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
In the US’ National Security Strategy (NSS) report released last month, US President Donald Trump offered his interpretation of the Monroe Doctrine. The “Trump Corollary,” presented on page 15, is a distinctly aggressive rebranding of the more than 200-year-old foreign policy position. Beyond reasserting the sovereignty of the western hemisphere against foreign intervention, the document centers on energy and strategic assets, and attempts to redraw the map of the geopolitical landscape more broadly. It is clear that Trump no longer sees the western hemisphere as a peaceful backyard, but rather as the frontier of a new Cold War. In particular,
As the Chinese People’s Liberation Army (PLA) races toward its 2027 modernization goals, most analysts fixate on ship counts, missile ranges and artificial intelligence. Those metrics matter — but they obscure a deeper vulnerability. The true future of the PLA, and by extension Taiwan’s security, might hinge less on hardware than on whether the Chinese Communist Party (CCP) can preserve ideological loyalty inside its own armed forces. Iran’s 1979 revolution demonstrated how even a technologically advanced military can collapse when the social environment surrounding it shifts. That lesson has renewed relevance as fresh unrest shakes Iran today — and it should
The last foreign delegation Nicolas Maduro met before he went to bed Friday night (January 2) was led by China’s top Latin America diplomat. “I had a pleasant meeting with Qiu Xiaoqi (邱小琪), Special Envoy of President Xi Jinping (習近平),” Venezuela’s soon-to-be ex-president tweeted on Telegram, “and we reaffirmed our commitment to the strategic relationship that is progressing and strengthening in various areas for building a multipolar world of development and peace.” Judging by how minutely the Central Intelligence Agency was monitoring Maduro’s every move on Friday, President Trump himself was certainly aware of Maduro’s felicitations to his Chinese guest. Just
When it became clear that the world was entering a new era with a radical change in the US’ global stance in US President Donald Trump’s second term, many in Taiwan were concerned about what this meant for the nation’s defense against China. Instability and disruption are dangerous. Chaos introduces unknowns. There was a sense that the Chinese Nationalist Party (KMT) might have a point with its tendency not to trust the US. The world order is certainly changing, but concerns about the implications for Taiwan of this disruption left many blind to how the same forces might also weaken
RSS