It is generally agreed that the economic crisis of 2008-2009 was caused by excessive bank lending and that the failure to recover adequately from it stems from banks’ refusal to lend, owing to their “broken” balance sheets.
A typical story, much favored by followers of Friedrich von Hayek and the Austrian school of economics, goes like this — In the run up to the crisis, banks lent more money to borrowers than savers would have been prepared to lend otherwise, thanks to excessively cheap money provided by central banks, particularly the US Federal Reserve. Commercial banks, flush with central banks’ money, advanced credit for many unsound investment projects, with the explosion of financial innovation (particularly of derivative instruments) fueling the lending frenzy.
This inverted pyramid of debt collapsed when the Fed finally put a halt to the spending spree by raising interest rates. (The Fed raised its benchmark federal funds rate from 1 percent in 2004 to 5.25 percent in 2006 and held it there until August 2007).
As a result, house prices collapsed, leaving a trail of zombie banks (whose liabilities far exceeded their assets) and ruined borrowers.
The problem now appears to be one of restarting bank lending. Impaired banks that do not want to lend must somehow be “made whole.” This has been the purpose of the vast bank bailouts in the US and Europe, followed by several rounds of “quantitative easing,” by which central banks print money and pump it into the banking system through a variety of unorthodox channels. (Hayekians object to this, arguing that, because the crisis was caused by excessive credit, it cannot be overcome with more.)
At the same time, regulatory regimes have been toughened everywhere to prevent banks from jeopardizing the financial system again. For example, in addition to its price-stability mandate, the Bank of England has been given the new task of maintaining “the stability of the financial system.”
This analysis, while seemingly plausible, depends on the belief that it is the supply of credit that is essential to economic health — too much money ruins it, while too little destroys it — but one can take another view, which is that demand for credit, rather than supply, is the crucial economic driver. After all, banks are bound to lend on adequate collateral and, in the run up to the crisis, rising house prices provided it. The supply of credit, in other words, resulted from the demand for credit.
This puts the question of the origins of the crisis in a somewhat different light. It was not so much predatory lenders as it was imprudent, or deluded, borrowers who bear the blame.
So the question arises: Why did people want to borrow so much? Why did the ratio of household debt to income soar to unprecedented heights in the days ahead of the recession?
Let us agree that people are greedy and that they always want more than they can afford. Why, then, did this “greed” manifest itself so manically?
To answer that, we must look at what was happening to the distribution of income. The world was getting steadily richer, but the income distribution within countries was becoming steadily more unequal.
Median incomes have been stagnant or even falling for the past 30 years, even as per capita GDP has grown. This means that the rich have been creaming off a giant share of productivity growth.
So what did the relatively poor do to “keep up with the Joneses” in this world of rising standards?
They did what the poor have always done — got into debt. In an earlier era, they became indebted to the pawnbroker, now they are indebted to banks or credit-card companies and, because their poverty was only relative and house prices were racing ahead, creditors were happy to let them sink deeper and deeper into debt.
Of course, some worried about the collapse of the household savings rate, but few were overly concerned. In one of his last articles, Milton Friedman wrote that savings nowadays took the form of houses.
To me, this view of things explains much better than the orthodox account why, for all the money-pumping by central banks, commercial banks have not started lending again and the economic recovery has petered out. Just as lenders did not force money on the public before the crisis, so now they cannot force heavily indebted households to borrow, or businesses to seek loans to expand production when markets are flat or shrinking.
In short, recovery cannot be left to the Fed, the European Central Bank or the Bank of England. It requires the active involvement of fiscal policymakers. Our current situation requires not a lender of last resort, but a spender of last resort, and that can only be governments.
If governments, with their already-high level of indebtedness, believe that they cannot borrow any more from the public, they should borrow from their central banks and spend the extra money on public works and infrastructure projects. This is the only way to get the big economies of the West moving again.
However, beyond this, we cannot carry on with a system that allows so much of the national income and wealth to pile up in so few hands. Concerted redistribution of wealth and income has frequently been essential to the long-term survival of capitalism. We are about to learn that lesson again.
Robert Skidelsky, a member of the British House of Lords, is professor emeritus of political economy at Warwick University.
Copyright: Project Syndicate
A failure by the Chinese Communist Party (CCP) to respond to Israel’s brilliant 12-day (June 12-23) bombing and special operations war against Iran, topped by US President Donald Trump’s ordering the June 21 bombing of Iranian deep underground nuclear weapons fuel processing sites, has been noted by some as demonstrating a profound lack of resolve, even “impotence,” by China. However, this would be a dangerous underestimation of CCP ambitions and its broader and more profound military response to the Trump Administration — a challenge that includes an acceleration of its strategies to assist nuclear proxy states, and developing a wide array
Eating at a breakfast shop the other day, I turned to an old man sitting at the table next to mine. “Hey, did you hear that the Legislative Yuan passed a bill to give everyone NT$10,000 [US$340]?” I said, pointing to a newspaper headline. The old man cursed, then said: “Yeah, the Chinese Nationalist Party [KMT] canceled the NT$100 billion subsidy for Taiwan Power Co and announced they would give everyone NT$10,000 instead. “Nice. Now they are saying that if electricity prices go up, we can just use that cash to pay for it,” he said. “I have no time for drivel like
Twenty-four Chinese Nationalist Party (KMT) lawmakers are facing recall votes on Saturday, prompting nearly all KMT officials and lawmakers to rally their supporters over the past weekend, urging them to vote “no” in a bid to retain their seats and preserve the KMT’s majority in the Legislative Yuan. The Democratic Progressive Party (DPP), which had largely kept its distance from the civic recall campaigns, earlier this month instructed its officials and staff to support the recall groups in a final push to protect the nation. The justification for the recalls has increasingly been framed as a “resistance” movement against China and
Chinese Minister of Foreign Affairs Wang Yi (王毅) reportedly told the EU’s top diplomat that China does not want Russia to lose in Ukraine, because the US could shift its focus to countering Beijing. Wang made the comment while meeting with EU High Representative for Foreign Affairs and Security Policy Kaja Kallas on July 2 at the 13th China-EU High-Level Strategic Dialogue in Brussels, the South China Morning Post and CNN reported. Although contrary to China’s claim of neutrality in the Russia-Ukraine conflict, such a frank remark suggests Beijing might prefer a protracted war to keep the US from focusing on
RSS