Peter Hartcher in the Sydney Morning Herald. He's not making any predictions, just offering some general observations in an easy to understand read. It's up to anonymous people on internet forums and the odd unhinged economist with a need for publicity to make bold predictions.
Scott
Scott
Central banker who goosed us all.
November 28, 2008
Kevin Rudd is quite wrong in his labelling of the cause of the global financial crisis. And Malcolm Turnbull is quite wrong in his core prescription of what to do about it.
Rudd has grown attached to his description of the crisis as a result of "extreme capitalism". That's akin to saying the Titanic sank because of "extreme sailing". The US economy and financial markets collapsed not because of the doctrine of capitalism, any more than the Titanic sank because of the practice of international shipping. The cause of the calamity was bad policy, just as the cause of the Titanic's fate was bad navigating.
At core, the made-in-America disaster is a simple matter. There were two parts to it.
First, US house prices were pumped up to unsustainable levels - a bubble - with prices so high they were bound to pop. In itself, this is not an unusual event. Booms and busts in asset prices, whether real estate or shares, are pretty common.
So common that in the postwar era rich countries have suffered a sharemarket bust every 13 years on average, and a real estate bust every 20 years on average, according to a study of 19 countries by the International Monetary Fund.
In four centuries of financial capitalism, this is a persistent problem - a rising market tends to move beyond all reason into hysterical excess. A bubble forms. It inevitably bursts. No news there. But on this occasion, the US housing bubble was bigger and uglier than your typical bubble.
Many of the world's central banks had been trying to keep bubbles under control. They were learning from two big lessons. One was Japan's implosion in 1989, when sharemarket and real estate bubbles burst simultaneously, leading to a decade of stagnation.
The other was America's 2000 sharemarket crash, the so-called Tech Wreck, when a bubble in technology share prices popped. This led to the US recession of 2001.
Can central banks really exercise any control over bubbles in asset prices? Yes. The Reserve Bank of Australia successfully dampened the Australian real estate bubble in 2002-03, using a combination of rhetoric and higher interest rates.
But in America, the country's top central banker, Alan Greenspan, drew a different lesson.
It was best summed up in this exchange with a sympathetic US senator in July 2001. As the American economy headed into recession, with 2.3 million jobs lost and $US7.8 trillion in wealth destroyed, the senator said to Greenspan during a congressional hearing: "If this is the bust, the boom was sure as hell worth it. You agree with that, right?" Greenspan calmly offered: "Certainly."
While other countries' central banks tried to avoid creating bubbles, the Fed set about creating a new one. Greenspan wanted to get the US economy out of its 2001 recession as quickly as possible. And he wanted to keep it growing until his looming mandatory retirement date of January 2006.
He goosed the US economy far too hard. He cut the official US interest rate to a ludicrous low of just 1 per cent - below the inflation rate - and held it there for a full year to mid-2004. In effect, Greenspan was subsidising US banks to borrow money. Money gushed into housing prices and the bubble burgeoned into an obscenely large mutation. Greenspan knew it would lead to a bust, but on the next guy's watch.
This was the core error. It was not "extreme capitalism." It was bad policy.
The second part was the failure of prudential regulation; particularly, failing to regulate the so-called subprime mortgage market and its derivatives.
This part of the story has received most of the publicity. But it only magnified the effects of the inevitable collapse. The housing market was always going to bust. And this was always going to lead to another US recession. I am not being wise in hindsight. I made this forecast in my 2005 book, Bubble Man: Alan Greenspan and the Missing Seven Trillion Dollars.
But the irresponsible behaviour in the financial markets amplified the size of the crash, and turned an American recession into a global one.
Whose job was it to police the US financial institutions and markets? Again, it was Alan Greenspan's Federal Reserve. Although his prudential responsibility was to regulate the banks and the markets, he had a conflict of interest.
He was already feeding cheap money into the economy to generate maximum speed. The last thing he wanted was to curb this by regulating the way money was being handed around. So he didn't.
In Australia, this task of policing the banks and the financial markets is given to the separate Australian Prudential Regulation Authority for exactly this reason. The US is now considering adopting the same structure.
Why does it matter what Rudd calls it? Because from the diagnosis comes the cure. The fault was not capitalism, extreme or lame. It was bad policy.
As for Malcolm Turnbull, he has made some sensible suggestions on how the Government should respond to the crisis, but the one he made this week is not one of them. Turnbull claims the Government must not allow a budget deficit. Already, Rudd has used half the projected budget surplus for this fiscal year as apackage to stimulate growth.
On Wednesday Rudd sensibly started to prepare the country for the possibility the surplus may evaporate entirely. This is exactly as it should be.
Budget policy should lean in the opposite direction to the prevailing economic conditions. When the economy is growing well, the Government should set aside its windfall revenues as surpluses. When the economy is shrinking, the Government should go into deficit to stimulate growth. That is the way sensible budget policy works.
Turnbull knows this well. To pretend it is some sort of irresponsibility of Rudd's is itself an act of irresponsibility. It marks the descent of Turnbull to economic stuntsmanship, no better than his predecessor, Brendan Nelson.
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