October 29, 2008

Can We Save The World Economy: A Panel

Last week Columbia University hosted a panel called Can We Save the World Economy with panel members George Soros, Nouriel Roubini and Jeffrey Sachs, hosted by John Roberts of CNN. The session was incredibly interesting and well worth the time to watch in full (1 hour 45 minutes) if one has the time.

Dr. Sachs was particularly good at summarizing why our economy has gotten so far off track and what must be done to make sure we are prepared to address the challenges ahead. He blamed the education given to economics students (what Atrios called Economics 101) which he said has been divorced from verifying what they expected to happen with what was really happening. As he said (my transcription, not exact quotes):

The way we train people to think in mainstream economics and I would say in mainstream politics have made it almost impossible [for people] to distinguish the surface and the underlying reality. Because [for the past three-plus decades] we had the Age of Reagan and the theory of Market Fundamentalism which changed the way we taught people to think. We told people that you just need to believe that the prices you see and the underlying model [which you are relying on] are close [because the Market knows how to value prices correctly].

Sachs says that economics stopped looking for cases that disproved their operating model, and began to assume that the model was correct and if things got out of hand (wow: housing prices are REALLY high) they shape their expectations to conform to their belief (Prices always go up). In other words, our schools were training students to eschew the scientific mode of thinking.

But Dr. Sachs noted you can only ignore reality for so long. Eventually reality has the last word on the subject. And he noted:

What fundamental, proper skepticism shows, [the type of skepticism that George Soros was taught] and also what the logic of economic bubbles shows and what the logic of biophysical bubbles shows, is what you see on the surface can completely hide and obscure what is happening below.

And it is our job as scientists and I would say our job as responsible citizens to understand the deep points and therefore to help rectify the discrepancies [between what we see on the surface and what is really happening] and keep us out of trouble.

My rough notes for this session can be found below the fold.

George Soros:
Underlying premises of market theory are wrong (said this 2 decades ago)
He asserts that markets do not accurately describe the real worth of thing
Eventually, the outcome of the market is so out of step with reality that it can no longer be believed.
Market Fundamentalism - belief that markets can self-correct.
Explosion of financial engineering - built ontop of a false assumption
Soros didn't think that this incorrect belief could have been sustained for so long.
The reason it did was because of intervention that didn't ever allow the markets to come back to reality.
- FED has the ability to guarantee system - but what about the other countries in the global economy don't have the ability to do that

Roubini:
In the late 1990s identified the next major victim of the financial crisis would be the US.
Deep recession in US
What about outlook for rest of world? Closely coupled world. Almost all the advanced countries in the world (50% of the world's GDP) was entering recessions BEFORE the latest financial crisis.
Major asset and credit bubble.
Bad policy decisions by FED - easy money, easy credit, investors underestimating risk, unsupervised markets, excessive risk-taking
Relying on self-regulating markets, very bad conflict of interest
Financial markets (last 20 years) have become less transparent and more opaque.
No ability for people to judge when there is no ability to tell where the risk is - walking blind on a mindfield.
Securitization - is the instrument that was used to transfer risk from original lender to someone far beyond.
No reason to care whether the loan was good, because it was someone else's problem.
How to reform the system - the incentives are critical for designing a system that works to promote the health of the system, and not something that destabilizes the system.
100 years: to create stable banks: (problem of lend long, highly leveraged, borrow short - can create bank runs)
- deposit insurance
- central bank which is not subject to bank runs
But shadow banking system is subject to bank runs - why we are having to fix that problem
Must have real deposits, less leverage
Key thing for now - vicious cycle that is taking the crisis in the financial system into the real economic.
Not only a subprime problem - affects every type of credit that we've had in the past few years.

