Is Global Economy a Mistake? Interview with Dr. Paul Craig Roberts

Paul Craig Roberts was Assistant Secretary of the US Treasury Department in the Reagan administration. He was Associate Editor of the Wall Street Journal editorial page and Contributing Editor of National Review. He is coauthor of The Tyranny of Good Intentions.

IN: According to the basic definition an economy is the realized social system of production, exchange, distribution, and consumption of goods and services of a country or other area.” Could you provide a brief assessment of the modern financial systems contribution to the above mentioned functions?

PCR: A financial system matches up savers with investors and higher returns with higher risks. When this becomes global, misbehavior by the reserve currency country causes problems for all.

IN: From my point of view the Wall Street investment systems have created much more harm than good for the world economy from 1929 onward. Wouldn’t it be advisable to eliminate so called “investment houses” altogether, leaving only a “traditional” banking system with a strict but simple regulations, in order to provide needed credits for tangible investments and a “safe heaven” for customers deposits?

PCR: In the US the Glass-Steagal Act separated commercial from investment banking. It was repealed in 1999. As a result of the present crisis, the major US investment banks have disappeared as such, having become part of depositor banks or having become banks themselves. I don’t want to hypothesize if the modern economy can do without the investment bank function.

IN: As you stated in your recent article, financial deregulation was an important factor in the development of the crisis. The most reckless deregulation occurred in 1999, 2000, and 2004. Subprime mortgages became a potential systemic threat when issuers ceased to bear any risk by selling the mortgages, which were then amalgamated with other mortgages and became collateral for mortgage-backed securities….The financial markets must be carefully re-regulated, not over-regulated or wrongly regulated. Don’t you think that the very existence of such “financiers” that have always been the economic parasites, poses a continuous threat to the global economy? The complexity of modern financial schemes makes it virtually impossible to create the “tamperproof” regulations.

PCR: Deregulation in the US resulted in part from the decline of the culture of prudence. Prudence lost its authority and was pushed aside by greed at all costs. Probably speculators should not be permitted to sell stocks and national currencies short.

IN: As the crisis unfolds, it becomes more apparent that the entire FIRE segment may be classified as a “burden” rather than “support” for tangible economy. Here is an excerpt from your article: Wall Street analysts pushed financial institutions to increase their earnings, which they did by leveraging their assets and by insuring debt instruments instead of maintaining appropriate reserves. This spread the crisis from banks to insurance companies. What kind of limitations (if any) should be imposed on the FIRE segment to assure its constructive role in the economy?

PCR: The problem is not that regulations were evaded, but that regulations were repealed. Risky instruments were permitted to proliferate without issuers having to maintain reserves against potential claims. For example, institutions that sold credit default swaps were not required to reserve against the instruments in the event they resulted in claims.

IN: You have acknowledged that a fractional reserve banking system based on fiat money appears to be capable of creating debt instruments faster than an economy can create real wealth. Add in credit card debt, stocks purchased on margin, and leveraged derivatives, and debt is pyramided relative to real assets. On the other hand you advocate measures to restore credibility to the US dollar as world reserve currency.
Having dollar (or any other national currency) as a reserve one, imposes an unfair tax on the rest of the global economy and provides plutocrats with the “imperial leverage” that is obviously unwelcome by the world’s societies. On the other hand, having gold as a reserve currency, proved to be an efficient solution. Dr. Ron Paul (R-Texas) backs such an approach. Even Alan Greenspan seems to acknowledge this concept. Could you comment on this?

PCR: Gold standards are not perfect. As Milton Friedman observed, central banks offset with monetary policy the automatic functionings of the gold standard. Another problem is the size of the world economy relative to the stock of gold. To sustain the current level of activity means a high price of gold and corresponding windfalls to current owners. Also, the annual increase in gold supply from mining might not suffice to sustain much growth in world output at stable prices.

Keep in mind that a large part of the current problem came not from private behavior but from Federal Reserve interest rate policy. It was the inexplicably low interest rates that set off the housing boom and inappropriate lending that initiated the collection of misdeeds that resulted in the current crisis.

