The crucial factor in the crash of 2008 is that it was not due to some exogenous event or extraneous shock but by the system itself. That means that the prevailing paradigm, the efficient market hypothesis, basically has been proven wrong. As such, the task ahead is not to restart the economy and the financial system but to create a new system because the old system has broken down. Words: 1285
In further edited excerpts from the original article* Hu Shuli (http://english.caing.com/) goes on to say:
I met George Soros twice recently, once at a close-door symposium at the International Monetary Fund Annual Meeting in Istanbul and, a few months later, at Davos, where he hosted a luncheon at the Hotel Seehof at which he gave a brief speech [along these lines]:
The Fed Failed to Prevent Recent Bubbles
Understanding what we have recently learned we have to revise our idea about how financial markets operate and recognize and accept the responsibility that one has to prevent bubbles from getting out of hand. That’s a responsibility that Alan Greenspan and the regulators explicitly refuse to accept.
Alan Greenspan said if markets can’t recognize a bubble, how can you expect the regulators to do so? He spoke of irrational exuberance, but there is nothing irrational about bubbles. As a participant, when I recognize a bubble, I rush out and buy and that’s the rational thing to do. Therefore you can’t expect markets to correct their own excesses. There is a need to maintain stability, and the authorities have to accept that responsibility.
How Markets are Regulated Must be Re-examined
The Fed will then say, ‘We don’t have the instruments to do it,’ and they’re right because just to control the money supply, doesn’t control credit. So credit needs to be controlled separately from the money supply. There has to be a radical rethinking of how markets should be regulated.
What happened in the recent financial crisis was not an ordinary bubble, it was what I call a super bubble. It was actually composed of little bubbles that kept cropping up and it’s very interesting to see the relationship between the little bubbles and the big one.
The super bubble had a basic underlying trend which was the ever-increasing use of credit and leverage. In that there was a misconception – the efficient market hypothesis, the rational expectations theory – and a set of political beliefs that went with it, namely, that the markets should be deregulated. As such, we had one financial crisis after another and each time, when the system failed, the authorities intervened and saved the system.
The way they did it was merging away the failing institutions and, if necessary, deregulating further and increasing money supply – reinforcing the underlying trend of increasing use of credit and reinforcing this false belief of what I call market fundamentalism. As such, the individual crises that we have experienced in the last 75 years were successful tests of a false hypothesis. They have actually reinforced and made the bubble grow bigger. It started in the subprime crisis and then spread from one market to another at an alarming and amazing speed, and that’s how it eventually became too big to contain.
With the mistake of allowing Lehman to go bust, actually the system did break down, and within a week had to be put on artificial life support. That life support involved an implicit guarantee that no other institution would be allowed to fail. The spigot was turned on with tremendous injections of liquidity, and effectively the collapsing credit was replaced by the only source of credit that was still credible: the credit of the state.
The markets have stabilized, and the concerted international stimulus got the world economy going again. Now there is a great desire, especially for those financial institutions that survived and now have a stronger competitive position, to carry on as before. Surviving this crisis [has been] feted as another successful test where we can say we survived and we are here, and we want to return to normal.
Unfortunately, the way the rescue was organized has created a lot of political resentment because, instead of injecting the capital into the banks at the equity level, the banks were allowed to earn their way out of a hole. The repair is making great progress [given that they] have access to capital at zero, and you can invest it in, let’s say, 10-year government bonds at three and a half percent.
The fact that the burden has been carried by the taxpayers, and that most of the shareholders and bankers basically came through free and clear, and that the banks’ management treated this windfall profit as something that has been earned (and therefore people had to be rewarded for it with bonuses), all created a political storm. That has actually led to the Obama administration imposing taxes and talking about the reorganization of the system as necessary – but this development came too soon, however, because we are not out of the woods.
The operation of re-establishing equilibrium consists of two parts:
1. Re-inforcing the dis-equilibrium, the excesses. If a car is skidding, first you have to turn the wheel in the same direction as the skid, and then you can establish and gain control. So the first operation ([the bailout]) actually reinforces the imbalances that were caused by the bubble, and the process has not yet been completed.
2. Next, for political reasons, you have to start taxing the banks and regulating them more closely. From an economic point of view, however, this is coming too soon because even the first part of the maneuver has not been quite completed. To tax the banks when you are doing everything to help them to earn their way out of a hole is directly against the policies that you’re currently pursuing.
The task ahead (and I don’t think this is fully recognized) is not to restart the economy and the financial system but to create a new system because the old system has broken down.
Deregulation is Contagious
Globalization has been pursued very successfully on false premises: on the premise that markets don’t have to be regulated. Deregulation is very contagious, because once the United States and the UK led the way, every country had to follow, otherwise capital would flee that country and since you can’t exist without capital, you had to do the deregulation that was necessary to affect the capital. So deregulation and globalization was contagious.
Regulation is not Contagious
However, now that you realized that markets can’t be left without regulation, you need global regulation but that’s not contagious. On the contrary, the regulatory authority still remains with the state which is led by national interests and, as such, to forge a consensus will be extremely difficult.
This is the challenge and the current confusion is making it very difficult to get there.
*http://english.caing.com/2010-02-25/100120791.html (Ms. Hu Shuli, the former founding editor of Caijing Magazine, is one of the founders and editor-in-chief of Caixin Media. She also serves as the Dean of the School of Communication and Design at Sun Yat-Sen University.)
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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