Last night I was asked what I thought was going on in the economy. Who knows? Not me and perhaps no one. But we can all make guesses.
My guess is that the essential problem is revealed, inadvertently, by Larry Summers in his July 18 op ed piece in the Financial Times, “How to Save the Eurozone in the Coming Critical Weeks.”
Regarding Greece and Europe he notes: “Three realities must be recognized if there is to be a chance of success. First, the maintenance of systemic confidence is essential in a financial crisis.” Too bad he doesn’t define “systemic confidence.” I’d guess it means denying that insolvent financial institutions are indeed insolvent.
If holders of financial assets, whether banks or private parties, can convince the public that these assets, even if worthless, must, at all costs, have their value preserved, then they will indeed wish to maintain “systemic confidence” to give them time to somehow impart value to these assets (or pass them on). In Summers’ words, “Third, there must be a clear commitment that, whatever else happens, no big financial institution in any country will be allowed to fail.” [emphasis added]
Where there’s a will there’s a way…sometimes. Many years ago, according to legend, a King Canute “set his throne by the sea shore and commanded the tide to halt and not wet his feet and robe.”
Perhaps Mr. Summers and his fellow economists, politicians and bankers will do better than poor King Canute. Mr. Summers’ suggestion for saving the Eurozone is “European authorities must restate their commitment to solidarity as embodied in a common currency and recognise that the failure of any Euroean economy is unacceptable.” [emphasis added]
Fortunately, “the technicalities of a policy response are not that difficult.” And, we are assured, “A default to the official sector will not be tolerated.” [emphasis added]
King Canute may have been a fool. Larry Summers most assuredly is not. Why then, would he make such apparently silly assertions?
I’d guess it’s because he understands all too well that the fundamental problem with the economies of both Europe and the United States is that there are billions (trillions?) of euros/dollars debt that can never be paid off. There simply is not enough wealth production to do it. Worse yet, not even the interest now demanded will be payable. In Mr. Summers’ words, “Meeting debt burdens at rates currently charged by the official sector for credit–let alone the private sector–would involve burdens on Greece, Ireland and Portugal comparable to the reparations burdens Keynes warned about in The Economic Consequences of the Peace.”
The reparations burden, if perhaps not the primary cause, was at least a contributing cause to the Great Depression. The question has to be asked, with the current large debt burdens clogging the arteries of all the Western economies, are we doomed to a repeat of the 1930’s and ’40’s? Can “It” Happen Again?
As Hyman Minsky noted, back in the Twenties and Thirties, governments were relatively weak; they were involved in only a small part of economic activity. When banks failed and the values of assets were wiped out, there was little, if anything, that the governments could do to preserve these asset values.
When financial asset values were wiped out, debts were also wiped out. By 1940 the arteries were pretty well unclogged. Going into World War II, both public and private debt burdens were minimal; the government was able to increase its debt, simultaneously providing savings to the workers/consumers, which they spent generously in the postwar prosperity.
Now governments are a huge part of the economy–strong enough to guarantee and preserve the value of many assets. (Bailouts, anyone? QE2 anyone?) The maintenance of the value of financial assets being the government’s top priority, debt forgiveness becomes impermissible. With wipeouts of financial asset values (i.e., letting banks “fail” or become nationalized) off the table, wipeouts of debt are also off the table. And the governments serving the banks, unlike in the 1930’s and in all previous financial crises, are strong enough to have their way.
No wipeout of debts, no unclogging of the economy’s arteries. 2011 is not 1932.
2011 may well be worse. Eventually people are bound to notice that debts that can’t be paid won’t be paid, and “systemic confidence” will vanish. However, by that time, governments will have taken on the worthless assets of the financial sector. By swapping their bonds for the toxic assets, they guarantee interest income to the former owners of these toxic assets.
By decreasing taxes on the upper income bracket, the government enables more after-tax money to enter financial asset markets, and thus the value of these assets can be bid up. With these tax cuts the government can and does pass the “real” losses onto the public. Due to the tax cuts, government debt becomes too big, “forcing” the government to starve “entitlements.” The public and especially the middle classes are accused of having been beneficiaries of government largess for too long. The money spent on the benefits they’ve been receiving is needed to pay interest on the increased government debts that were incurred buying the toxic assets, waging wars, and cutting tax revenues.
What do I think is going on in the economy? My out-in-left-field guess is that a rare, fundamental change in governance is occurring throughout the West, comparable to what happened in the transition from feudalism to nation states. Now the transition of power is from nation states to the international banks and multinational corporations. We are seeing the rise of new sovereigns and a new political-economic world order.
No, Larry Summers is no fool. It looks as if he and his cronies, unlike King Canute, will be able to stop any tide from even dampening their toes.
Addendum: Michael Hudson’s interview, “Wall Street’s Euthanasia of Industry” shows far better than I could what’s going on.