, it pretty much works. For middle class Americans like me, not so much. Median wages in the US have been flat for about forty years– that is, my whole lifetime. Meanwhile productivity has kept increasing. This contradiction has been masked by the entry of women into the workforce and the growth of debt and the blindness of elites to the travails of those less fortunate, but it is still a very big deal.

    Thursday, January 23, 2014 at 5:02 pm | Permalink

  2. Dryly 41 wrote:

    I respectfully dissent from you respectful dissent of Martin Wolf. It seems to me you are talking about apples while Wolf is talking about oranges.

    The United States suffered banking panic/depressions in 1819, 1837, 1857, 1873, 1884, 1893, and, 1907 before the mother-of-all following the October 1929 stock market crash. It was called The Great Depression. The New Deal abandoned the laissez faire approach to finance in favor of “strict supervision”. The kept the restrictions on interstate branch banking set forth in the McFadden Act of 1927. President Calvin Coolidge, with Andrew W. Mellon and Herbert Hoover as Secretaries of Treasury and Commerce signed it to protect small banks and prevent excessive concentration of economic and political power by large financial institutions. The framers of Glass-Steagall instituted deposit insurance but were keenly aware of the “moral hazard” with bankers having access to what Louis Brandeis called “other peoples money” with a government guarantee. They sought to counter the “moral hazard” problem with “strict supervision” including the McFadden Act restrictions which they kept, and, separation of commercial and investment banks, and, also, restrictions on other speculation by financial institutions. They believed in a market economy but that the markets had to be honest, which they were not in the 1920′s(or 2000′s), hence the Securities Act and enforcement.

    It worked. The United States enjoyed financial stability for 78 years and 11 months after the return to laissez faire by repealing the McFadden Act and Bank Holding Act of 1956 leading to Too Big To Fail institutions with a great deal of “moral hazards”. Oh, and the financial system collapsed 9 years after the “strict supervision” of finance was repealed(deposit insurance remains even though the media always reports Glass-Steagall was repealed. I come down on Martin Wolf’s side on this one.

    With respect to the accolades accorded Nixon and Kissinger kow towing to Mao and the resultant Most Favored Nation trade agreement and allowing Communist China into the WTO with no mechanism to enforce unfair trade practices(assuming the despicable human rights record does not matter i.e. forget about Tiananmen Square-which I don’t) I think it has been a disaster for the United States with the loss of millions of jobs. The Chinese Communist party leaders have started to assert itself by claiming most of the South China sea and exacerbated tensions with Japan over uninhabited rocks. It’s crazy but it’s happening. Where it ens we don’t know but we made it possible with the trade deals.

    So I respectfully dissent here as well. I think Martin Wolf has it right.

    Monday, January 27, 2014 at 10:04 pm | Permalink

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