IN: In your recent article: “What is to be Done?” you have proposed a concise and workable remedy for the US economic ills. With you Uncle Sam’s hat off, could you tackle this problem from a broader perspective? What would be the ultimate solution for the global economy in current circumstances?

PCR: The global economy, other than traditional trade, is perhaps a mistake. Initially, investors believed that global diversification in equity ownership would shield investment portfolios from being all weighted with the home country’s stocks, thus protecting portfolios from large declines from corrections. In practice, the global economy now brings down all equities together. The global economy subjects each national economy to the mistakes made elsewhere.

Igncy Nowopolski October 28, 2008 - 11:55am

Igncy Nowopolski's diary | printer friendly version |

( categories: Economics )

not an option

based on the federalist papers, I don't think it's possible to avoid a global economy since that's what traditional trade gets us; the ramp up, of course, will be scary but, once we're there, I think people will appreciate its benefits.

I say this because, every single day, I see international collaboration that's exciting.

I recently read that the US was using 30% of the world's resources while having only 5% of the world's population; hence, the adjustment to a fairer worldwide economy will be tough for us but it's the right thing to do.

sadly, though, being born in the US will no longer automatically make you one of the big, protected fishes in the pond.

mrmx October 29, 2008 - 4:50am

Infrastructure

Without an infrastructure that any person can plug into, doesn't unfettered global trade benefit mostly larger players?

In theory, it's great that I can make a product and sell it to billions of customers rather than millions, but in reality, unless I have a handle on foreign languages, foreign supply chains, etc., I'm not going to be able do this.

Meanwhile, larger players across the globe *will* have access to my natural markets, and will probably crush me.

NoPolitician October 29, 2008 - 10:09am

the next generation will adapt

the marketplace of ideas is transformed by bigger ideas and most people don't have those bigger ideas.

from what I've seen, people will adapt and there's no reason to believe that the kids in the next generation, with transformational power, can't learn languages or cooperate with others to make it possible to overcome the language barriers.

here in minneapolis, I see mexicans, who can't speak english, build homes; as you know, the actual building process doesn't require language; hence, one spanish speaker is enough to direct the energy of a whole crew in the right direction.

if I understand the soundbytes of krugman, we have 300 million in the US while there are 1000 million in china so, if economic development is uniform (fair), it will probably happen 3 times faster in china. add in India, with 1000 million, and then the US only has 1/7th of the worldwide economy. moreover, if all 4000 million people in the world are considered, less than 1/13th of them live in the US.

so, to be successful, our children will have to form partnerships.

mrmx October 29, 2008 - 11:22am

US needs to come down, not China to come up

Two news stories today caught my eye/ear:

China's GHG emissions now equal to the US

By 2035, we'll need two Earths to support us

Bottom line: Everyone wants a piece of the pie, but we've run out of pie.

Petronius October 29, 2008 - 12:37pm

Obama Claus Keeps Saying "Ho, Ho, Ho!" Though

hence, all the Obamacrats think that the sky will open up, angels will appear and heaven is at hand.

Howerver, I keep telling the Obamalusionists that Thanksgiving is the next holiday, not Christmas, so "be thankful for what you have!"

The statistics you mention are scary; Hopefully we can turn water into wine.

mrmx October 29, 2008 - 5:51pm

The income distribution

... has to be flattened both between and within countries. Lowering the standard of living of the U.S. will create instability if the burden isn't shared. There are still a lot of people in coutries like China that live in abject poverty.

Beto October 29, 2008 - 8:51pm

Japan

the social safety net in Japan imploded, as I understand it, after their real estate crash and senior citizens were forced out onto the streets.

the same thing will probably happen here since the haves will hold onto what they have and put political energy into protecting it.

mrmx October 30, 2008 - 9:53am

Don't bet on it

The US is very different from Japan, where there is strong social cohesion and being "polite" is a social virtue.

In the US rude rules. There will be civil unrest here if things get really tough. The pictures of riot police gassing seniors might even make the evening news. Should be interesting.

