My article on the limits of reason was published in Express Tribune recently (Monday April 13, 2015). This essay shows that logic is limited in its ability to arrive at a definite conclusion even in the heartland of mathematics. Pluralism is required to cater for the possibility that both Euclidean and non-Euclidean geometries represent valid ways of looking at the world. The world of human affairs is far more complex. In order to study and understand societies, one must learn to deal with a multiplicity of truths. This argument, which is related to the first, has been made in my article “Tolerance and Multiple Narratives” which was published in Express Tribune earlier (March 29, 2015). These ideas form part of the background for supporting the drive for pluralism in our approaches to economic problems.

The existing international financial architecture, left over institutions from the Bretton Woods period, proved useless to prevent or warn against the 2007-2008 crisis, or even less, solve it. Only when a new presidential grouping (G20) meeting was called for in London in March 2009, the issues of how to coordinate countercyclical policies and inject resources into the economies were discussed. At that time, a UN high level Commission was created to propose reforms to the international financial architecture. The results of what became known as the Stiglitz Commission came to light in April 2010; the Commission’s recommendations were, however, shunned by some large UN member countries due to their rejection of the principle of global solutions for global problems. Indeed, some European countries and the US still insist on national solutions, that is on the use of local regulatory agencies in the international financial field.

Eight years have elapsed since the crisis emerged in 2007. There are no negative impact on the real sector as well as the financial sector is still being felt by leading financial institutions or Central Bank’s authorities. The major financial problems are dealt with at a national level in spite of being a global problem. Since 2010, the SEC has levied large fines against TBTF banks’ wrongdoings according to the definition of LIBOR, the commodity markets, the exchange markets and the fraudulent sale of collateralized debt obligations with credit risk approval from the three large American credit rating agencies; European regulators have done some of the same. Simultaneously, vulture funds attacked Argentina and made evident a nonsense of having the last creditor obtaining a better payment terms than the first one, breaking the usual understanding of the pari passu principle while a New York judge held the country hostage to his decisions. Finally all the G7 economies have come to reflect over 100% public debt on GDP ratios with only one approach to resolving this problem: austerity affecting economic growth, the price levels, and employment. As a consequence, debt indexes have increased sharply, depressing economic activity and prices.

From this background emerges the need for a new international financial architecture.
The conference, that is being organized by Oscar Ugarteche and Alicia Puyana,  focuses on the current global financial scenario and what appears as the new international financial architecture, which poses many questions that need to be addressed:

  • How did the crisis affect the structure of the financial sector in the different regions of the world? What kinds of provisions where implemented to manage the impact?
  • Has the financial crisis influenced the financial flows for productive sectors in the regions?
  • Have the regional financial architectures been adequately reformed after the crisis? Do they have any margin of autonomy to reform, or are they totally dependent on foreign banks and external funds?
  • Can vulture funds be considered as an element of the so-called new financial structure to prevent crises, or are they one more cause of instability?
  • Are the IMF and the available existing international reserves sufficient to prevent another major crisis?
  • Can the IMF be reformed, despite European and US reluctance to do so?
  • How should debt reduction mechanisms function in this new global scenario?
  • Are there lessons from the Latin American debt crisis of the 1980’s for Europe? Or is it a new type of crisis?
  • Are the austerity programs recently imposed on indebted countries an appropriate policy measures to prevent financial crisis, such as the one in 2008?

Papers falling within the broad topic of the conference as well as on related aspects that are not explicitly noted here are welcomed.

As the Chair of the Wea Conferences, I invite you all to submit papers and participate in the Discussion Forum.

For deadlines, guidelines and submission:

This was published in Express Tribune Opinion Pages on March 16th, 2015 —Keynes vs IMF. It is placed in the Pakistani context, but the same issues are relevant for Greece, Spain and Ireland.

Leading economists like Keynes and Fisher had forecast prolonged prosperity, just prior to the Great Depression of 1929. The shock of the Great Depression led Keynes to create Keynesian Economics. According to conventional economic theory, increasing the quantity of money in circulation has only one effect: increasing the level of prices. That is, printing money is inflationary, and has no effects on the real economy. Many economists of the time noted that massive bank failures had led to substantial reduction in the money supply. They came to a realization that these events were related. Contrary the classical theory that money only effects prices, the shortfall in the money supply caused the massive unemployment of labor and other factors of production and the contraction of the GNP.

