The green shoots of misplaced optimism

Readers of the mainstream business and political press may have noted that a consensus is emerging amongst policymakers and the financial community – that the world has now seen the worst of the recession and that a full-blown economic depression will be avoided.

The leading optimists who express this view – such as the Head of the European Central Bank Jean-Claude Trichet – argue that the evidence now shows that the pace of global economic decline has been slowing and the “markets” may be “bottoming out”. The more optimistic, indeed Panglossian members of this fraternity, including market traders (this fraternity includes few women) are betting that signs of the so-called “green shoots” of recovery are now visible, heralding as it were the birth of a new spring for global capitalism. Here is an example from a Financial Times editorial on May 8 2009 titled “World discovers it is still breathing”

The end of the world has been cancelled for now, if we are to believe recent market movements. Confidence is slowly returning to investors, who have discovered they are still alive after last autumn’s near-death experience. Government policies – from unorthodox central banking to stress testing – have soothed the worst fears. The signs of rekindled optimism are everywhere. A long rally has brought equity markets back from the abyss reached earlier in the year. The oil price, though still far below recent records, is pointing up. So are sovereign bond yields –indicating investors’ wariness of where public finances are headed but also a renewed willingness to tolerate volatility in stocks. The mood has changed so much that people are even willing to buy bank shares.

The ideological function of reports such as this is to justify bailout measures that have been designed principally to socialize the losses of capital – whilst demanding little from the financial sector which was the leading force that propelled the world economy into this disaster in the first place.

Rarely mentioned in the mainstream media is the degree to which these measures are skewed heavily in favour of capital and how the bailouts have to be judged in terms of the opportunities forgone to spend the money in a variety of other ways (see my post on the opportunity costs of the G8 bailouts). Moreover, many of the conditions imposed involve very little real accountability and public commitments on the very financial institutions and regulatory authorities that are largely responsible for the mess.

Pangloss was the eternally optimistic philosopher in Voltaire’s novel Candide, who claimed in the face of 18^th century famines, waves of religious persecution and other man-made disasters that humanity as a species lives the best of all possible lives in the best of all possible worlds, a world that therefore it would be fruitless to attempt to change. It would take a Panglossian of the first order – or perhaps an editorial writer suffering from market-induced euphoria associated with the “green shoots” hypothesis – to ignore how the real burdens of the current global economic emergency are felt most intensely amongst ordinary people throughout the world – as their basic livelihood and security is threatened. Indeed the Financial Times had earlier noted this aspect of the global crisis just over a month ago:

Almost unnoticed behind the economic crisis, a combination of lower growth, rising unemployment and falling remittances together with persistently high food prices has pushed the number of chronically hungry above 1bn for the first time”. (Financial Times April 6 2009).

Throughout the world governments and companies are using the crisis to force pay cuts and demand greater “flexibility” on the part of workers – perhaps another reason for misplaced market optimism? Pay cuts are economically irrational in a slump when aggregate demand is falling – higher wages and expanded social benefits for ordinary workers would help to produce greater economic stimulus.

One of the key causes of the global financial collapse was the way that real wages of American workers stagnated and in some cases fell over the past 25 or 30 years – such that workers’ growing consumption and expenditures on housing was financed by ever-higher levels of indebtedness. Wall Street compounded the problem by pressing for the deregulation or self-regulation of finance which allowed what is euphemistically called “financial innovation” to develop – specifically the bundling of mortgage and other securities in complex derivatives, as well as practices associated with a very risky borrowing and investment. This potent mixture triggered the crash in the United States which has now spread globally.

The Risky Business of Global Finance

Attached is a December 1995 draft for a chapter that was published in 1997 for a book I edited for the United Nations University: Globalization, Democratization and Multilateralism (see Publications page for full details).

It sketches the global financial system of the mid 1990s -- a system that contained many of the seeds of the enormous and catastrophic collapse that has just occurred. The article links global finance to the everyday lives of individuals and families -- and specifically to how levels of personal indebtedness were on the rise in the USA partly due to stagnating real wages and growing family expenditures -- an unsustainable situation.

The second half of the essay "The Risky Business of Global Finance" shows how the financial system emerging during the Clinton Administration was not only built on these "real" foundations of indebtedness of individuals and families, but also how it was prone to collapse at it highest levels, not least because of the way the expansion of financial firms and banks was partly based on the proliferation of risky financial derivatives. Created largely on Wall Street, the essay suggested that derivatives formed an equivalent of a "black hole" at the epicentre of the interconnected universe of high finance.

Partly at issue then -- as of course now -- is the neglect by governments (notably the US and UK) of the need for prudential regulation to make the system safe, accountable and secure from collapse. The essay therefore calls for more "democratic surveillance" of financial systems to protect the life savings and incomes of the vast majority of the population.

Perhaps this proposal could be taken up today?

To view the pdf click here