Guest Post: "Breaking News: The GFC was not caused by Beer Swilling, Cocaine Snorting Traders"

Satyajit Das, of Traders, Guns & Money fame, is keeping tabs on what he calls GFC plot lines, or what one might also call The Search For The Guilty.

The latest caught in the dragnet is…economists! But Das thinks some of the books still miss key issues.

From Das:

Just when I had finally worked out that the GFC had been caused by beer swilling, cocaine snorting, lap dancing club habitues who were irresistible to the opposite sex, I find I was wrong! It seems that the GFC was the work of economists who wish that they were beer swilling, cocaine snorting, lap dancing club habitues irresistible to the opposite sex.
This quartet of books focuses on the political economy of the GFC.

Andrew Gamble, Professor of Politics at Cambridge, in The Spectre at the Feast (2009; Palgrave MacMillan), provides a succinct overview of the economic background to the GFC. Gamble traces the shift in economic thinking and policy from Keynes/ Hayek through to the Friedman/Chicago School and its impact of the global economy. Gamble also assesses some of the current policies designed to restore the economy to health. A lively and eminently readable text provides the reader with a guide to how the present crisis is merely another chapter in the progression of the “dismal science” and familiar cycles driven by “animal spirits”.

Restoring Financial Stability: How to Repair a Failed System (2009; John Wiley) is a collection of readings lightly edited by Viral Acharya and Matthew Richardson on the GFC. Organised around seven loose themes (causes; financial institutions; governance; derivatives; role of the Fed; the bailout; international coordination), the 18 policy papers of varying quality propose ambitious ‘market based’ solutions to the problems revealed by recent events.

Fifty years ago, C.P. Snow, in his “Two Cultures” lecture, identified the divide between literary and scientific intellectuals. Restoring Financial Stability reveals a similar divide between theoretical economics and market practitioners. The tired nostrums that are put forward rehash age-old proposals for more capital, increased transparency and ‘better’ regulation that have failed repeatedly in the past.

Many of the problems in financial markets revealed by the GFC relate to the detailed plumbing and interconnectedness of financial markets. Some of the essays show a fundamental lack of understanding of critical micro-structure issues of how financial markets operate that detract from the proposed solutions. As Yogi Berra once remarked: “In theory there is no difference between theory and practice but in practice there is.”

Richard Khoo’s The Holy Grail of Macroeconomics: Lesson from Japan’s Great Recession (2009; John Wiley) and the Gary Saxonhouse and Robert Stern edited Japan’s Lost Decade: Origins, Consequences and Prospects for Recovery (2004; Blackwell Publishing) provide fascinating insights into the problems of Japan that, despite protestations from Western officials, have striking similarities with the GFC. It seems that we are all in danger of turning Japanese.

Originally published in 2008 and now updated, Khoo argues that there are two phases in an economy – the “yang” ordinary phase when the private sector maximises profits and the “yin” post-bubble phase when the private sector moves to reduce debt and repair balance sheets. Khoo’s interesting thesis is that conventional economic policy may not work in the yin phase. This essential insight is crucial in understanding the evolution of a post-GFC world and the impact of aggressive government policy actions and their eventual withdrawal.

Japan’s Lost Decade, published earlier, provides a series of short perspectives on the collapse of equity and real estate markets bubbles and their relationship to Japan’s persistent economic problems. Both books provide insights into the effect of price shocks, deflationary pressure and the failure of policies in Japan that hold important lessons for everybody in the aftermath of the GFC.

The GFC poses important challenges in our understanding of economic processes and policy options. The economy may simply be too complex and unstable to be controlled by simplistic government intervention. There may be inevitable boom-bust cycles that cannot be easily eliminated, as a whole generation of economist assumed. As Keynes observed “the difficulty lies not so much in developing new ideas as in escaping from old ones”.