Keynesian theory is based on a very simple idea that conduct of the ordinary business of an economy requires a certain amount of money. If the amount of money is less than this amount, then businesses cannot function – they cannot buy inputs, pay laborers or rent shops. This was the fundamental cause of the Great Depression. The solution was simple: increase the supply of money. Keynes suggested that we could print up money and bury it in coal mines and have unemployed workers dig it up. If money was available in sufficient quantities, businesses would revive, and the unemployed laborers would find work. By now, there is nearly universal consensus on this idea. Even Milton Friedman, the leader of Monetarist School of Economics and arch-enemy of Keynesian ideas, agreed that reduction in money supply was the cause of the Great Depression. Instead of burying it in mines, he suggested that money could be dropped from helicopters to solve the problem of unemployment.

But what about inflation? Isn’t it true that printing money in massive quantities would lead to inflation? According to Keynesian theories, this would happen after full employment was achieved. That is, once the economy reached its maximum production capabilities, further money could not contribute to an increase in production. At this point, printing more money would only lead to inflation, exactly as the classic economic theory predicts. Keynesian theory gives the Central Banks of the worlds an extremely important task: maintaining the money supply at exactly the right level to create maximum production without running the risk of inflation. Keynes also said that monetary policy may be insufficient for the task, and the government had direct responsibility to ensure full employment using fiscal policies.

Regulation of financial markets, social support for the poor, and government responsibility to provide jobs for all led to decades of prosperity in Western economies. The share in the wealth of the bottom 90% increased, while the share of the top 0.1% decreased. This state of affairs did not please the wealthy elites, who launched an extremely successful attack against Keynesian ideas in the 1970s. The Arab oil embargo led a sharp rise in oil prices and inflation, while simultaneously disruptingdisrupting productive activities and creating unemployment. Keynesian theories state that we can only have one or the other; “stagflation” or simultaneous presence of high inflation and high unemployment is ruled out.

This weakness in Keynesian theory was successfully exploited by the rich and powerful to argue that the main problem lay with government interventions. Reagan dismantled some of the post-Depression regulations which limited the powers of the wealthy financiers, as well as the social support and unions which strengthened the labor class against them. In particular, with great fanfare, Reagan de-regulated the Savings and Loan (S&L) Industry. Exactly as in the Great Depression, the banks took advantage of this to speculate in risky investment with the depositors’ money, and lost billions of dollars, creating a nation-wide banking crisis. However, the government had learnt its lessons from the Great Depression, and did a massive bailout to prevent a financial crisis entailed by the collapse of the S&LsL. Over the next few decades, deregulation unleashed the power of the financiers, and cuts in social services weakened the labor class, with predictable results. Speculative financiers gambled heavily with the money of others deposited in banks, leading to myriad monetary crises. At the same time the labor class was squeezed, resulting in rising inequalities and massive concentration of wealth at the top.

In the post-Keynesian era, the clarity of Keynes has been lost. Many Central Banks have gone back to pre-Keynesian ideas, abandoning the goal of full-employment, and focusing solely on controlling inflation. Substantial doubt has been created as to whether or not monetary policy, or helicopter money, can be useful in solving problems of unemployment. When countries spend more foreign exchange on imports than they can earn, they are forced to borrow dollars from the IMF. As a condition of such loans, the IMF insists on austerity – governments should balance budgets and not print money to finance deficits. According to the IMF, financing deficits with increases in money supply can lead to high inflation, with heavy economic costs. However, according to Keynes, we should increase money supply in an economy with high unemployment such as Pakistan. Printing money is not inflationary in such a situation. So who is right? Keynes or the IMF?

Recent research by Princeton economists Mian and Sufi sheds considerable light on the answer, which is obvious in retrospect: Both Keynes and IMF are right. What happens depends on who picks up the helicopter money and what they do with it. If those who get the money buy land, property values will go up. If they invest in stocks, this will create a bubble in the stock market. If they put it in their Swiss accounts, this will lead to depreciation of the exchange rate. However, if the money is used wisely, to invest in projects which increase the productive capacity of the economy, this will create employment and generate the economic returns needed to provide support and backing for the newly created money.

