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Capitalism loses a compass

PARIS, October 6 – Capitalism is in the deepest crisis for 80 years, drunk on a binge of cheap money which made fools of the regulators, analysts say.

The market system is going through a life-changing experience which will determine for decades the way the global economy works, but its death is greatly exaggerated.

Public outrage, and political responses, if concentrated on increased state intervention, risk being simplistic, experts warn, offering various conclusions from the crisis:

— the dollar is losing its pre-eminent role and the United States some of its power; a revised global monetary system is needed.

— a central cause of the crisis was too much, too cheap central bank money for too long, mainly from the US Federal Reserve; another was wrongly targeted regulation.

— rules for financial markets and state intervention must be re-defined but not necessarily increased.

— a national focus on banking might slow or reverse globalisation; cross-border bank competition should increase.

— developing countries would be hard hit if market economies were to put the clock back.
There is broad agreement that anger aimed at bankers is a bad guide to errors made and reforms needed.

French President Nicolas Sarkozy, current president of the European Union, has spoken of a need "to rethink the entire financial and monetary system…to create the tools for worldwide regulation".

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German Finance Minister Peer Steinbrueck declared: "The USA will lose its superpower status in the global financial system. The world financial system is becoming multipolar". Russian President Dmitry Medvedev went further: "The time of domination by one economy and one currency has been consigned to the past."

Some voices in the United States objected that government rescue measures were "financial socialism".

French newspaper Le Monde argued this week that free-marketeers have lost the initiative and Keynesian proponents of state intervention were back in favour.

Edwin Le Heron, an economist at the Institute of Political Studies in Bordeaux, said he smiled when he heard Sarkozy attack capitalist excess. "If I had said the same thing, I would have been called a Bolshevik."

The broad view of economists interviewed by AFP came from London School of Economics finance professor Ron Anderson. This was "absolutely not" a move towards the end of capitalism, he said.

Policymakers were only considering "a market solution" framework, but "it is clear we are in the process of drawing the border line between the state and the private sector when they meet in the financial sector."

Those lines, laid down after the 1930s Depression, had become "blurred and eroded through financial innovation and technology," Anderson said. "We have to go back to the drawing board and lay out exactly where the roles of the state are and aren’t. In general, I don’t think we need a lot more state."

At the Organisation for Economic Cooperation and Development, a policy forum for 30 leading nations, the deputy head of financial affairs Adrian Blundell-Wignall, blamed bad policy.
"The private sector was circulating money available at what they thought was the right price, and there was too much liquidity, and the regulating control was wrong," said Blundell-Wignall, a former Australian central bank official and fund manager.

"This isn’t a question of having more regulation and more commissars, but better regulation."

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He criticised a controversial banking rule that asset values must be aligned with market prices because when markets plunged banks could become dangerously undercapitalised, and other rules allowing investment banks owned by banks to obtain cheap capital for high-risk business.

Another vital regulation was flawed because banks with equivalent profiles could apply it differently in calculating capital-to-risk ratios. "A sports analogy would be that each player could play to different rules," he said.

"This crisis is a defining moment in history, maybe the biggest crisis ever," he asserted, arguing that the long-term benefit for the taxpayer "must be not more regulation but appropriate regulation."

For Jean-Marc Daniel, economics professor at the Paris ESCP-EAP business school, the crisis arose from the 1987 stock market crash. The head of the US Federal Reserve bank Alan Greenspan pumped out dollars to avert systemic collapse, but after the crisis he went on providing unduly cheap money, Daniel argued.

This excessive supply of dollars drove up a US balance-of-payments deficit, stoking global imbalances, and a boom in property and raw-material prices.

Economists at the Bank for International Settlements, the central bankers’ central bank, have made a similar analysis which comes close to a mea culpa, blaming a long period of high growth and low interest rates, and "imprudent and excessive credit growth."

Daniel asserted: "This crisis has nothing to do with capitalism. In a capitalist system, one regulates the external deficit."

When Ben Bernanke took over at the Fed, the policy choice was to increase taxes or interest rates. "The origin of the subprime crisis is a power struggle between the government and the central bank on who will be first to limit people’s buying power."

When rates went up, people could not pay, Daniel said. "The drama is the banks lent to the poor because everyone thought that by speculating on their homes, they could get rich."
Daniel said Sarkozy had expressed "a fundamental truth", but was attracting little European support partly because France had not controlled its own overspending and now had a big balance of payments deficit.

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Referring to the international Plaza and Louvre agreements in the 1980s to stabilise the dollar and payments imbalances, and to European arrangements before the eurozone, Daniel said "we need a world ‘snake’", a framework in principle "but very flexible in practice."
An organisation like the International Monetary Fund should draft a new scheme "but associating closely other regions and powers," given that under the Chiang Mai agreement in Thailand in 2001 Japan and China had already guaranteed the monetary situation in that region.

Open-market principles were giving developing countries a huge boost and "it is important that this great accident on the roadway does not deprive them of this growth", Daniel said, arguing that banking was still too national and uncompetitive.

Rules had to be adapted, "but we must not have more state intervention; rather more control of monetary creation."

The crisis has accelerated a fall in the pre-eminence of the dollar and meant a shift in global economic power, he said, forecasting that if monetary and payments imbalances were ended "then there will be a dollar crisis … probably violently."

Francis Kramarz, economics professor at elite Polytechnique in Paris, said a strong state was essential to supervise rules on transparency and conflicts of interest. Reforms were needed, but widespread state supervision would be "far too cumbersome."

Pointing to the strong growth in developing countries, he said care should be taken to make sure that "public opinion does not throw the baby out with the bathwater."

For Nicolas Veron, a researcher at the Bruegel economic policy think tank in Brussels, the big question is: "Will the economic system that emerges from this crisis be as open as in the last 10-15 years or less open."

Financial capitalism "is not dead, it will survive and credit will return, because it is a fact of life, but what is not a fact of life is open economies."

The internationalisation of finance had been a powerful force in globalisation, matching savings in Asia to investment elsewhere, for example.

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Policymakers were focusing on crisis steps but should also focus on the "potentially devastating economic and political effects" if cross-border financial integration were reversed.

"Everybody is looking for villains baying for financiers’ blood because it is difficult to understand how capital markets work," he observed. "This is not the first case when there’s a complete disconnect between the professional discussion and public debate."

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