We haven't seen anything big like that since the protests against the Vietnam war. They got pretty ugly, too. Everyone remembers the Kent State massacre but there were many other pretty horrible incidents also, a number of which I witnessed up close.

tjfxh October 30, 2008 - 10:14am

Resonance

The curious thing is that if seniors do march, these will be some of the same people who marched at Kent State.

History sure is funny...

Petronius October 30, 2008 - 8:49pm

Resource limits

The finite nature of natural resources means that humanity has a three-way choice between accepting vast disparities in standards of living across the planet, accepting a low (i.e. medium HDI) standard of living globally, or reducing the population so that available resources are sufficient to support a western-style standard of living for everyone.

We're most probably stuck with option #1 because it is the default position. Option #2 is politically impossible in the west and will not happen unless it is forced on us by a global catastrophe. Option #3 is probably impossible because the only completely effective way to reduce a population (leaving out genocide...) is to increase living standards first.

Wandering Cynic November 3, 2008 - 3:56pm

#1 is not an option

The reason is that natural resources are insufficient to supply the disparity unless the disparity is seriously reduced which is your #2. At some point, with the population high enough, even #2 will not work whence the only option is that global catastrophe creates #3 but at the #2 standard of living.

"You have no respect for excessive authority or obsolete traditions. You're dangerous and depraved, and you ought to be taken outside and shot!" - Joseph Heller

Joaquin November 3, 2008 - 4:06pm

Doesn't there need to be a combination

of International players as well as players within a country? I.e., outsourcing of jobs to the lowest paying ones isn't working out particularly well for countries either in 3rd worlds or in developed nations. 3rd world workers are being taken advantage of by multinational companies--they've become slave labour! Trade between countries isn't on a level field--subsidies are paid in richer countries. In some cases in developed countries, framers are actually paid NOT to grow stuff while people in developing countries starve. Food that should be going into mouths is being used to fuel vehicles!

There should be room for manufacturing in developed countries as well as poorer countries.

Until there are corrections in trade agreements e.g. IMF and WTO doesn't get to make horrid demands on poorer countries with their lending; I don't see much hope that millions won't starve. IMF recently loaned money to prop up the Krona then demanded they raise interest rates from 12% to 18%. Seems to me that 18% only adds to their woes!

Fair is a two-way street! There has to be room for both.

Unfettered capitalism isn't the answer nor is socialism of everything on this planet. The two need to worth together for the benefit of all. Who gets to decide where to draw the line varies from country to country. What formula needs developing? What might rid the world from greed?

canuck October 29, 2008 - 5:48pm

Economic globalization is inevitable

Globalization is inevitably coming but not without fits and starts.

The elite recognizes this transition from economic nationalism to internationalism and is setting the stage on their terms, i.e., market capitalism that is ruled by concentrations of wealth and power in which the the creation and control of money is under the control of the Western elite.

It doesn't have to be this way, and it's not a done deal by long shot. In fact, this is a good chance that market capitalism typified by neoliberalism, neo-imperialism and neocolonialism will break down before this transition can be successfully effected.

Market capitalism is taking a hit right now due to the overreach of US financiers, and it doesn't look like they are going to be able to pull this one out without creating a global disaster that will undermine confidence among others in the "magic" of so-called free market, free trade and free capital flow, at least the way things are now structured.

The unfolding of this economic drama will be the central theme of this century. It will be shaped by forces that are not yet clear, but whose outlines can be discerned. Technological innovation will introduce a new energy regime that will be a game-changer, for example.

tjfxh October 29, 2008 - 7:40pm

"will undermine confidence

"will undermine confidence among others in the "magic" of so-called free market, free trade and free capital flow, at least the way things are now structured."

My confidence isn't lost since corruption has been with us forever. It would be much worse if capital remained in the hands of folks who couldn't manage it well and I think that most of the folks on Wall Street are parasites not managers.

mrmx October 30, 2008 - 10:13am

Lessons learned

Lessons learned will help shape the emerging global economy.

1. Markets are the superior way to discovery price, evaluate risk, and maintain dynamic equilibrium in a changing environment populated by a great many players and factors.