When Keynesian policies of full employment and social support for laborers eroded the wealth shares of the power of the rich, it is an article of faith for the wealthy elite, the counterattack created alternative policies, as well as theories and ideologies to support these policies. Decades of experience with these policies, codified in the Washington Consensus as privatization, liberalization and stabilization, has shown that they produce increasing inequality but do not produce growth. Alternative models for successful development are always corrupt. The historical record does not bear this out.available. The most spectacular recent example was labor leader Lula of Brazil. After being elected president in 2003, his deficit financed programs of social support and investment created progress and prosperity. Under Lula, Brazil went from being the most heavily indebted country in the world to the eighth largest economy, and 20 million people rose out of poverty. There are many other examples of wise public spending listed by Ellen Brown in The Public Bank Solution: From Austerity to Prosperity. Other kinds of examples also exist, where reckless and corrupt governments can wreak havoc on the economy, as the IMF fears. Can we rise to the challenge which faces us in Pakistan? That is, to curb corruption and spend efficiently on social services and productive investments, leading to the Keynesiian outdcomes of full employument wiithoujt inflation?

Modern history is largely driven by the battle of the rich (top 0.01%) against the masses (bottom 90%). Over the past few decades, the rich have been tremendously successful in having it all their way. A previous blog post on “Deception and Democracy” illustrates by examples their successful conversion of democracy into plutocracy in the USA. As pointed out by Polanyi, unregulated markets create disastrous outcomes for the majority. Therefore, in a democratic environment, theories which misrepresent facts and justify massive inequalities are essential pillars of support for the plutocrats. Spreading these theories via media and educational channels helps create an environment where people support policies which go against their common interests.

As many posts on austerity on the RWER blog have shown, austerity has only caused massive damages to the European Union (just search for “austerity” on the blog). Theories which support austerity as a policy are disseminated by premier educational institutions and provide a crucial pillar of support for enforcing such policies. Equally, educating the public about the flaws of such policies and providing a viable alternative is an essential element of a counter-attack. Ellen Brown has performed a tremendous service with her books “From Austerity to Prosperity: The Public Bank Solution” and also “Web of Debt: The Shocking Truth about our Monetary System and how we can break free.”  I have tried to pick up certain key insights from these books and summarized them as a solution to development problems in Islamic economies in my paper: “On the Nature of Modern Money.” However this paper is lengthy and complex, and meant for a professional audience. My newspaper article “Keynes vs. IMF” presents a brief and oversimplified version of some of the key ideas the public needs to learn, in order to be able to overcome the illusion that austerity is good for them.

An important point here is that the real world economists need to take their case to the public, which is victimized by the neoclassical economists. Talking among ourselves is not helpful except in terms of discovering the strongest arguments and best lines of attack. There is absolutely no point in trying to get published in leading journals, or trying to change minds of professional economists – they have the most to lose. Our natural audience are those who have the most to gain by listening to our message. This means that we need to make much greater efforts to convey our message to the general public. This involves participating more on popular forums like conventional blogs, writing book reviews for good books, providing critiques and alternatives for bad ones, writing for newspapers etc. It also involves making the efforts required to translate and present our theories and models in ways attractive and comprehensible to a general audience.

