I have promised to write about what has happened to the economy. I don’t pretend to think anyone but me is reading this, but writing is an interesting and useful exercise to focus, organize, and challenge my thoughts. So with that caveat, here are some thoughts on how to think about what is going to be the greatest challenge of our lives, the looming depression. Hope I am wrong by the way about this being a depression, but I think most people are in denial.
To my mind there are really two distinct issues, capitalism in general and its place in the modern world (I call this macro-economics), and what happened to bring down our economy in the specific case of the crisis we are facing (I call this micro-economics). In the macro-economic discussion, the real issue is what does capitalism look like in the 21st century and can it be controlled. I think the best book out there on this subject is Paul Krugman’s Depression Economics and the Crisis of 2008. Although Professor Krugman focuses on the various crisis’s of economies throughout the world since the Great Depression, the whole trend of capitalism becomes much clearer and although he doesn’t offer any solutions, some are fairly self-evident.
On the micro-economic issue, most of us think that the problem came from the housing bubble and greed and that is true as far as it goes. But this crisis really started back in the 80’s and with an attitude and psychology toward wealth formation and free markets when conservatives and their beliefs became co-opted by Democrats setting us on the road to disaster. Here I am relying on several sources.
If you are going to read about what happened you have to become conversant in the various financial instruments and lingo of the markets. Best way to understand the financial instruments in an unbiased view of them is through Frank J. Fabozzi’s Handbook of Financial Instruments (Derivatives, Hedge Funds, Futures, Collateralized Debt Obligations, Credit Default Swaps, puts, takes, long, short, arbitrage, moral hazard, etc.). Once you are conversant in at least a basic understanding of how these financial instruments work, and the regulatory structure around them, then you are ready to start to understand what really happened in the micro-economic crisis.
But as I indicated above, you also have to understand the psychological environment in which these instruments were employed and that takes some understanding of the conservative revolution that took place beginning with Ronald Regan. So along with some of the books I would recommend, I will throw in one on the psychology of conservative thinking, The Political Mind by George Lakoff. In total these books/sources include:
- Depression Economics – Paul Krugman
- Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism – Kevin Phillips
- The Origin of Financial Crises: Central Banks, Credit Bubbles, and the Efficient Market Fallacy – George Cooper
- The Handbook of Financial Instruments – Frank Fabozzi
- The Pedator State – James Galbraith
- Panic – Michael Lewis
- The Political Mind – George Lakoff
- The End of the Financial World as We Know It – Article by Michael Lewis and David Einhorn (New York Times)
- Six Errors on the Path to the Financial Crisis – Article by Alan Blinder (New York Times)
Yes I am a card carrying and charter member of the boring book club. My wife often asks me if I ever read fiction and her point is that sometimes fiction gets more to the truth than non-fiction. But I can’t help myself.
In the following weeks, I will lay the foundation for the following conclusions, but I thought you would like to know where I am going in case you don’t want to go there:
- Capitalism is still the best way to advance the world, create wealth for all, and spur innovation
- Capitalism as we knew it is over. With the interconnected markets and complexity of financial instruments, capital’s ability to freely and rapidly flow from one market to another creates a volatility that greatly increases risk that has been underestimated in the past. Capitalism is inherently an unstable system
- Tools that we have used to control the economy to smooth out normal cycles are no longer effective, may be counter productive, and the free market will have to be a lot less free if we want to reduce these cycles (requirements for minimum capitalization, limits on leverage, limits on currency speculation, limits on financial instruments)
- Flow down was a “free ride” theory of the conservatives that in operation has create large income gaps between the rich and poor with a shrinking middle class
- The philosophy of wealth creation as a measure of good is a bankrupt philosophy that encouraged greed as a worthy value that added wealth to everyone
- Governments around the world are going to have to cooperate more to stabilize the world economy and the reign of “government is the problem” is over
- Capitalism and venture capitalism needs to be nourished, but the focus of making money in the financial markets as opposed to investments in companies that create real goods and services other than debt service has to be redirected
Okay, it is a tall order. But if we don’t learn from this crisis, push partisan dogma out of the way, and face the reality of world we live in, we will simply repeat these mistakes, as many including me would argue we are repeating the mistakes that lead to the Great Depression. Ah, but only if the world was as simple as it was back then. This is not going to be easy.