Alasdair Macleod – 4 October 2010
Joseph Stiglitz, who is described by the Sunday Telegraph as “one of the world’s leading economists” has updated his book, Freefall. Stiglitz provides last Sunday’s Telegraph with an exclusive extract, headed, The euro may not survive. For those who don’t know Stiglitz, he is a card-carrying Keynesian and a Nobel Prize winner; for those of us that do he is nearly as misguided as Paul Krugman, another Nobel Prize winner.
Early in his extract, he regrets that when the G20 brought the developed countries together, “there was a moment when the whole world was Keynesian, and the misguided idea that the unfettered and unregulated markets were stable and efficient had been discredited”. This sets the scene for us, being a firm statement that he does not believe in a free market. Furthermore this extract is so full of common Keynesian fallacies that he provides a useful text for criticism of daft Keynesian ideas without going to the needless expense of buying his book. And it is so muddled that I shall restrict my critique to just a few of his key misconceptions.
- He states that “Critics claim that Keynesian economics only put off the day of reckoning”, and he argues that to the contrary, unless we go back to basic principles of Keynesian economics, the world is doomed to a protracted downturn. Mr Stiglitz is confusing cause and effect. A primary cause of all our troubles is the expansion of credit, firstly fuelling the dot-com bubble and secondly the residential property bubble. Mr Greenspan rescued us from the former by pitch-forking us into the latter. A further cause is the growth of non-productive government at the expense of the productive private sector; a result of past interventions that are never unwound. The crisis has been created by the very policies he believes in, and he somehow thinks that even greater doses of credit-creation and budget deficits will get us out of it. The world is doomed to a downturn because attempts by governments to undermine free markets eventually fail, not because of insufficient stimulus. The problem with basic Keynesian theories is that they rely on tricking the market with unsound money, and successive waves of intervention have left us with a legacy of debt and devalued savings, or put more simply, we are bust.
- He states that “The low interest rates on long-term bonds and inflation-indexed bonds suggest that the ‘market’ itself is not too worried about inflation, even over a longer period”. This is incorrect. Bond yields reflect the fact that the Fed and the Bank of England are pricing bond markets through QE purchases, wrongly persuading fund managers that government bonds are a safe-haven. You cannot draw conclusions from a rigged market.
- He believes that governments can still do more to help the private sector grow – “if the old banks won’t lend, create some new banks that will”. He fails to understand that banks are operating in an economic environment that is totally different from before the credit-crunch. The private sector is burdened with an insupportable debt mountain and it is a bad bet. Banks’ primary duty is to their shareholders, and they will seek the best returns available, commensurate with risk. And guess what – their best returns come from lending money to governments and to dynamic businesses in developing economies. If governments were to create new banks with a different approach, bankers would have to be retrained to have the sense knocked out of them.
- “Had Greece and Spain been allowed to decrease the value of their currency, their economies would have been strengthened by increasing exports”. This is a common assumption that goes all the way back to Keynes’ Tract on Monetary Reform, and is wholly fallacious. If it was true, Germany’s and Japan’s trade surpluses would have diminished as their currencies rose, and the continual devaluations of sterling and the US dollar would have diminished their trade deficits as well. Experience shows that devaluation does not reduce trade deficits, as Stiglitz wrongly states. Trade imbalances are simply the result of government interventions: debtor nations run unbalanced budgets, intervene in the currency markets, inflate the money supply and permit banks to create excessive levels of credit. Without these inputs, the private sector always balances its trade and capital flows; with them it does not have to.
- Our final example addresses the future for the euro: “There is one solution: the exit of Germany from the eurozone or the division of the eurozone into two sub-regions.” This recommendation overlooks the fact that there is no exit mechanism and for the treatment of affected debt. What creditor is going to agree to redenominate his loans in drachmas, pesetas or lira? It also overlooks the fact that members of Stiglitz’s new sub-region would be simply unable to raise money in the capital markets without paying considerably higher interest rates than they do today. Leaving the euro would accelerate their bankruptcy and create the economic and banking crisis Stiglitz says he is trying to avoid.
These misconceptions in Stiglitz’s book extract are but a small sample of his Keynesian errors. Unfortunately, they have been repeated so often that they are now unquestioned. People like Stiglitz have become an integral part of the establishment and their insistence on interventions and regulation to counter perceptions of private sector short-comings is finally wearing the private sector down. That is why the global economy risks collapse, and not as he supposes, from insufficient Keynesian stimulus.
Like Paul Krugman, Stiglitz has achieved the highest honours the establishment can bestow in the form of a Nobel Prize. Yet the wise man reads his writings in the knowledge that they are infallibly wrong and therefore excellent guidance for what is right.