As Bagehot (1873) clearly said:  banks trade money. In the current banking scenario, the interconnections between credit and capital markets foster the growth of banks’ assets and profits. The other side of the “coin” shows higher corporate leverage and household debt. As a result, all society has been subordinated to trading private money.  Accordingly J.M.Keynes, money, as the institution that founds the exchange system, is a link between the present and the future. Money trade by banks fosters the capital accumulation process that develops through time and involves credit contracts.  In a context of uncertainty and speculation, the tensions between money as a public and as a private good overwhelms central banks’ actions, as we are seeing in the current bail-outs. The 2008 financial crisis has shown sources of worldwide financial fragility: the financial innovations regarding bank’s asset, liability and capital management, the movement toward securitized finance, the growing importance of institutional investors, besides the random investors´ behavior in a context of capital account openness.    Indeed, the evolution of banking practices can be apprehended in a changing historical context where tensions between the regulation of capitalist finance and the strategies of innovative profit-seeking banks arise.  In fact, since banks play a crucial role in determining the pace of growth, any new banking practices and products  turn out to affect the overall stability of the economy. From H. Minsky we learned that financial innovations are not just techniques or product phenomena, but involve institutional changes. Banking practices have increasingly included risk management, such as liquidity, credit, interest rate and currency risk. Banks have increasingly adopted an integrated approach called asset & liability management and enhanced further banking innovations. The target of this process is to expand the endogenous money creation by banking institutions since the new loans are considered profitable. Accordingly H. Minsky, the growth of financial innovations did not mainly occur because of competitive market forces. Under his opinion, the role of both banking regulation and monetary policy has been outstanding to explain new management practices and innovations.  In the context of the “New Deal” segmented system of financial regulation, commercial banks began to actively manage liabilities, in order to raise additional funds. In the 1960s, as a result of banks’ innovations, the development of the fed funds market in the US turned out to reduce the Fed’s ability to use legally required reserves to constrain bank lending. In other words, financial innovations turned out to subvert constraints imposed by financial regulation and monetary policy.  More recently, the 2008 financial global crisis revealed that the evolution of  banking practices deeply depends on the arbitrage/speculation made by global players in the financial markets. In the aftermath of the crisis, banks continue trading money, but the distinction between private and public debt has become blurred.  To fund banks’ assets, central banks have been expanding loans to commercial banks at both short and longer-term maturities.  In addition to low interest-bearing deposit facility, central banks’ actions have also included the acquisition of government bonds issued by Treasuries to face the debt crisis.     In this scenario, many nation- states – that used to defend the expansion of financial liberalization – have taken a stake of more than 50% in banks’ capital and implemented austerity programs that fostered unemployment and the lost  of social rights. Indeed, the social costs of the banking sector bail-outs have undermined the idea of efficiency of the self-regulated financial markets and the trust in the social dimension of public policies. Considering this background, two relevant questions arise: Which is the room for maneuver of nation-states to shape a financial  agenda towards sustainable economic and social growth? Could banking regulation induce more control over banks’ management practices in the future?.

Karl Marx was deeply moved by the plight of the exploited laborers in industrialized England in late nineteenth century. He theorized that the dynamics of capitalism would lead to increasing exploitation, until the laborers revolted against the system. After the revolution, the laborers would create a new economic and political system, which would be far more equitable than capitalism.  This Marxist prophecy was wrong, but did contain one core truth: increasing exploitation of workers did lead to a breakdown of capitalism during the Great Depression. The same dynamic has repeated itself in creating the global financial crisis of 2008. This article explains the parallels.

We can partition the economy into a real sector and a financial sector. The real sector is where the production takes place; these are the farms, factories, and other industries which produce real goods and services directly beneficial to human beings. The financial sector is based on activities which are not directly productive, such as lending money for interest, speculating on stocks, foreign exchange, and using derivatives and insurance contracts to gamble on the outcomes of real activities. In the roaring 20’s, wild appreciation in stock prices led to a situation where it became substantially more profitable to gamble on stocks than to invest in real productive activities. Increasing shares of wealth in hands of gamblers and decreasing returns to productive activities cannot be sustained for long, and led to a collapse of the real sector, which is called the Great Depression.

Collapse of the real sector led to massive unemployment, and human misery on a large scale. It is correctly said that Keynes rescued capitalism from the fate Marx had prophesied. Conventional economic theory holds that market forces of supply and demand will automatically eliminate unemployment. Keynes revolutionized economics by repealing the law of supply and demand in the labor market, and urging the government to intervene to help the unemployed laborers. The Keynesian compromise provided relief against the worst effects of capitalism, and prevented the more radical changes suggested by Marx.

In her brilliant book, The Shock Doctrine, Naomi Klein has provided a detailed picture of how a counter-revolution was planned and executed by a small segment of society which was unhappy with the Keynesian compromise. An opening was provided by the 1970’s oil crisis which led to stagflation in the USA, contrary to central premises of Keynesian theories. The monetarist school of Chicago was quick to stage a comeback. They argued that the Great Depression was caused by government mismanagement of the money supply, rather than a failure of the free market.  Using strategies described by Klein, these free market theories were applied all over the world.

Reagan and Thatcher implemented these free market policies in the USA and UK with predictable results. From 1980 to 2006 the richest 1% of America tripled their after-tax percentage of our nation’s total income, while the share of the bottom 90% dropped over 20%. Between 2002 and 2006, it was even worse: an astounding three-quarters of all the economy’s growth was captured by the top 1%. The same pattern of sharply increasing inequality holds globally; the wealthiest 250 people have more than the poorest 2.5 billion people on the planet.

