Willem Buiter, former Bank of England policymaker, professor at the London School of Economics and ex-chief economist of the European Bank for Reconstruction and Development, has set the cat among the pigeons at this year’s Jackson Hole economics symposium.
In a paper bearing the title “Central Banks and Financial Crises”, Buiter has charged the US Federal Reserve with messing up its response to the credit crisis, a mistaken focus on “core” as opposed to actual inflation and, most serious of all, of being captured by vested interests on Wall Street. That is by no means all: Buiter points out that the US central bank displays a marked reluctance to take the necessary steps to increase US savings, which will correct global imbalances and lead to a more rational financial system, as opposed to what he calls the current “Ponzi Finance” system.
Buiter says several economists were earlier arguing that the US consumer needs to consume less and save more, but now that he is at last doing that, they are now proposing “fiscal and monetary measures aimed at stopping the US consumer from doing what he ought to have been doing all along. This is a vivid example of St. Augustine’s: Rs.Lord, give me chastity and virtue, but do not give it yet.’ The fall in private consumption growth, and indeed in private consumption, should be welcomed, not fought.”
Indeed, he argues that at least part of the reason for the series of rate cuts by the US central bank was because it didn’t want stock prices to fall, a desire that reflected too close a proximity to Wall Street. In particular, he singles out the decision on 21 January 2008 to implement a rate cut of 75 basis points (one basis point is a hundredth of a percentage point) in the Fed funds rate at an unscheduled meeting and alleges that the sole purpose was to prop up the stock markets, which were jittery following a meltdown in Europe.
Buiter says that this was proof positive of the existence that the so-called “Greenspan put” (the belief that markets would always be supported by the Federal Reserve chairman) had turned into a “Bernanke put” or in fact a “Fed put” hypothesis. In fact, most of the arguments he uses in his Jackson Hole paper had already been made in an earlier paper titled “Lessons from the North Atlantic Financial Crisis” published last May.
In that paper he reiterated Hyman Minsky’s argument that, unlike in the real economy, there is no spontaneous, self-regulating mechanism in the financial economy. As a result, the financial sector expands very rapidly during booms and can contract even more sharply during a bust.
The solution, says Buiter, is to introduce limits on the ability of institutions to leverage up during boom times. He now argues for enhancing and extending the prudential norms that apply to banks to any institutions that are deemed “too-big-to-fail”.
Naturally, few economists at Jackson Hole agreed with Buiter’s radical analysis. What’s more interesting is his prediction of the future. He minces no words, pointing out that “the rest of the world is unlikely to continue to provide the US consumer (private or public) with credit on the terms of the past. The current financial crisis was made in the heartland of financial capitalism—on Wall Street, in the City of London, in Zurich and Frankfurt. It has revealed the deep rot in the heart of the financial system of the north Atlantic region. The old, lingering suspicion that self-regulation meant no regulation has been confirmed. Those who sold or tried to sell this corrupt financial system to the rest of the world have been exposed as frauds or fools. The rest of the world will not see the US (and the US dollar) or the UK (and sterling) or even the euro area and the euro as uniquely safe havens and as providers of uniquely safe and secure financial instruments. Risk premia for lending to the US and the UK are bound to increase significantly, even if there is no US dollar or sterling crisis. The position of New York and London as bankers to the world, and especially to the emerging markets, will be permanently impaired.” Small wonder that Buiter cut a lonely figure at the symposium.
Buiter’s concerns about the US central bank being in thrall to Wall Street seem strange—after all, it was the Wall Street banks that originally proposed the creation of the US Fed at the beginning of the 20th century. Also so far, there has been little evidence of his prediction about the rest of the world getting disenchanted with the US, and Asian central banks have continued to buy US securities. Perhaps Buiter has not understood the compulsions of the current system of financial capitalism and the leading role played by the US in it. Professors Sam Gindin and Leo Panitch have pointed out that no major state saw an opportunity in the crisis to challenge or undermine the American state. “Rather, their integration into global capitalism meant that they identified this crisis as their crisis as well. They effectively recognized the US central bank as the world’s central bank and cooperated with it in coordinating internationally repeated provision of liquidity to the banks. As in the previous instances of financial crises during the 1980s and 1990s, this reproduced and extended the American state’s leading role in managing global capitalism.”
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at email@example.com