What a lovely week it has been for capitalism! When the markets are going up, no one takes any notice of them and everyone, one way or another, benefits. Not just the CEOs, the shareholders but also the employees, the mortgage holders, those with insurance policies and the myriads who enjoy the fruits of the spending power that markets generate. When markets go down, there is a bafflement and people begin muttering about the morality of the market.
Similar is the situation with the prices of goods and services. When prices of things go up, we get strikes and bandhs (these do not bring prices down but are a bit of a superstition, like a rain dance). When prices go down, for instance with oil, no trade union rejoices or exhorts its members to put in extra work. Yet one man?s price fall is another?s income loss. One man?s stock market ruin is another?s opportunity. In capitalism, we all are part of an ongoing game in which we take our bets- on our mortgage interest rate not changing, our job being secure. When our bets go right, we attribute this to our cleverness. When they go wrong, we blame the system.
Even the most sophisticated market players do not like it when the bets go against them. This is for a simple reason. Markets invite herd behaviour. When everyone is telling you that the Sensex/Dow Jones/Footsie can only go up, you believe them. Somewhere at the back of your mind, you know that this particular bull run only started a few years ago, and no bull run lasts for ever. But there is a collective will to ignore such doubts. After a while, ?experts? tell you that this is a new paradigm or a new economy to which the old rules no longer apply. Business cycles, they say, are a thing of the past. But it all ends in tears. The old truth that Keynes wrote about in the superb Chapter 12 of General Theory is still valid. People prefer being wrong in a herd than being right in isolation. They have a collective amnesia when it suits them, and the longer the bull run lasts, the more the stock market resembles a casino.
This is the perspective of economists ranging from Marx and Keynes to Hayek and Minsky. Keynes alone was confident that he could fix capitalism so as to cure it of its cyclical tendencies, but he was over-optimistic. The eternal verities of Marx and Hayek, one from the Left and the other from the Right, are now coming home to roost. There is no cure for the cycle because the cycle is the healthy way capitalism works.
It was the finance theorists who eliminated history from economics and who preached efficient markets in which the the current price is all you need to know. Then came the Black-Scholes revolution and a proliferation of assets, which even the most sophisticated CEOs hardly understood. Soon they started to believe that securitisation removed all risks. Cheap credit was pumped by Alan Greenspan and abetted by George Bush?s double deficits and everyone thought the boom was permanent. Banks and financial institutions grew in size and their pay packets ballooned. There seemed to be no limits to the hubris of the Masters of the Universe.
But capitalism is rational, indeed super-rational, It teaches bitter lessons for those who indulge in herd behaviour, those who believe that markets afford free lunches of ever increasing prices and yields. It thrives on booms and busts. Indeed the only cure for extended bull runs that lead to shoals of bad investments is a drastic crisis . This alone can clean up the distortions and the mess, and re-establish sound valuations. Busts are the way in which capitalism survives to live another day and deliver on the promise of the next boom.
So, the dinosaurs?Lehman Brothers, Bear Stearns, Morgan Stanley, AIG?have been killed off. About time too. My only worry is that every rescue that does not impose severe costs on the shareholders and the CEOs only feeds moral hazard. There is no reason to be kind to any player in the financial markets. If they don?t know markets can go up as well as down, they should not be there. Retail depositors need protection, and for that you should have deposit insurance. But do not feed the bulls please. Let capitalism take its course.
?The author is a prominent economist and Labour peer