Jeffrey Sacks: (Earth Institute)
Soros has taken on the Economics profession - over last 20 years. A profession that was very proud of itself, ingrown, self-congratulatory profession
What allowed so many to not see what was in plain view
Alan Greenspan's FED and Alan Greenspan, himself.
Monetory policy was very, very aggressive
Invoked the internet bubble, and then after 9/11, Greenspan did it again.
-- Global glut of money.
Fed also is responsible for regulating the financial industry.
Greenspan embodies the Market Fundmentalism that Soros discussed
Ayn Rand disciple (the founder of the concept)
Why is our situation at such an extraordinary point at this time?
What's the difference between this bubble collapse and the previous one around the Internet? (much bigger problem) - stock market and the .com.
- houses, mortgages, affects most people
1. been going on longer, more time for households to take on debt, get seriously undercapitalized themselves, core of economy - household sector - is very bad shape
2. this time, the credit system is implicated in this in a different way.
When asset prices broke, the finanical institutions found themselves undercapitalized
There was not there there. (modest declines of asset values caused extreme distress in the system.)
Break came, when decapitalization of banks turned into a full fletched panic.
When world realized that Leaman's collapse meant Nothing was safe.
Every major financial institution was under severe stress.
That risk has been "mostly" contained, but readiness of central banks to step in, has helped keep the system from truly collapsing.
So why do we have to experience a depression?
Because what was happening in the real economy could not be sustained as it was not built on reality. Can't just give away houses to people who cannot
Using society's resources to
Economy was allocating financial resources to build things, buy things and finance things for which that market demand can no longer continue
If people cut back to live within their means, new spending goes into other things that compensate for the consumption falling.
Balance demand.
Government is the only place where investment could be found
Making it happen smoothly is beyond our tools and the problems of our problems leading to problems
have to wait for new government - haven't had a government that works effectively for perhaps 3 years.
Soros - the bubble of american supremacy - do need global coordination.
Gone through a period of deep unreality
- climate change
- energy
Scientists will tell you that this type of collapse can also happen in the physical world
Treatment of the poor in the world is also a great amplifier
What I know about our traing since the early 1980s
"The way we train people to think in mainstream economics and I would say in mainstream politics have made it almost unable to distinguish the surface and the underlying reality. Because it not only it was the Age of Reagan and Market Fundamentalism, changed the way we taught people to think."
Told people you just need to believe that the prices and the underlying model are close - not trained to be skeptical, what you see on the surface is what is really happening.
What fundamental, proper skepticism, ... and also what the logic of economic bubbles shows and what the logic of biophysical bubbles shows, is what you see on the surface can completely hide and obscure what is happening below. And it's our job as scientists and I would say our job as responsible citizens to understand the deep points and therefore to help rectify the discrepancies and keep us out of trouble.
We need to train people to understand that What you see on the surface can completely hide and obscure what is happening under the surface.

What fundamental, proper skepticism, [which George Soros was taught] and also what the logic of economic bubbles shows and what the logic of biophysical bubbles shows, is what you see on the surface can completely hide and obscure what is happening below. And it's our job as scientists and I would say our job as responsible citizens to understand the deep points and therefore to help rectify the discrepancies and keep us out of trouble.

Posted by Mary at October 29, 2008 12:58 AM | Economy | Technorati links |
Comments

I think the best that could be said of what I learned in "Economics 101" was that if a market is actually like the one described in the book, things will work out in much the way economic theory predicts. Of course, as the prof teaching the course admitted, the assumptions are invariably less than perfectly true. There aren't armies of widget manufacturers who in turn sell their widgets on every street corner.

So I'm continually amazed by free market ideology, because it's clearly only true in the abstract. In reality, markets nearly always turn into monopolies or oligopolies. When that happens, they're no longer "free". The reply you get from such people when you say this is the empty-headed slogan "I'd rather have them running the market than the government", with never a clear rationale for why that even matters.

I need to listen to this video, clearly. Soros' assertion that eventually the market is no longer an accurate picture of reality (if I have that correctly) is fascinating. His conclusion (the second last line of the article) I believe is a correct one. If we've learned nothing from this grand experiment in free markets of the last few decades, it should be that.

Posted by: Cujo359 at October 30, 2008 11:08 AM