2. Command economies are not as efficient as market-based economies.

3. Fiscal and monetary disciple are necessary to maintain stability while providing for flexibility.

4. Economic neoliberalism leads to monopoly capital and oligarchic plutocracy, and in extremis to state capitalism and economic dictatorship.

5. Socialism is compatible with market capitalism through regulation, oversight, progressive taxation, and other instruments that provide for distributive justice and the establishment of a commonwealth based on personal liberty and responsibility within a social community committed to the principle that all persons are created equal, therefore have equal rights.

tjfxh October 30, 2008 - 11:17pm

Are You Being Sarcastic?

The classical notion of efficient markets is based on some assumptions that are often unrealistic. In circumstances where those assumptions are valid, markets do well, but those assumptions are frequently inappropriate.

Just because water flows downhill doesn't mean it's going to find the lowest point, or the best route to get there.

NateTG October 31, 2008 - 1:35am

See point 4

The neoliberal view of "free markets" is flawed because such markets are not actually free. Free markets require an environment that promotes equilibrium. The political setting of economic neoliberalism is designed with a thumb on the scale.

When I claim that markets are efficient, I am talking about markets as mechanisms for balancing supply and demand in the textbook microeconomic sense. Problems affecting market bias arise from political policies at the macro level, ergo, the myths of "free market capitalism."

The task at hand is to remove that bias and get the thumbs off the scales that tilt them toward the predominantly Western wealthy and powerful, funneling wealth upward and resulting in monopoly capital in the pockets of a global but chiefly European and American plutocratic oligarchy.

Removal of this bias requires macroeconomic policies that respect market efficiency at the micro level instead of replacing market action in response to supply and demand to discover prices and to price risk.

This will be a huge task in the process of globalization that institutions like the IMF and World Bank are now handling in a very biased fashion, and national macroeconomic policies are also working at cross purposes, both globally and within the countries themselves.

If this transition is not accomplished well, the result will be global neo-feudalism.

Two factors to consider: Is political equality possible without economic equality? Can aggregate demand lead to economic stability and growth based on innovation without economic equality to fund it? Which leads to point 5.

tjfxh October 31, 2008 - 12:32pm

Globalization is a great idea, all things being equal.

...but then all things aren't equal, are they?

Scratch one great idea.

Petronius October 30, 2008 - 8:53pm

Mortgages as Investments

I don't see anything bad about lenders packaging mortgages (not slicing or dicing them) and selling them as investments to informed investors provided the risk of the investor is limited to interest rate risk, i.e., banks and other mortgagees retain the default risk. In lay terms, they replace the defaulting mortgages by equivalent ones.

I worked for a company's pension fund in charge of the administration and we used to buy packages of mortgages from banks and trust companies. The administration would monitor to make sure that we received the monthly payments from each lender and we would sample the payments to ensure that the payments were properly allocated as to interest and capital repayment. It is a lot of work but the benefit to the fund was the ready availability of cash-flow from mortgages at a higher rate than other debt instruments because of the capital repayment. (This enabled the fund to have money available for investment without having to request [additional] funds from the company).

Albert

Albertde October 29, 2008 - 9:10pm

adsf

Mortgages are a boon to home ownership and the construction, appliance, furnishing,etc. industries. Responsible lending is a good idea. Fannie Mae was also a good idea in that it freed up reserves for further lending, thereby expanding growth.Securitization was a too idea, too, since it spread risk, making capital go further.

However, all of these good ideas can become bad ideas if they are not implemented responsibly, which they were not. Irresponsible mortgage lending lead to defaults. Fannie Mae being run for profit instead of as a public utility led to unwise risk assumption and over-leveraging. Securitization by the broker-dealers that also abused leverage, amplified by hedge fund overlevering, was even more irresponsible in that it ignored systemic risk.

All these things are now coming together to take the system down.In the end, financial entrepreneurship (risk-taking for profit) trumped the fiduciary responsibility that falls to the financial industry as intermediary between savings and credit.

The solution is to enforce responsibility through strict accountability. This also requires eliminating moral hazard from the system and adhering to strict discipline. That means running the financial system for the benefit of the economy and not chiefly for the profit of financial institutions, owners and personnel.

tjfxh October 30, 2008 - 11:08pm

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