Superficially, “Laissez-Faire” or no interference in markets seems like a fair and equitable philosophy – let everyone do whatever they want. In fact, it is highly inequitable; the poor don’t have choices, while the rich and powerful take advantage of this liberty to extract money from the less rich. Financial wheeling and dealing is used to transfer money from the real sector to the financial sector controlled by the wealthy. A simple method is the leveraged buy-out, which allows the wealthy to purchase a real productive business for peanuts, and extract all profits for themselves. More complex methods like CDO’s (collateralized Debt obligations)“… may not be properly understood even by the most sophisticated investors,” according to financial wizard George Soros. Just before the global financial crisis, the value of financial derivatives (which represent different types of complex gambles) alone was 10 times the GDP of the planet. The worth of the financial sector was more than 50 times that of the real sector. This illustrates the increasing inequity that arose between the real productive sector and the financial sector which ultimately broke the backs of the working people. Many people ranging from religious scholars to financial wizards have correctly traced the roots of the global financial crisis to the limitless greed of capitalists. Removal of traditional restraints to this impulse have led to an extraordinary concentrations of wealth combined with extraordinary exploitation and injustice.

Related Article: The Vacuum Cleaner Effect.  opposing trickle down economics.

The current crisis in economic theory has deep historical roots. To understand it, we must go back to sixteenth century Europe. Continual warfare and bloodshed among different Christian sects led to the search for a secular basis for society. How can we achieve cooperation in a society composed of religious groups with different goals? Secular thinkers promoted freedom and wealth as the core values of a secular society. One could expect different groups with conflicting goals to agree to these as common goals for the society. Freedom and wealth would provide each group with the possibility and material means to pursue whatever goal they desired.

Considerable effort was put into promoting freedom and wealth as desirable collective goals, because these were in conflict with prevailing and dominant religious conceptions. Efforts of secular thinkers led to the transition from the Biblical maxim“the love of money is the root of all evil” to its opposite: “lack of money is the root of all evil”. Duty to society takes precedence over individual liberty in traditional society. Secular thinkers created a political theory which puts individual freedom above claims of the social order.These momentous changes were fundamental in creating the modern world.

Secular thinkers disagreed about effects of allowing individual freedom and pursuit of wealth on society.  The disagreement was about the nature of human beings. Rousseau felt that human beings were naturally good, and hence advocated anarchy – no rules or regulations of any kind were required. On the opposite extreme, Hobbes thought that human beings were naturally evil. Without strong government enforcement of extensive laws, life would be “nasty, brutish and short,” if people were allowed complete freedom to act as they desire. Locke took an intermediate position, finding society and government necessary, but with minimal rules acceptable by all.

The debate between Locke and Hobbes continues to this day in various guises.  The Hobbesian view was that extensive government control and regulation in all spheres of life is required for a stable social order. Followers of Locke argued that minimal control would suffice. A very important ingredient in the victory of minimal government views was the “invisible hand” argument of Adam Smith.  He argued that even though people are selfish, society would benefit by allowing them freedom to pursue self-interest. This provided a counter to the Hobbesian idea that selfish individuals would destroy society unless there was extensive government control.

Laissez-Faire economics is based on intellectual grounds prepared by Locke and Smith. It argues that one should allow maximum freedom to individuals in the economic sphere. We are witnessing today the outcomes of a social experiment spanning two centuries. Whereas traditional societies warn strongly against pursuit of pleasure and wealth, secular thinkers thought that these baser tendencies of humans could be harnessed for the betterment of society. As long as the institutional frameworks of politics, justice, and society were sound, allowing freedom for pursuit of wealth would enrich society.

All religions and cultural traditions have asked individuals to sacrifice selfish pleasures to fulfill social obligations, and frowned on pursuit of wealth.  The outcomes of this social experiment make clear why this is so.Contrary to the expectations of secular thinkers, individualistic pursuit of wealth and pleasure did not remain confined to the narrow domain of economic activities. When profits were permitted to trump compassion, the odious actions of Shylock the Jew became socially acceptable.Bankers threw millions out of their homes for nonpayment of interest after the financial crisis of 2008. According to a recent report on Fractured Families, “the fabric of family life has been stripped away.” The relation between greed and the global financial crisis will be discussed in the third and last part of this essay.

For a collection of writings presenting critiques of conventional economic theories, see: Guide to Economics.


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