Monday, December 15, 2008
An article in Business Week says this of the Madoff scandal:
Business Week is discussing investments and the economy. But isn't the same true about America's political and justice system?
Painfully, the allegations of fraud surrounding the Madoff affair are also exposing the fundamental fallacy of the global economy. Like Madoff's trusting investors, the rest of the world was willing to assume that the U.S. economy as a whole was a low-risk, good-return investment. This belief drove the entire structure of global trade and finance for the past 10 years. And when the subprime crisis showed this assumption of low risk to be false, the financial crisis resulted.***
The big unanswered question, for years, was why this money flow [from China, Japan, and America's other creditors] persisted. Why the heck were foreign investors willing to lend the U.S. such large amounts of money on such good terms? Economists and journalists spun out hypothesis after hypothesis (we'll see more below), but there was no agreement on why.
Now we see what happened. Wall Street firms—big operators like Lehman and relatively small fish like Madoff—told foreign investors they could put their money into the U.S.—the world's safest economy—and still make decent returns.***The Wall Street boom of recent years was built, as far as I can figure out, on selling the low-risk story to foreign investors. In fact, most of the financial innovations of recent years were about making investments in the U.S. 'safer' for foreign investors. The enormous growth of foreign exchange enabled those abroad to protect their U.S. investments from exchange-rate fluctuations. The sudden increase in credit default swaps could be used to protect foreign bond investors from problems with individual countries. And collateralized debt obligations, which could be divided into high-risk and low-risk pieces, increased the supply of low-risk investments to be sold outside the U.S.***
However, the low-risk, good-return story simply wasn't true . . . .
What comes next? The fallacy is punctured. Globalization will be seen as what it is—a game with risks that can't be wished away.
The Velocity of Money and Wink-And-Nod Leadership
The world is in deflation, partly because the velocity of money (i.e. the speed at which a dollar bill changes hands from one person to the next) has slowed to a crawl, bringing on deflation and worsening the financial crisis.
As perhaps the world's leading living authority on monetary policy and the Depression notes, banks won't lend to each other because they don't trust that the other guy has an accurate balance sheet, and is not about to get sucked into a black hole of derivatives liability.
Surely I can't argue that lack of trust in the government has anything to do with the slow down in the velocity of money?
"President George W. Bush has bestowed on his intelligence czar ... broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations."
Moreover, political leaders who lie repeatedly send the message to the rest of the country that it is okay to lie. In other words, the government's lying about Iraq, spying, torture, and 9/11 (see below) sends the message that the government won't punish liars. And by implication, that means that the banks and other financial players knew they could get away with murder.
In a wink-and-a-nod era, the people who played fast and loose with our money knew they wouldn't get in trouble. Madoff, the former Nasdaq chairman, is emblematic of that wink-and-nod thinking by financial as well as political leaders.
We need to show that even the political leaders will be held accountable for their war crimes and their lies and that even the financial captains will be held liable for their scams. Only then will Wall Street really get the message that they have to be honest. Only then will Americans start believing in one another again.
Post-World War II America
A 2005 letter in premier scientific journal Nature reviews the research on trust and economics:
Trust is indispensable in friendship, love, families and organizations, and plays a key role in economic exchange and politics. In the absence of trust among trading partners, market transactions break down. In the absence of trust in a country's institutions and leaders, political legitimacy breaks down. Much recent evidence indicates that trust contributes to economic, political and social success.
Similarly, political economist Francis Fukuyama wrote a book called "Trust: The Social Virtues and The Creation of Prosperity", in which he argues that social capital is a major contributing factor in building economic prosperity around the world. (Note: I know what an unsavory character Fukuyama is, or at least was.)
After World War II, the U.S. had enormous social capital. We were looked at as the "good guys" in the war against Hitler, Mussolini and Hirohito. Many people worldwide - rightly or wrongly - wanted to copy America.
When Bush was elected, I told my wife (and have argued ever since) that we were moving into a "post world war 2" period. Specifically, I knew that - with Bush as president - America would go start some wars, that America's military policy and image would both change drastically, and that the post world war 2 trends would all change.
The facts - which all of the world knows - that the boys lied us into war in Iraq, tortured widely in Iraq and Afghanistan (importing communist Soviet Union torture techniques) and then said "we don't torture", spied on Americans (even before 9/11 ... confirmed here and here) and said "we don't spy", and covered up the facts about 9/11 (even the 9/11 Commission thinks there was a coverup ... see also this) have destroyed the world's trust in America.
Indeed, if American leaders employed communist torture techniques, Stalinist suppression of freedoms, and launched wars based on false pretenses like Hitler, can anyone believe that our leaders are not using the treasury as their own piggy bank and manipulating the economy, just as those systems did?
We can only restore trust by coming clean and holding everyone who committed these crimes - even the high and mighty - responsible.
In the words of the Business Week article on Madoff, the government's "fallacies" about the need to invade Iraq to stop WMDs, the need to torture to get information for use in the war on terror, the linkage of Iraq and 9/11, and the inability of the government to stop the 9/11 attacks have now all been "punctured". Everyone now knows that they simply weren't true.
The Emperor has no clothes. And the sooner that we admit it, the sooner we can address reality and start to restore trust in America.